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Midmarket financings: Where the action is

by Max Frumes | Published September 9, 2011 at 2:31 PM

Large-cap dealmaking appears to have dropped off a cliff in the face of market volatility and economic uncertainties, but there's life on the smaller end of the spectrum.

Consider the recent flurry of financings. On Wednesday, Sept. 7, New York private equity firm Riverside Co. closed its secondary buyout of medical survey company Avatar International LLC with financing from Golub Capital of about $50 million. On the same day, Monroe Capital LLC said it provided a $22 million unitranche facility to freight hauling logistics company Links Global LLC to refinance existing debt and provide growth capital. Late Tuesday, First Atlantic Capital Ltd.-backed Resource Label Group LLC announced it tapped $53.5 million in secured senior credit facilities from lender NXT Capital to fund its add-on acquisition of Pamco Printed Tape & Label Co.

For now, midmarket lenders are saying their backlogs are at or above what they consider normal levels, and several acquisitions and refinancings have closed post-Labor Day. Industry practitioners indicate the broader middle market may continue to make up the bulk of buyout activity if the high-yield market doesn't return soon.

"At the lower end, bankers are still really busy, with banks that want to hold the paper hungry to put money to work," said Fran Beyers, a senior market analyst at Thomson Reuters LPC.

The high-yield and broadly syndicated loan markets began to tighten in early summer, and banks have turned hypercautious in light of weak economic reports following the U.S. debt downgrade and worries over Europe's debt crisis.

During the Great Recession, large-cap deals came crashing to a halt, while the middle market -- defined as companies with $50 million in Ebitda or less -- didn't immediately fall as much. The midmarket accounted for 48.5% of dollar volume in 2009, the highest percentage since 2001, according to Thomson Reuters LPC.

That had not been the case through August this year, with midmarket activity trailing off along with large caps. In July and August, there were twice as many midmarket deals as the third quarter of 2009 but only half as many as in the third quarter of 2010.

Alternate credit sources for syndicated buyouts -- including new and existing collateralized loan obligation pools and business development companies, or BDCs -- have all slowed. BDCs, publicly traded vehicles that buy into various parts of corporate debt structures, are all trading below their net asset values, which hampers their ability to lend. New CLOs, which staged a brief comeback in early summer, are now on hold again.

Often the middle market lags the large cap, depending on global economic factors and when these start to impact those companies. In terms of volume, the number of midmarket deals in 2009, for instance, ultimately fell from 123 in 2008 to 43 in 2009.

For now lenders say they're not seeing a material impact on profit from the perceived growth concerns in the U.S. economy.

However, credit markets are becoming increasingly bifurcated. Certain midmarket buyouts that would have relied on institutional investors to provide part of the capital for debt financing have been put on hold, sources said. Those deals that don't rely on large syndications -- such as club deals or single-loan deals -- are getting done.

"This is a market that favors reliable lenders with balance sheet muscle and sponsors who can line up commitments," Golub Capital CEO Lawrence Golub said.

Golub's firm holds a one-loan facility to fund Riverside's loan for Avatar. "Golub's ability to buy and hold the entire debt facility allowed us to have certainty to close this transaction," Karen Pajarillo, a partner at Riverside, said in a statement.

Riverside's acquisition allows seller Veronis Suhler Stevenson to exit at a return multiple of more than 4 times its investment in June 2008.

Golub said investors are nervous because of concerns over how to factor slow growth and a potential double-dip recession into pricing, according to Golub.

"It's a very weird market, completely weird," he added. "There's no capital markets desk in today's lending that knows at what interest rate a deal will clear."

In one of the few recent closings, the $175 million, seven-year covenant-lite loan backing New Mountain Capital LLC's investment in SNL Financial LC cleared at LIBOR plus 700 basis points, with a 1.5% LIBOR floor on Aug. 24, fully 100 basis points higher than anticipated.

Other deals coming to market should expect a similar bump in pricing, such as the $340 million in senior secured credit facilities backing Abry Partners LLC and Berkshire Partners LLC's buyout of Telx Group. Morgan Stanley and TD Securities Inc. launched a loan package for the deal Thursday, looking at a rate of LIBOR plus 600 to 625 basis points, with a 1.25% LIBOR floor for the term loan portion.

Smaller loans are somewhat less volatile because they are not as widely syndicated. Investors in midmarket loans also have a different profile, according to professionals. Midmarket lenders are "buy-and-hold investors, not traders," Churchill Capital's Randy Schwimmer noted in his latest newsletter, On The Left.

"There will be enough deals trying to get done by the end of the year to keep things busy, but the decisive factor will be how many of them close," Golub said.

Golub said his firm has 80 deals in the pipeline. Monroe Capital LLC of Chicago has 20. Each firm has four deals remaining in documentation. Two of Monroe's are for acquisitions, according to Monroe Capital CEO Ted Koenig.

Koenig said company performance will tell the story; other factors such as interest rates and availability of capital will be favorable for buyout activity.

"The conditions are ripe for a good run here in the market. All the building blocks are there," Koenig said. "Performance is going to be the wildcard. With decent performance, you'll have buyout activity. The good news for us is there are a lot of companies that are performing well."

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Tags: financing | Golub Capital | middle market | Riverside Co.

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