In down year, private credit greases M&A wheels
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Non-bank lenders continue to dominate the market for mergers and acquisition (M&A) financing and other funding tools, stepping in where Wall Street remains on the sidelines.
Why it matters: The soaring private credit market is filling a banking gap created by inflation and interest rates spikes, adding both risk and reward for those seeking deals in a down market.
Driving the news: U.S. M&A value dropped 6% to $1.36 trillion in 2023 as economic uncertainty and choppy markets weighed on buyers.
Yes, but: For those who did pursue deals, private credit was there to help.
- Morgan Stanley said in a report that the private credit market grew to $1.4 trillion this year, a 60% jump from 2020.
- Term sheets that used to have JPMorgan, Goldman Sachs, and Morgan Stanley listed on the paper, now name Ares, Blue Owl, and HPS as the lenders.
Zoom out: Early this year, Western Digital announced a deal led by Apollo Global Management. But it wasn't the kind of leveraged buyout Apollo is known for, sealed with an equity check and a slug of bank loans.
- Instead, Apollo and hedge fund Elliott Management purchased $900 million of convertible preferred shares of the data storage company.
- "[Preferreds] are a way to fill a financing gap in an environment where inflationary worries creates a tight funding market," says Tim Donahue, Lazard's Global Head of Capital Solutions. "The alternative is unsecured or subordinated debt, but those markets aren't ideal at the moment."
- Lazard was among the advisers on the Western Digital deal.
Be smart: Preferred shares, convertible notes, and unitranche loans (a blend of senior and subordinated debt) are all forms of private credit agreements sloshing around corporate finance at the moment.
- These options are traditionally more expensive for a company than a traditional loan, and can be more risky.
- "I think the narrative if you're an investor is, 'we really like this company but they're not willing to sell to a sponsor. So we want to give them capital, facilitate what they're doing, and have a seat at the table," Donahue says.
Zoom in: Private credit fund raising is booming, as PE firms and other investors seek to capture the spike in demand, and take part in the direct lending trend.
- Warburg Pincus raised more than $2 billion for a capital solutions fund in September. KKR and Carlyle Group are raising similar funds in Europe.
Flashback: In May, Baxter International agreed to sell its biopharma solutions business to two private equity firms for $4.25 billion.
- A group of private credit lenders led by Ares Management financed the deal, which included a $1.6 billion unitranche loan.
- "More traditional sources of capital, i.e. the syndicated loan market or the high-yield bond market, have been less active. So that's been a great opportunity for us," says Jana Markowicz, Ares' COO of U.S. direct lending.
What we're watching: Recent economic data and market activity shows that Wall Street banks are returning to portions of the lending market. But it remains to be seen whether that return, bolstered by direct lending, is able to push M&A volumes higher.
