State of the Middle Market M&A Private Equity Financing January 2012 DEBT ADVISORY GROUP The Capital Markets Desk for the Middle Market
Results From Lincoln s 2012 Financing Market Survey Do you believe senior leverage will be... Do you believe total leverage will be... 100.0% 80.0% 1.9% 0.0% 34.6% 25.8% 11.8% 100.0% 80.0% 0.0% 0.0% 29.1% 19.4% 9.4% 60.0% 54.1% 60.0% 55.3% 40.0% 63.5% 74.2% 40.0% 70.9% 80.6% 20.0% 34.1% 20.0% 35.3% 0.0% 2010 2011 2012 0.0% 2010 2011 2012 Higher No Change Lower Higher No Change Lower Do you believe senior pricing will be... 100.0% Do you believe mezzanine/2 nd lien pricing will be... 100.0% 80.0% 54.5% 50.0% 37.6% 80.0% 36.4% 38.7% 24.7% 60.0% 60.0% 40.0% 20.0% 0.0% 35.5% 36.4% 14.5% 9.1% 2010 2011 2012 35.3% 27.1% 40.0% 20.0% 0.0% 56.4% 53.2% 7.2% 8.1% 2010 2011 2012 51.8% 23.5% Higher No Change Lower Higher No Change Lower 2012 Lincoln International LLC 1
Stabilizing Liquidity Conditions in U.S. Debt Market Observations Volume of CLO Issuances ($Bn) Since the volatility experienced in summer 2011, liquidity has stabilized within the leveraged loan market: CLO volume increased in 2H 2011 with issuances of $9.6 billion, bringing the year-end total to $12.4 billion Prime and high yield fund flows improved from significant outflows experienced in Q3 2011 With their capital base stabilizing, lenders are well-positioned to put more capital to work As debt markets calm, conditions are increasingly favorable for sponsor-backed M&A $12.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 $12.4 $4.1 $4.1 $4.5 $2.6 $1.2 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 2011 Monthly Loan Prime Fund Flows ($Bn) $5.0 $3.0 Survey Result: 2012 LBO/Control Transactions Will Be Unchanged, 24% $1.0 -$1.0 -$3.0 -$5.0 Lower, 6% Higher, 70% -$7.0 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Source: Lincoln International 2012 Financing Market Survey 2012 Lincoln International LLC 2
Multiple Other Indicators Support Favorable Lending Conditions Loans Outstanding Under Default (Percent of Principal) Average Bid and Ask of Flow Name Leveraged Loans 12.0% 10.0% 10.8% 100 98 8.0% 6.0% 4.0% 5.0% 96 94 92 90 2.0% 0.0% 0.2% 88 86 Bid Ask Market Dynamics Flex Statistics Record low default levels indicate stronger company fundamentals and appropriate capital structures As a result, lenders are currently predisposed to deploy capital The secondary market has improved, making primary issuances more attractive Flex statistics through the fourth quarter, an indication of recent market sentiment, demonstrate improved market conditions 50% 40% 30% 20% 10% 0% Flex Down Flex Up 2012 Lincoln International LLC 3
Despite Improved Conditions, Middle Market Volume Declined Middle Market Leveraged Loan Volume ($Bn) Middle Market LBO Transaction and Leverage Multiples $5.0 $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5 $0.0 $4.9 $4.7 $3.1 $3.0 $1.8 4Q10 1Q11 2Q11 3Q11 4Q11 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 9.3x 8.9x 8.4x 8.0x 6.5x 4.2x 4.0x 4.6x 4.6x 4.8x 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 Leverage Equity Other 45% Equity Observations While most market participants expected a robust fourth quarter, loan volume declined Although no definitive reason for the volume decline has been cited, factors contributing to the softness in middle market leveraged loan volumes likely include: Low growth expectations Lack of visibility towards future earnings Continued global macroeconomic uncertainty European debt crisis Increase in M&A activity from strategic buyers With fewer opportunities to deploy capital, buyers competed on price although lenders continued to require significant equity 2012 Lincoln International LLC 4
