Neil Sutton, head of corporate finance at PricewaterhouseCoopers (PwC), tells James Harris about how private equity firms are coping with miserly debt multiples. 

Neil Sutton, head of corporate finance at PricewaterhouseCoopers (PwC), tells James Harris about how private equity firms are coping with miserly debt multiples.

Led by KKR’s £955 million buy-out of Pets at Home, the recent announcement of three big buy-outs in the space of a week is a promising sign for the private equity community. However those toasting the return of debt-fuelled megadeals may be disappointed.

Neil Sutton, head of corporate finance at PricewaterhouseCoopers (PwC), says: ‘Even in the recent big deals, it’s still clear that debt multiples haven’t bounced back anywhere near where they were two years ago.’

In fact, debt markets may never return to their former glory. A recent survey by DLA Piper and Hawkpoint revealed that almost two-thirds (63 per cent) of banks and private equity firms think the syndication market for senior debt will never return to the height of the market in 2007.

As banks remain reluctant to lend, firms have been forced to put more equity into deals. Sutton adds: ‘Where previously you would expect a deal structure to be 60 per cent debt, that’s been flipped on its head.’
Faced with the prospect of putting more of their own money into buy-outs, firms have had to adapt: ‘Private equity houses can cope with smaller returns – they want to deploy capital, because otherwise what is their business model? If your reason for being is to buy businesses, then it’s better to deploy capital than not do anything.’

Sutton also points out that a lot of private equity firms are under pressure to invest their existing funds before they raise any new money, which is also driving activity.

This need to do deals has been propping up the market: ‘We thought there would be a permanent reduction in pricing as a consequence of the lack of debt, but actually firms are putting more money in and that has kept prices up. Exit multiple averages for private equity deals compared with a couple of years ago have barely changed.’

Alternative structures

A larger equity slice is not the only way that firms are coping with the debt drought. Some are taking a more radical approach to deals. Sutton says: ‘Historically private equity firms have focused on majority control, but firms are now more likely to acquire minority stakes in businesses.’

Taking minority stakes also opens up new opportunities to invest in companies that are not for sale. Sutton explains: ‘It’s favourable to the vendor who might not be sure if he wants to sell, but appreciates the benefit of greater commercialisation or an enhanced management team which a good private equity house can provide.’

For Sutton, the move away from highly leveraged deals is not necessarily a bad thing: ‘There is an argument that says debt multiples became overly high and it put pressure on good businesses that had strong levels of profit but were struggling to deal with a high debt burden.’