Private Capital – Outlook for 2024

A subdued 2023 is in the rear-view mirror but the outlook for 2024 is positive – how do Private Capital players in Australia optimise their chances of deal success in 2024?

Optionality

On both sides of the M&A equation – Private Equity and Private Credit – embracing 'optionality' will be key to success in 2024.

The outlook for 2024 is positive as a subdued period of M&A activity since mid-2022 into 2023 means that there is a build of stalled / failed exits, deals approaching their scheduled exit horizon (and, as a result of both factors, LPs impatiently waiting for capital to be returned) and a build-up of capital for deployment (both on the private equity and private credit side) – a combination of factors that should create a positive M&A pipeline.

Setting to one side the on-going issue of sellers and buyers being able to bridge the 'valuation delta', what should private equity and private credit be focused on in respect of the potential financing opportunities in 2024?

Private Equity

1. Diversification of Funding Sources: early into 2024, it's clear that liquidity has re-entered the loan market with both the public high yield bond and syndicated loan markets offshore showing appetite for new deals, while Private Credit funds sit on record amounts of raised capital. Even investments banks (Deutsche Bank, JPMorgan, Citi, SocGen, Wells Fargo to name just a few) are launching their own on-balance sheet credit funds to further enhance market liquidity. Now is the time for Sponsors to flex their leverage to create competition between the public and private markets to drive higher leverage, lower pricing, greater capital structure flexibility and continued convergence between favourable high yield and loan market deal terms.  Already an established technique in the North American and European markets, this would be a relatively novel approach in the Australian market.
2. Dual Track (Exit / Refinancing) Processes: not all Portfolio Companies will represent an easy exit in 2024, as there will be a vintage of deals completed in the pre-Covid window of 2016-2020 where the (envisaged) trajectory of the business has been knocked off course by the various macros headwinds that have occurred (inflation, Covid, higher base rates, consumer behaviour).  In these cases, exits at an acceptable valuation may be challenging and a Sponsor may need to dual track a 're-setting' of the capital structure alongside any M&A process. Making use of the liquidity in the credit markets, and finding partners who can provide flexible capital solutions (including junior debt and/or quasi equity options to allow a partial refinancing of the existing capital structure alongside traditional senior secured refinancing options), will be key to executing an 'amend to extend' or refinancing (or combination of both) to 'bridge' their equity to an exit in a more favourable environment in the future.
3. Execution Certainty (P2Ps): one of the keys to any successful bid, particularly to the Board of a PLC target, is execution certainty.  More so when the offer requires financing.  Sponsors should be focused on ensuring that their financing is: fully underwritten (and documented) at launch; provides flexibility on changes (including an increase in the offer price) to the terms of the offer; and, most importantly, allows optionality regarding method of implementation (Offer vs Scheme).  

Private Credit

1. Cov-Lite:  for Private Credit funds wanting to offer an alternative to the TLB loan market, the ability to provide a cov-lite option will be required. Certainly, for Private Credit lenders wanting to be an offshore option for global Sponsors making acquisitions in Australia, they will need to provide an option that competes with / matches what those Sponsors can obtain in Northern Hemisphere markets. This will be a leap of faith for some but perhaps their focus ought to be on: (i) what is the right business for a cov-lite financing; and (ii) what does the lender want to ask for in return for the absence of a financial covenant?
2. Flexibility on Terms: in either M&A or refinancing opportunities, a key differentiating factor will be the ability to provide flexibility on terms.  In the current market climate (and to hedge against changes to the market climate in future), Sponsors will be focused on terms such as: (i) Portability (to provide the optionality of an exit without the requirement for new financing to be obtained by the incoming owner); (ii) PIK Toggle (to provide cashflow relief for a business wanting to preserve cash for uses other than debt service and/or encountering liquidity issues); and (iii) Cash Retention (to provide as much cash as possible to grow / turnaround business, Sponsors will want flexibility in relation to (or the absence of) requirements to sweep 'excess cash' and/or asset sale proceeds).  
3. Flexibility on Capital Solution: in 2024 the opportunities for Private Credit will be many and varied, and increasingly a premium will be attached to players who can provide 'flexible capital'. The ability to deploy across the capital structure and across the life cycle of deals will be valued by Sponsors as they seek creative solutions to new money financings and/or the re-balancing of existing capital structures. Can you provide junior capital? Can it be in the form of Holdco PIK and/or pref equity? Can you act as the 'anchor lender backstop' on an A to E exercise? If it is unsuccessful, can you lead a refinancing by providing a backstop for whatever existing debt cannot be refinanced in the market (via second lien or HoldCo PIK and/or pref equity and/or combination of options)? Can you help provide a bridge to a return to positive equity value? Can you backstop a liability management exercise?

In all the examples above, the key is whether: (on the Private Equity side) can you obtain or (on the Private Credit side) can you provide 'optionality'.