Friday 17 January 2020

US LBOs hit peak valuations, as margins compress

The best LBO vintages are when the market is trading at under 8x EBITDA and that EBITDA is depressed after an economic or sectoral downturn. 

Per S&P LCD news, last year saw the LBO bubble finance deals at 11.5x late cycle EBITDA, as margins fall. The senior loans, that are mostly CLO financed, dont go over 5-5.5x EBITDA, so the LBOs are having to put up 5-6x EBITDA in equity.

While the debt is paid on time, many of these deals will become equity zombies for the LPs, and just management fee cash cows of the LBO GPs. The GPs will drip feed more equity or do something else to keep the worse deals alive for as long as possible, after all it is not their money and as long as the deal is alive they get management fees and a free, leveraged option on any improvement in the company. 

Given the loans are floating rate, if the economies start to rebound later this year and the Fed is forced to start hiking late 2020 or 2021, it will put even more pressure on the deals. With debt at 5x EBITDA, if Libor rises 100bps, it uses up 5% of EBITDA in increased interest.

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