Amid the deal frenzy of the past few years, private equity firms could all but guarantee successful exits with no better way to market their portfolio companies than via formal auction processes.

Marketing materials showcasing optimistic EBITDA projections would be distributed to deal-hungry buyers, while hard bid deadlines created competitive tension that fed to the highest possible price.

But a major cool-down in the past six months has stung investor confidence, leading vendors to adapt the traditional auction formula towards more flexible sale processes, choosing to conduct bilateral negotiations from the onset or entering exclusive negotiations at an earlier stage, according to advisors, funds and lawyers speaking to this news service. 

“Auction dynamics have completely changed in the past year – I’m not even sure if people run them anymore,” Frédéric Stevenin, managing partner at PAI Partners, told this news service.

The move to less structured and more direct negotiations is gaining traction as vendors try to circumvent difficulties in raising debt financing and the reputational risk of exposing management teams to a protracted process that could end up hitting a dead end, said one due diligence provider and a lawyer.

“In 2021, the winning buyers were often not the best informed, but the last ones to get on the ship, without doing that much work and just putting in the biggest cheque,” said Stevenin. “People are more selective now – it’s about the probability of whether someone can deliver a fully financed offer.”

Why-lateral

Bilaterals, alongside terms that allow buyers to enter exclusivity earlier and for longer periods of time, lend to a higher confidence that a deal will complete with less reputational risk where it does not. Vendors can ensure that buyers are credible with financing already in place while buyers have more time for due diligence.

Each process coming to market feels a bit more exclusive than the last, said one German-based banker, with another adding that shy sponsors are using the downturn to say that they are not in the market but are having talks with people, ready to sell if an offer materialises.

Last November, Mergermarket reported that technology buyout specialist Hg was running an unstructured process for German supply chain software developer Transporeon, opting to engage a narrow pool of strategic buyers in informal conversations without hard deadlines. 

More recently, Nordic Capital has been holding focused conversations with sponsors, including TPG and Onex, to steer its exit from large-cap dental chain European Dental Group, as reported. The vendor collected indications of interest but has not held formal rounds of bids.

The method has also been used to get deals over the line, where the auction route failed. CEE-investor MidEuropa cut a deal for ophthalmology group Optegra by clinging onto talks with vendor H2 after formal bids failed to meet the price hurdle, allowing more time to discuss more preferable terms, as reported at the time.

This is not to say that auctions have stopped completely. 

One Benelux-based fund said that it is still a “valid tool” and it would continue to opt for the formal process when it had an exit planned. A sign that the traditional competitive process continues to be effective include recent deals such as food conglomerate IFF’s [NYSE: IFF] carve-out of Savory Solutions, where PAI fought out competition from Partners Group and CapVest, as well as OMERS’ exit from British calibration services group Trescal, ultimately won by EQT Infrastructure. 

Creative edge

This change comes as private equity investors face a new era of expensive and illiquid debt underwriting that has dented buyout activity in the last months. 

The second half of 2022 saw sponsor exits at their lowest point in a decade, plummeting 76% to EUR 24.9bn in the second half of 2022 from the period prior, according to Dealogic. Sponsor buyouts also dropped in the period, hitting their lowest value since 2013 at EUR 44.5bn, a fall of 57% from 2H21.

Meanwhile, the new trading environment is providing some sponsors with an edge: “Buyers are using the scarcity of financing as an asset,” said Allan Bertie, the co-head of European investment banking at Raymond James. “They can secure financing and try to pre-empt a process by delivering a reasonable price with high certainty of completion – thereby avoiding a competitive process.”

The cooldown of the red-hot auction market of the last year has also allowed some sponsors more time to find an angle ahead of any competitive processes. “We are being a lot more creative on deployment, which means we’re really getting into bilateral conversations with founders, families and financial owners of companies to look for places to invest,” said Peter Michel, a principal with Permira’s healthcare team. 

Adapt to conquer

The increase in bilateral talks is just part of the toolbox that sponsors are using to get deals done, pushed by the never-ending imperative of deployment and the pressure to return capital to LPs to help with re-ups on future funds. 

Other tactics gaining relevance include all-equity cheques with a view to line up the debt later, akin to KKR’s EUR 2.3bn buyout of French insurer April Group from CVC, which tapped lenders and banks for a EUR 950m hybrid debt package weeks after pre-empting a formal auction process, as reported. 

Any type of deal where the debt is portable is also being widely explored for creative deployment, said one lawyer. That includes GP-led secondaries and minority stake sales, as maintaining a majority shareholder means no change needed in debt, while still creating some liquidity. 

In December, British Columbia Investment Management and Preservation Capital Partners sold a 34% stake in British insurance broker BMS Group to Eurazeo for GBP 355m. 

Some funds are not shying away from keeping all options on the table. Healthcare specialist sponsor GHO is exploring both a minority stake sale and the transfer of its majority to either a special purpose vehicle or a new flagship fund for British pharma services company Sterling Pharma, as reported. 

This trend is expected to continue for as long as debt underwriting remains difficult, according to the sources.

Although it would be premature for anyone to sound the death knell of the private equity auction, as European dealmakers endure dark months of deal scarcity they may at least expect it to be in hibernation for some time.

by Rachel Lewis in London, with additional reporting from Harriet Matthews, Patrick Costello and Rupert Cocke