Investors’ growing hunger for yield has helped support record-breaking levels of primary issuance across the European leveraged finance space, which has already surpassed the previous record peak of €260 billion for 2017 as a whole and is on course to top €300 billion for the calendar year.
In total, more than 6,000 deals worth over €450 billion have been signed worldwide across the PE universe year-to-date, according to The Economist. Notably, U.K. firms have been the most popular targets, with over 350 changing hands, the most since recordkeeping began in the 1980s.
This upswing of PE activity has claimed household U.K. names like Asda, Morrison’s, the Automobile Association (AA), John Laing, LV and Ultra Electronics since the start of the pandemic. The purchase of Morrison’s by CD&R for £7.1 billion was the biggest transaction since KKR bought Boots in 2007.
The roots of this activity can be traced back to the Brexit referendum of 2016, which delivered the biggest U.K. political upset in decades and sent shockwaves through financial markets. Amid the political upheaval, equity valuations for U.K. companies underperformed peers, aided by a decline in the pound, driven by deterioration in the terms of trade and a challenging fiscal/monetary backdrop.
Sensing an opportunity given the U.K.’s laissez-faire takeover laws, PE desks added headcount in the U.K. Strangely enough, it would be the supermarket sector, a largely listed quasi-oligopoly of four large operators with control of 70% of the market, that would prove to be of greatest interest. These businesses are highly attractive to private equity firms given their stable end-market demand, predictable cashflows and large freehold property estates that sponsors rely on to raise and service debt.
With spreads having compressed this year, it has been economic for sponsors to maximize leverage and fund deals in the leveraged finance space. (For example, there’s strong demand from CLOs underwriting growth in single-B rated secured debt.) The step-up in U.K.-related bond and loan issuance has put pressure on existing GBP assets, however. For example, the spread on the 10-year GBP bonds of some of the more liquid UK names have underperformed their euro equivalent by up to 20 bps since the end of August, while the anticipated syndication of the Morrison’s deal, has seen U.K. retailers flounder in recent days.
We expect that, as U.K. deal volumes normalize through 2022 and technical pressures abate, valuations will likely recover, making this potentially an attractive time to be overweight U.K. assets in the leveraged finance space.