Shifting Landscape of Active Lenders Transforms Capital Structures Investor Base Institutional Lenders Lender Activity in the Primary Market (% Volume; excl. banks) 350 300 250 257 237 Insurance Companies, 2.9% Finance Companies, 6.9% 2006 200 150 100 Prime-rate Funds, 12.9% CLOs, 61.2% 50 0 2006 2007 2008 2009 2010 2011 Hedge Funds, 17.0% Market Dynamics Although the number of active lenders has remained largely unchanged, the composition of capital providers has changed dramatically from 2006 to 2011 The current lender base consists of a larger percentage of BDCs, alternative investment funds and relative value players whose investors have higher return requirements Insurance Companies, 6.7% Finance Companies, 5.0% 2011 CLOs, 41.5% As a result, more alternative structures (i.e. unitranche) are being placed in the market to satisfy the need for higher yields Since many CLOs are nearing the end of their reinvestment periods and new CLO formation activity is very limited in the middle market, the prevalence of non-traditional financing structures is expected to continue Prime-rate Funds, 17.9% Hedge Funds, 29.0% 2012 Lincoln International LLC 5
and Return Expectations, Leading to Higher Yields CLO Investment Capacity ($Bn) BDC Dividend Yields $180.0 $160.0 $140.0 $120.0 $100.0 $80.0 $60.0 $40.0 $20.0 $0.0 2011 2012 2013 2014 2015 10% 9% 8% 7% 6% 5% 4% 8.3% Reinvesment Capacity Ending Reinv. Period Source: Thomson Reuters Source: BB&T Capital Markets Market Dynamics The current universe of CLOs will essentially be out of capital by 2014 Assuming $20-25 billion of annual CLO formation, investment capacity will still dramatically decline from current levels The capital previously provided by CLOs (which, historically, had low funding costs and benefited from significant leverage) now largely comes from BDCs, hedge funds and other relative value players The pricing and leverage levels attained by CLOs generally are not available to these alternative investors, who typically have hurdle rates of at least 8% to 10% As a result of these return expectations, even though lenders are well-positioned to fund middle market deals and the current demand for capital is relatively low, pricing levels are not expected to decline significantly If deal flow picks up substantially, pricing may increase even further ` 2012 Lincoln International LLC 6
Alternative Structures Currently Prevalent in the Middle Market Traditional Structures Alternative Structures Secured Revolver Club Term Loan B Senior Term Loan Unitranche Pro Rata Traditional Sub Debt Unitranche First-out / Last-out Second Lien Term Loan Rate Only Sub Debt Private High Yield Unsecured 2012 Lincoln International LLC 7
Overview of U.S. Middle Market Pricing and Terms Lincoln s View on Pricing and Terms Borrowers with less than $10 - $15mm EBITDA Borrowers with at least $10 - $15mm EBITDA Pricing Multiples Pricing Multiples Asset Based Senior L + 200 300 LIBOR Floor: none n/a L + 175 250 LIBOR Floor: none n/a Cash Flow Senior L + 550 650 LIBOR Floor: 100-150 2.00x 3.00x EBITDA L + 500 600 LIBOR Floor: 100-150 3.00x 3.50x EBITDA Unitranche L + 800 900 LIBOR Floor: 200 L + 800 900 LIBOR Floor: 200 2 nd Lien Loans Unlikely 3.50x 4.50x EBITDA L + 900 1100 LIBOR Floor: 200 4.00x 5.00x EBITDA Sub Debt Cash of 11% - 13% PIK of 2% - 4% All-in of 14% - 16% Cash of 11% - 13% PIK of 1% - 3% All-in of 13% - 15% Equity n/a 40% n/a 35% - 40% 2012 Lincoln International LLC 8
