European leveraged loans face dry spell as LBO pipeline shrinks

By Claire Ruckin

LONDON (Reuters) - Europe's leveraged loan market is in for a dry spell as the pipeline for new buyout financings has reduced dramatically, partly due to sponsors facing increased competition from corporate buyers to buy assets.

January kicked off to a busy start with a number of leveraged loans syndicated. There are still some deals in the market, including Austrian packaging group Constantia and UK safety and survival equipment maker Survitec, but after that the outlook looks bleak for the next couple of months.

"The pipeline is looking thin. This is a lumpy business," a loan banker said.

There is still M&A activity with a number of deals in the auction pipeline. However, sponsors eager to put cash to work are facing stiff competition from newly confident corporate buyers that are paying up for credits and winning auction processes, cutting off much needed supply to Europe's leveraged loan market.

There is significant financing available to back private equity bids as banks and investors are eager to lend, often on aggressive multiples. Despite high leverage being available, knockout bids from trade buyers mean sponsors have to contribute substantial equity to compete which dilutes returns, Fitch Ratings said in a recent report.

Irish building supplies group CRH (CRH.I) agreed a 6.5 billion euro (5 billion pound) acquisition of assets that rivals Lafarge (LAFP.PA) and Holcim (HOLN.VX) needed to sell ahead of their planned merger, outbidding a private equity consortium led by Blackstone (BX.N). CRH was in a stronger position than the buyout firms because it could integrate the assets into its own business and therefore offer a higher price.

"CRH expects a return on equity in the high-teen percentages in 2016, with 90 million euros in annual synergies, whereas private equity sponsors typically aim for returns over 20 percent. The high targeted returns are due to the demands of investors and the cost of payouts to management to secure their support," Fitch said in the report.

Large trade acquisitions could spark smaller opportunities for sponsors if trade buyers seek to divest some of the assets they acquired.

CRH will not keep sole control of all the assets it agreed to buy and is in talks with private equity firm KKR (KKR.N) to partner on investing in the UK assets. Bankers are lining up just over 1 billion pounds ($1.53 billion) of debt financing to back KKR's investment in the UK assets.

"There are some more deals happening and M&A breeds M&A but there is a persistent threat from trade and that will not go away," the banker said.

AUCTION PIPELINE

The pipeline of potential European sales is building, which will see sponsors and trade buyers going head-to-head in the bidding process.

Even if sponsors or leveraged corporates win some auctions, there is an inevitable delay as the M&A processes take time, bankers said.

"It will get a bit quieter in Europe's leveraged loan market after the current raft of deals pass. More M&A is coming through although it is around two months down the line before that hits our market," a second loan banker said.

Some of the larger potential sales include the Swedish power grid of state-controlled Finnish utility Fortum (FUM1V.HE), which could fetch around 6 billion euros; a 4 billion euro sale of oil company Total's (TOTF.PA) rubber and insulation unit Hutchinson; a 2 billion euro sale of German motorway service station group Tank & Rast; Refresco Gerber which could fetch 1.5 billion euros; and French building materials group Saint-Gobain's (SGOB.PA) potential 3 billion euro sale of its European glass bottle maker Verallia.

(Editing by Christopher Mangham)