Too big to sell? Getting creative to get LPs their pay day
2024 was, perhaps optimistically, slated to be the year of the exit and we did see a number of sale processes launch and sign, particularly in the second half of the year. However, despite the buzz around certain mega-assets in highly sought after sectors, the anticipated queue of bidders didn't always materialise.
A key issue? Some of these mega-assets command a cheque size that few PE sponsors operating in this market can write alone (now, much less in a few years time when the exit cycle comes full circle if projected growth stories play out) and listed markets remained an unpredictable alternative.
With this in mind and the liquidity clock continuing to tick, we expect to see more sponsors get creative on how they deliver a pay day to their LPs.
There have been some recent high profile examples of sponsors sitting on large assets divesting (meaningful) minority stakes to take some money off the table and then rolling their remaining stake into a younger vintage fund or a continuation fund or exploring listing pathways. Superannuation funds and other institutional co-investors are natural partners here.
It's also increasingly clear that there is – at long last – a thawing of the IPO market, with sponsors more open to the avenue following the (early) success of Guzman Y Gomez (as well as the Sigma / Chemist Warehouse reverse takeover). There are reports TPG Capital is market testing a potential float of Greencross (having earlier gone down the sell down path and explored a trade sale) and Bain Capital’s proposed IPO of Virgin Australia is again back on the agenda (itself post a sell down to a strategic partner). Others will follow.
In a market where scale can sometimes become an impediment, dealmakers with large assets will be thinking well beyond the traditional auction playbook to realise returns this year.
The emergence of structured products
There has been a marked increase in PE sponsors using complex structured products and derivatives over the past couple of years, and we expect this trend to accelerate in 2025. The most common uses are:
- Leverage: embedding leverage into investment vehicles through the use of margin loans, total return swaps and similar products to facilitate a return of capital, liquidity or increased yield.
- Access: facilitating exposure to an asset where the sponsor is unable to directly acquire the exposure because the sponsor's investment vehicle does not hold a necessary regulatory authorisation or the asset is simply unavailable. In these circumstances, the sponsor may acquire a synthetic exposure to the asset through a total return swap or similar instrument issued by a counterparty (typically a financial institution) that can hold the asset.
This trend is not unique to PE. Private credit funds are also increasingly using these types of products (as well as loan-on-loan, credit net asset value, collateralised loan obligation and asset-backed securities structures) to achieve similar outcomes. These types of products are being deployed on an asset-by-asset basis or, in some cases, on a portfolio wide basis.
While this market is somewhat nascent in Australia, as it continues to evolve, it will gives buy-side and sell-side participants leeway to develop bespoke products to meet the applicable commercial parameters, without being overly constrained by following a 'market standard' approach.
As sponsors and financial institutions increasingly compete for the same assets, we have also noticed a trend toward financial institutions building out their sell-side capabilities in relation to these types of products and thereby keeping a foothold in the market. Interestingly, we are also seeing some private credit sponsors offering these products to their competitors' credit funds.
The general growth trajectory of Australia's private capital markets has caught the attention of the Australian Prudential Regulatory Authority, which has flagged that "the changing dynamics between public and private markets" as one of the top items on its 2025 agenda and, on 26 February 2025, released a discussion paper on the topic. Watch this space.
Private credit rolls on
In 2024, Australia saw a significant increase in transactions funded by private credit solutions. Most of the largest deals funded by private credit were not new acquisitions, but included refinancings and debt upsizes where private credit facilitated PE sponsors' buy and build ownership strategies. Private credit also supported many notable leveraged buy-outs in 2024, such as Carlyle's acquisition of Waste Services Group and the APM take-private.
Australia is increasingly seen as an attractive market by global sponsors, a trend expected to continue in 2025. With the rise in activity from global sponsors, more aggressive documentation terms from the US and European markets are appearing in Australian private credit transactions. Due to the competitive nature of the private credit landscape in Australia, global credit funds are leaning into 'strong' credits and accepting offshore document technology to secure larger allocations.
Private capital is expected to continue proving its flexibility as a liquidity solution in 2025. In 2024, it provided a lifeline to underperforming businesses, particularly in the construction and consumer sectors, through subordinated debt instruments where all interest is capitalised. Mezzanine debt was also used by businesses as a means to access supplementary capital. As base rates remain high, businesses in distressed sectors are likely to increasingly turn to these forms of financing solutions offered by private credit funds.
2025 has the potential to be a strong year for private capital deployment. With several large cap sale processes slated for 2024 not proceeding amidst the on-going build-up of aging assets in sponsors' portfolios over the past few years, the pressure for exits has only increased. Many deals in the pipeline suitable for private credit solutions reportedly already have multiple interested parties. Private credit is an attractive option in competitive auction processes with many private credit players in Australia having the capacity to take most, if not all, of the capital stack culminating in a more streamlined bid process for sponsors.
Pockets of distressed opportunities
Consumer inflation, wage inflation and the high cost of interest payments continue to increase the cost of business for Australian companies, putting pressure on profit margins and cash flows. These economic challenges are impacting business valuations and the ability of companies to raise capital and refinance their existing facilities with traditional lenders. Recently published ASIC insolvency data also shows an upward trend in insolvency appointments.
In this landscape, and notwithstanding the recent interest rate cut, we expect to see significant distressed investment opportunities for distressed credit and special situation funds, private credit providers and PE firms seeking to purchase discounted debt positions. We anticipate that the construction, engineering, infrastructure industries, healthcare, and hospitality and retail industries, will be particularly vulnerable to higher input costs and wage inflation. Alternative lenders and private capital providers, which can offer greater structuring flexibility, will be an important source of capital for distressed companies. We are also starting to see larger and more high-profile distressed companies and expect this trend to continue in 2025.
Distressed investments are likely to take the form of both M&A transactions and acquisitions utilising statutory insolvency processes. Increasingly, we are seeing creative structures that use statutory insolvency processes to create value that would not otherwise exist in a solvent transaction. For example, loan-to-own strategies, which traditionally have been used by PE as a restructuring technique, are increasingly being used by well-advised corporate purchasers to obtain a potential competitive advantage in an insolvent sale process. The APA Group's strategic purchase of senior secured bank debt to successfully acquire the Basslink interconnector from Basslink's administrators is one recent example, and we are engaged on a number of similar transactions in the mining and mining resources sectors.
We are also seeing insolvency processes used to compromise liabilities that would otherwise be entirely value destructive. The recent LOGOS acquisition of the Qenos Group is an example. Qenos was a failing petrochemical business with significant liabilities and the administration process allowed LOGOS to cleanse those liabilities and obtain commercial land of significant value.