News & Analysis

Buying a public company on the cheap has been a popular strategy for private equity firms in the past two years, driven by the growth in buyout fund sizes and the availability of cheap debt.

Now, with those favorable market conditions fading, the frenzy is winding down.

Buyout firms spent big on take-private deals in 2022, with a record $195.1 billion deployed to acquire 47 publicly traded companies in the US, according to PitchBook data. Take-privates accounted for about 19% of all US PE deals by value last year, the highest since 2016.

The high level of deal value shed light on PE firms' increased appetite for mammoth deals—the average size of public-to-private transactions stands at $4.15 billion. There were a slew of deals valued at or above $10 billion, including acquisitions of Citrix Systems, Anaplan, Zendesk and Nielsen.  

However, some dealmakers think that trend will quickly lose momentum as a suite of challenges—from a harsher fundraising environment to difficulties obtaining debt financing for large buyouts—stifle investors' enthusiasm for such transactions.

A majority of publicly listed tech companies are still trading at relatively attractive levels, but there aren't ample opportunities that PE firms can act on, according to Jason Greenberg, Jefferies' co-head of global investment banking for technology, media and telecom.

PE funds are usually limited on how large of a deal they can make, based on a percentage of the fund size. To participate above that limit, firms sometimes partner with other GPs or involve their limited partners through co-investments.

However, following the decline in public equity values last year, many LPs are seeking to decrease their exposure. LPs that found themselves over-allocated to private equity are less apt to participate in co-investments now, Greenberg said.

"We are seeing a reduction in the number of funds targeting deals that require substantial co-investment," he said. "This puts a practical cap on the size of deals GPs can do as [they are] limited to writing a check only using capital committed to the primary funds."

Despite the recent recovery in public markets, multiples for public tech companies are still lower than they have been in a long time, with many of these companies trading at less than half of their three-year highs, Greenberg said. But the number of PE firms that can pull off a deal above $10 billion remains slim, he added.

Hard bargains for debt financing

The syndicated loan market slowed in 2022 after a brisk start to the year. Banks transitioned into risk-off mode and retreated from funding outsized buyouts, driven by higher market volatility.

Private credit funds with ample dry powder stepped in and became an increasingly important source of debt funding for these deals. But that market also has slowed as risk climbs. Lately, private credit lenders reduced the loan sizes they are willing to hold and require stricter leverage requirements with higher risk premiums.

"There are a lot of undigested loans that are sitting on the banks' balance sheet, so there's not a lot of appetite [from banks] to finance those big go-private transactions," said Markus Bolsinger, the co-head of law firm Dechert's private equity unit. "But even for the smaller ones, I think it's harder to get debt financing."

Of the 47 PE-led take-privates last year, only 36%, or 17 deals, were financed with new debt, PitchBook data shows. In 2021, more than half of such deals raised additional debt.

At the same time, uncertainty about future interest rates has added a layer of complexity to executing a buyout deal, making it harder to estimate whether a target company will be able to pay back its debt, Bolsinger said.

The constrained availability of debt and elevated borrowing costs pushed PE firms to cap the amount of leverage they are willing to place on a deal.

Right now, any debt structure that comes with a rating in the highly speculative territory may not get sufficient investor demand, Greenberg said. Even if the company was able to take on these lowest-rated loans, the higher cost of the debt package would make that deal unattractive to sponsors, he said.

Against that backdrop, some investors have turned their noses up at take-privates altogether.

PE executives now rank take-privates as their least favorite type of deal under consideration, according to a survey conducted at the beginning of Q3 2022 by Dechert and financial news and data provider MergerMarket.

"People don't really transact well in an uncertain market," Bolsinger said. "They need certainty on what the interest rate environment is and what the inflation environment is. Right now, getting a deal financed is not easy, and the terms are not attractive."

Take-private pivots

Some firms have retained interest in the hunt for deal targets in the public market.

Earlier this month, Vista Equity Partners said it would acquire insurtech company Duck Creek Technologies at a $2.6 billion valuation. Duck Creek hit a market cap of around $5 billion when it went public in 2020, but the take-private deal was still rich for current shareholders, who stand to earn a 46% premium on the stock price.

Thoma Bravo is nearing a deal to purchase Canada's Magnet Forensics for C$1.8 billion (about $1.35 billion), a 15% premium over its price before the deal was announced.

"I think the vast majority of take-private activity will occur in the deal size between $500 million and $3 billion, as sponsors of the larger funds—$15 billion to $25 billion in size—can write the equity check directly out of their fund," Greenberg said.

PE firms still pursuing take-privates will increasingly look to midsized public companies, an area that has taken a back seat during the surge in mega-buyouts, according to PitchBook's Q3 2022 US PE Middle Market Report. These smaller deal sizes will be easier for firms to swallow as funding becomes harder to secure.

The IPO boom in 2020 and 2021 created a large swath of midsized public companies whose market capitalization now sits below $1 billion. PE buyers could set their sights on these newly minted middle-market public companies at a time when large buyouts are becoming harder to finance, according to the report.

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