Market sentiment improving but dealflow likely to remain bifurcated – Baird

"There is no escaping that [M&A] activity will be significantly down this year, on a net basis," says Baird managing director Vinay Ghai. "But the mood in the market, and activity levels, have already been positively shifting in the space of just two months." 

Ghai says mid-market deals have been able to complete since April where the target is resilient to or benefiting from the coronavirus crisis, particularly in the areas of healthcare, software and IT services – although of the 160 buyouts to complete in Europe in Q2 2020, only 50 were valued at above €50m. Such deals have included EQT's acquisition of Germany-based hygiene and cleaning products manufacturer Schülke from its parent company Air Liquide, or Gilde's acquisition of healthcare software company Corilus from AAC Capital in Belgium. 

Baird managing director Paul Bail says the outlook is also changing when it comes to the debt market. "Syndication is moving again, as evidenced by the ThyssenKrupp Elevator syndication, which is a clear indication that the public debt markets are open across leveraged loans and high yield. The Covid-19 overhang is being sorted out, and new and larger deals can now come to market." 

"Talking to banks, there is now appetite to underwrite again," says Bail. Club deals have been scarce during the crisis, with the notable exception of the provision of a $1.3bn loan in KKR's acquisition of Coty's professional beauty and hair business, Wella. 

"Unitranche has remained available, and borrowers have unsurprisingly been hungry for the product. But it will remain for the high-profile, resilient businesses," Bail says, highlighting deals including Hayfin's provision of 5x EBITDA unitranche leverage of €100m for Avista Capital Partners' acquisition of Vision Healthcare. "Nevertheless, leverage has generally remained at 0.5-1x below pre-Covid-19 levels, with unitranche pricing 50-150bps above, although more recent deals are seeing competition driving these differentials down."

In spite of some encouraging signs, it is clear that the problems caused by the slowing M&A market are far from over for many GPs, who will be keen to commit record levels of dry powder.

Says Ghai: "Covid-19 will knock a year off the usual five-year investment cycle for PE. There will be a huge pressure to deploy, with fewer assets to go around. So we are seeing a significant reallocation of sector priorities for PE firms. But it will be tough for them to find the right dealflow, and consequently pricing for quality assets will also stay pretty high for the time being." 

Nevertheless, Ghai does not expect this pressure to prompt standard buyout funds to seek a potential upside from riskier businesses in the near term. "We are not seeing a lot of movement yet on appetite for riskier assets, as opposed to focusing on the 'ultra-resilient' bracket. Most PE houses are not set up to do riskier or more complex deals, and riskier assets will continue to be very difficult to finance, further limiting PE appetite. That said, pressure to deploy could easily change this dynamic next year." 

"At the same time, we have seen an awful lot of money being raised for special situation vehicles," Bail says. "So we could see a large divergence between high-quality and distressed dealflow – with not much in between – for some time." 

One such fundraise was Sherpa Special Situations III, a Spanish vehicle that held a final close on €120m in June. Nordic private equity firm CapMan also plans to launch its first special situations fund after the summer, to focus on turnarounds.

On the M&A outlook for H2 2020, Ghai remains cautious. "Most deals inked during Q2 have been for assets well-known to potential buyers, and with processes often initiated pre-outbreak. Processes that may come up in Q3 and Q4 will be less well-known to the buy-side, which will impact how they play out. Processes are likely to become more tailored and nuanced. This could benefit PE, which tends to be nimbler and more deliverable on tight deadlines; corporates will be slower out of the gate for M&A." 

Both managing directors say the crisis is also likely to reinforce the pan-Europeanisation of private equity, which has been gaining momentum in the past five years in particular. "More funds are moving their focus, opening offices on the ground and shifting capital," Ghai says.

According to figures from Unquote Data, compiled for the Unquote's 2020 Annual Buyout Review, France saw the largest market share in Europe for the first time in 2019, recording 236 buyouts, compared with the UK's 231. 

In Q2 2020, France once again accounted for the largest share of the buyout market (20%), with DACH, the UK and Benelux narrowly behind (17%).

"The fact that many European countries have opened up their economies faster than the UK may well play a role in the continuing pan-Europeanisation process," Ghai says. 

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