Percent development Volatile European Macroeconomic Environment with Development 10yr Government Bonds 2011 (% yield) Volatility in Global Equity Markets Ensues (% change) 8.0% 10% 6.0% 4.0% 2.0% 7.09 % 5.63 % 3.35 % 1.86 % 0% (10%) (20%) 6..05% -4.88% -19.48% -23.67% 0.0% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Germany Italy Spain France Source: Bloomberg Note: Greece 10yr government bond yield currently at 35.15% (30%) Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Eurostoxx Financial Dow Jones FTSE 100 Euro Stoxx 50 Source: Bloomberg Spreads of Corporate Bonds vs. 5yr Swap (bps) Commentary 800 AA- A BBB+ BBB BBB- BB 700 600 500 400 300 200 100 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Source: Bloomberg BB: 477 bps BBB-: 302 bps After a swift recovery in the first half of 2011, markets declined since July 2011 and traded with high volatility with the financial sector showing the worst performance with a decline of 22.11% In light of the sovereign crisis, yields for 10yr government bonds have increased significantly over the past 6 months This led to increasing yields in the secondary market and to a shutdown of the high yield bond market in 2H 2011 Polkomtel (Euro 990 million) and Orange Switzerland (CHF 550 million) are the first attempts in 2012 to reopen high yield bond market 2012 Lincoln International LLC 9
Change in percent...european Financial Sector Heavily Impacted Created... Share Price Development of Selected Banks (% change) CDS Spreads of Selected European Banks (bps) 30% 20% 10% 0% Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12-10% -20% -30% -40% -50% -60% -70% -80% Deutsche Bank Unicredit Soc Gen BNP Commerzbank Santander -34% -78% -64% -43% -74% -32% 700 600 500 400 300 200 100 0 555 367 364 284 307 208 215 240 188 119 142 154 108 97 Barclays BNP Commerzbank Deutsche Santander SocGen Unicredit Bank Jan-11 Jan-12 Source: Bloomberg Source: Bloomberg Required Capital of Selected Banks on New Stress Test ( Bn) Commentary 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 15.3 8 5.3 3.2 2.5 2.1 1.5 1.4 0.4 CDS spreads of European banks have increased significantly, reflecting the exposure to sovereigns and the existing weak capital structure Banks are forced to increase their Tier 1 capital ratio to 9% until mid 2012 in order to strengthen their capital base Consequently, banks have to de-risk balance sheets by reducing lending, selling assets or attempting capital increases Recent attempt of Unicredit to raise Euro 7.5 billion of capital was only possible with massive discount of 43% to actual share price Source: EBA Note: Capital requirement based on the market valuation of the respective bond portfolio and a core capital ratio of 9%; numbers rounded to one decimal 2012 Lincoln International LLC 10
USD / EUR Spread 3m Euribor / EONIA...Weakening Trust Amongst Banks and Repricing of Risk ECB Overnight Deposits by Banks ( Bn) 500 452.0 412.0 400 300 270.0 299.0 200 198.0 145.0 100 91.0 0 July August September October November December January Source: ECB Spread 3-month Euribor vs. EONIA (bps) 1.8 1.6 High: 1.56 1.4 1.2 Current: 0.93 1.0 0.8 0.6 0.4 0.2 0.0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Bloomberg EUR / USD Development Commentary 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 Jan-10 Jan-11 Jan-12 Source: Bloomberg The increase in spread between EURIBOR / EONIA and overnight deposits of banks with ECB show lack of trust amongst European banks This results in little to zero underwriting appetite of banks, making larger financings very difficult to structure Euro / USD exchange rate dropped to 1.27 in January 2012 marking a 2 year low to the US dollar 2012 Lincoln International LLC 11
Snapshot of European Leverage Market European Leverage Finance Volume ( Bn) Current LBO Pricing Trends 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 Leveraged Loans Mezzanine HY Bonds Senior A E+425bps 475bps / 6 yrs Senior B E+475bps 525bps / 7 yrs Senior C n.a. Second lien n.a. High Yield Bond c.7% (BB+) to 12% (CCC) Mezzanine E+ 1,100bps 1,200bps incl. warrants Fees 400bps 500bps OIDs 3% 5% (where applicable) Average equity contribution in current deals is 50% Deals are structured on a club deal basis with a take and hold of Euro 25 million, as no underwritings are available Annual Pro Forma Debt / EBITDA Ratio of LBOs Outlook 2012 7.0x First Lien/EBITDA Second