According to a recent Deloitte report, the global private debt market could reach USD1.4 trillion by 2023, thus making it the third largest alternative asset class (after hedge funds and private equity). This is an asset class that has really come of age over the last decade, as private debt managers stepped in on the back of the ’08 global crash to address some of the liquidity squeeze. And Europe in particular has substantially benefited, allowing leading players such as Tikehau Investment Management and Ardian to build substantial platform businesses to service the European middle-market.
According to a recent Deloitte report, the global private debt market could reach USD1.4 trillion by 2023, thus making it the third largest alternative asset class (after hedge funds and private equity). This is an asset class that has really come of age over the last decade, as private debt managers stepped in on the back of the ’08 global crash to address some of the liquidity squeeze. And Europe in particular has substantially benefited, allowing leading players such as Tikehau Capital and Ardian to build substantial platform businesses to service the European middle-market.
“In 2010 onwards, following various regulatory introductions such as AIFMD in Europe, the asset class became very structural,” says Mathieu Chabran, co-founder of Tikehau Capital. “It was to credit financing the equivalent of what private equity had become 20 years earlier.
“Over the next decade, I believe it will be here for the long haul, particularly when one looks at where global interest rates are, as people continue to look for yield alternatives.”
In 2018, Tikehau launched its most current private debt vehicle. Five years ago, the team were looking at 100 potential transactions in Europe and closing on 8 or 10 of them. But such has been the growth of the asset class that over the last 12 months, that has risen to over 400 potential transactions “and still we are closing on the same 8 to 10 per cent. By having a bigger Fund, you need to be able to look at a much wider opportunity set,” observes Chabran.
Private debt managers have to anticipate their growth, like any business. Tikehau is a USD25 billion investment manager and has remained highly selective in the way it allocates capital. “The Fund we are currently finishing capital deployment for, which we raised in 2018, has exactly the same credit status and credit metrics (total leverage, covenants etc.) as the fund we raised in 2015. We haven’t suffered any deterioration because we expanded the platform with a view to remaining highly selective on deal flow,” states Chabran.
This is a key point when one considers the risk investors face when allocating to private debt sponsors who do not necessarily have the size or experience of established players, and have entered the marketplace simply to chase money. This has led to fears over covenant-lite deals, as some managers have sought to put capital to work as quickly as possible.
“There are exceptions at the upper end of the market, but covenant-lite is really more of a factor in the large-cap market,” comments Mark Brenke, Head of Ardian Private Debt and Managing Director. “Covenant-lite is not something we personally see in the middle-market, which has a more attractive competitive dynamic than the large-cap market.”
Ardian just recently announced it had raised EUR3 billion from investors for its fourth generation private debt platform to provide financing to mid-market companies across Europe.
Established in 2005, the Ardian Private Debt team now has EUR7 billion assets under management with over 120 deals completed since inception.
The latest platform, which closed above its EUR2.5 billion target, builds on the success of Ardian’s third generation platform, which raised EUR2 billion in 2015, and will continue to provide flexible and tailor-made financing to companies across Europe.
“Our private debt strategy has remained highly consistent since we launched our first platform in 2005,” explains Brenke. “We try to balance a platform size that is as relevant in that market segment as possible while at the same time maintaining selectivity. A key long-term success driver in private debt, given the asymmetric return profile (ie capped upside, unlimited downside) and requirement to minimise losses is to get the balance right between deployment pressure and maintaining selectivity.”
The amount of private credit capital being raised in Europe is substantial but Chabran believes there is still a long way to go “as long as private credit managers effectively dedicate the appropriate resources to the origination platform they need”.
“Unlike private equity, you cannot be just operate out of London and think you can cover Europe from one office. Private debt is much more granular, more local, and this comes at a cost. As such, we may see some consolidation in the market when people realise the cost of running such a business is high.”
At Ardian, its latest platform has been broadened to include stretched senior debt to capture more of the buyout market and compete more effectively against bank lenders.
This is illustrative of how Europe’s private debt market continues to mature and evolve.
“Private debt as an asset class has matured over the last decade and as a result you are seeing investors increasingly being able to differentiate between different risk/reward profiles across the capital structure,” explains Brenke. “Eight or nine years ago, private debt moved into first lien debt via unitranche, and this remains the key activity today but we’ve now started to use stretched senior debt, which implies a lower risk profile relative to unitranche, and a slightly higher risk profile relative to senior debt.”
He confirms that within Europe, the vast majority of businesses Ardian backs (to finance LBOs) are PE-owned.
“Some 80 per cent of the businesses we’ve backed in our last couple of funds have been PE-owned, 20 per cent have been sponsor-less businesses. Our most active sectors over the last eight years have been B2B services, Healthcare…basically less cyclical, highly cash generative businesses are what we tend to favour,” states Brenke.
France remains the largest overweight position in Tikehau Capital’s current fund but it has diversified over the years to look at transactions in Italy, Spain, “where we’ve had some encouraging success”, as well as opportunistically in the Nordics and Benelux.
“Over the past 12 months we’ve been more active in the UK. Some of our competitors were overweight the UK and are rebalancing as a result of Brexit, which has created a supply/demand imbalance opportunity for us,” confirms Chabran.
When asked what risks might result from a rising rate environment over the coming years – given how cheaply businesses have been able to finance their operations – Brenke stresses that every deal presented to the investment committee will include scenarios to show how sensitive the capital structure would be to a rising rate environment.
“That will be reflected ultimately in what we think is an acceptable debt capacity for a business, over a seven-year period, which is typically the loan maturity we use.
“No-one has a crystal ball but we will run various scenarios based on the extensive due diligence our team has done. Given the fact that the vast majority of businesses we back are highly cash generative, the key risk is less attached to a rising base rate and more on top-line issues; what could the impact be on revenue or EBITDA? However, interest rate risk would still be a factor,” comments Brenke.
Tikehau Capital actually view a rising rate environment as a potentially compelling opportunity, in terms of secondary markets.
“We just hired Olga Kosters who sits in our New York office. When and if a rate rise happens, some investors might choose to reduce their exposure to private debt and that could create opportunities for us,” concludes Chabran.