By Tessa Walsh
Dysfunctional financing markets are threatening new buyouts such as the 1.5 billion pounds ($2.3 billion) sale of British frozen food retailer Iceland, which saw first-round bids submitted this week, and France Telecom's 1.5-2 billion euro <FTE.PA> sale of Orange Switzerland.
"Big deals require capital markets confidence," an M&A advisory specialist said.
The European leveraged loan market is effectively closed until it clears a 7 billion euro backlog of deals and the high-yield bond market is closed to all but repeat issuers until secondary prices recover, which is not anticipated soon.
Buyout financing has reached an impasse as banks are unwilling to underwrite new deals and private equity firms are not willing to pay increased fees to secure financing.
"Banks' cost of capital has shot up dramatically. Even on club deals, fees and pricing will have to go up to make leveraged financing attractive for banks," said James Burns, director of acquisition finance at Lloyds Bank.
Private equity companies are exploring alternative financing routes, such as the mezzanine market as an alternative to high-yield bonds.
Some credit funds, such as Haymarket Financial LLP, are willing to underwrite loans, but are only interested in smaller mid-market deals of up to 200 million euros.
Financing problems could push prospective buyouts into the arms of trade buyers, but even strategic buyers are nervous about overpaying in the current environment.
The financing bottleneck may force a painful rethink for sellers on the prices that they expect to realize from sales. Vendor loans - where sellers offer a loan to cut the purchase price - could be back on the agenda.
"The price expectations of sellers needs to reflect the price of capital," a senior banker said.
Bankers said that Iceland Foods can support around 600 million pounds of debt on its current Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA), which would support a necessary BB/BB- rating.
Iceland's buyout would therefore require a high-yield bond and loan financing package, but the European high-yield bond market remains shut.
"The financing on Iceland will be challenging to put together, but not impossible should the high-yield market re-open soon. Banks are certainly cautious about taking on additional underwriting positions without a large amount of visibility on the sell-down," Burns said.
Banks working on Iceland's financing have approached mezzanine investors as an alternative to the high-yield bond market, as seen on the buyout of Swedish alarms maker Securitas Direct.
Orange Switzerland could be executed as a bank club loan, but it is proving increasingly difficult to find a group of banks with similar funding costs to agree terms and conditions.
"Orange Switzerland will not get done this year, or even the first quarter next year. We'll be waiting a while for big ticket deals," a partner at a debt advisory firm said.
($1 = 0.638 British Pounds)
(Additional reporting by Natalie Harrison and Isabell Witt; Editing by David Cowell)