Lien/EBITDA Other Debt/EBITDA 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 We expect the European sovereign crisis to continue at least until 1H 2012 with banks expected to further reduce lending activity European corporates with US exposure will increasingly try to raise financing in US markets to access larger liquidity Total leverage multiples range from 3.5x for cyclical businesses to 4.5x for businesses with healthcare assets Large LBOs (above c Euro 250 million) will remain difficult to finance due to lack of underwriting appetite 2012 Lincoln International LLC 12
Bringing Efficiency to the Middle Market Lincoln International U.S. Advised on Over $1 Billion of Financings in 2011 Atlas Holdings has refinanced its portfolio company $45,000,000 Senior Credit Facilities $48,000,000 Junior Capital KPS Capital Partners has acquired Revolving Credit Facilities Unitranche Term Loan Industrial Opportunity Partners has acquired $16,000,000 Senior Credit Facility $9,000,000 Junior Capital Exponent Private Equity has financed the U.S. subsidiary of its portfolio company Senior Credit Facility Private Equity Group has acquired Two Portfolio Companies $65,000,000 Senior Credit Facilities KPS Capital Partners has recapitalized its portfolio company $20,000,000 Revolving Credit Facilities $113,000,000 Unitranche Term Loan Atlas Holdings has refinanced its portfolio company Industrial Opportunity Partners has refinanced its portfolio company Shareholders have refinanced Gryphon Investors has recapitalized its portfolio company Graham Partners has acquired Platinum Equity has refinanced its portfolio company $50,000,000 Senior Credit Facility $27,000,000 Senior Credit Facilities $7,500,000 Junior Capital $44,500,000 Senior Credit Facilities $28,000,000 Second Lien Facilities $155,000,000 Senior Secured Credit Facilities Senior Credit Facilities Junior Capital $40,000,000 Junior Capital Lincoln International U.K. 2011 Capital Raise Assignments A portfolio company of Vitruvian Partners has raised acquisition financing 39,000,000 Senior Debt 10,000,000 Accordion 4,000,000 Revolving Credit Facility Undisclosed Covenant restructuring 48,000,000 Senior Debt 14,000,000 Mezzanine 14,000,000 Revolving Credit Facility H.I.G. Capital has refinanced 32,000,000 Senior Debt 13,000,000 Acquisition Facility 22,500,000 Accordion 10,000,000 Overdraft + Guarantee H.I.G. Capital has refinanced $16,000,000 Senior Debt $4,000,000 Revolving Credit Facility Vitruvian Partners has acquired the company 65,000,000 Senior Debt 4,000,000 Revolving Credit Facility 2012 Lincoln International LLC 13
Lincoln s Debt Advisory Group adds the following value to each assignment: Robust process ensures best available pricing and terms Strong relationships with over 300 capital sources throughout the world Multiple capital structure alternatives are generated which enhances certainty of closing Provides clients with transparency and control over financing process Lincoln s independence assures there is no conflict of interest Maximum leverage of time and resources for management team and financial sponsor DEBT ADVISORY GROUP Lincoln International U.S. DAG Team International DAG Heads Ron Kahn Managing Director (312) 580-6280 rkahn@lincolni.com Robert Horak Managing Director (312) 580-2804 rhorak@lincolni.com Christine Tiseo Director (312) 580-6287 ctiseo@lincolni.com Natalie Marjancik Vice President (312) 506-2729 nmarjancik@lincolni.com Dominik Spanier Managing Director - Germany +49 (69) 97105-428 D.Spanier@lincolninternational.de David Graham Associate (312) 506-2757 dgraham@lincolni.com Ryan Deegan Associate (312) 506-2754 rdeegan@lincolni.com Dylan Lyons Analyst (312) 506-2760 dlyons@lincolni.com Justin Malina Analyst (312) 506-2785 jmalina@lincolni.com Jonathan Broome Managing Director U.K. +44 (0) 20 7632 5238 jbroome@lincolni.com