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Deal Selection Is Key to Private Debt Resilience
“This is a very good environment to deploy capital,” says Doug Cannaliato, who in his role as a Senior Managing Director at Antares Capital focuses on deploying senior-secured financing to support private equity-backed transactions. And despite some headwinds, Cannaliato is optimistic about private debt – at least in the way Antares approaches it, which Institutional Investor discovered in a sit-down with Cannaliato, is purpose built to stand up to challenges.
It’s a challenging environment for institutional investors, many of whom have flocked to private markets in recent years. Looking forward, do you expect private debt to remain as attractive to investors?
Cannaliato: I do, and in the context of what we do at Antares, I’m even more optimistic. We’re only in senior secured loans, 100% of our loans have sponsors behind them, and leverage is coming down while pricing is going up. Most of the volume we have comes from our large portfolio, so even when M&A volume is down – as it is now – we still have strong volume and support from our existing borrowers. These are companies we know well and have experience working with – we know the management teams, and that makes us comfortable putting additional money to work in this lower leverage, higher economics environment.
Where do you see the opportunities emerging in 2023?
Cannaliato: On a new deal basis, our pipeline is down a fair bit from very strong levels a year ago. But again, a lot of our volume comes from our existing borrowers doing add-on acquisitions. When these borrowers buy smaller companies, they can do so for lower multiples. Even in the current environment, purchasing add-on acquisitions at lower multiples than the initial borrower makes a lot of sense.
We’ve seen moderate new deal activity, and today it’s typically focused on deals below $3 billion, and frequently even less than $1 billion. Transactions of $3 billion plus are happening less frequently for the time being.
So, the new deal market hasn’t run dry, as some might suggest?
Cannaliato: That’s not the case at all. Our deal volume has been moderate throughout 2022, and I expect that to be the case in 2023. Part of what supports true new deal volume – as opposed to add-ons – is the amount of private equity capital on the sidelines. Even as our leverage multiples have come down, purchase price multiples haven’t come down that much. Granted, we have seen some transactions not trade in this environment – but for the most part, transactions are getting done and purchase multiples have only reduced modestly. As a debt investor, that means we have more equity support behind us in these transactions.
Any sense of when we might see an uptick in volume?
Cannaliato: If you look at the public stock markets of late, you might think M&A could start to come back tomorrow. I don’t think that’s going to be the case, but hopefully in the second half of 2023 we’ll see volume picking up. And in the first half we expect to see that steady moderate volume.
Many investors are bracing for a rocky 2023. If that’s the case, do you feel your portfolio is well positioned and resilient?
Cannaliato: We’re in sectors that are less impacted by cyclicality, including healthcare, financial services, business services, high-end technology, and software. We do that for a reason, and we haven’t seen many cracks in our portfolio in the current environment. Many companies we lend to are market leaders and have been successful in passing through price increases. At some point, that becomes harder to do, but we believe we’ve built a diverse and defensive portfolio of businesses with strong value propositions that should be able to hold up during market cycles.
We’ll likely continue to see some pressure on the portfolio, but it’s held up well and we’ve pressure tested it for future rate hikes. Default rates continue to be low. Even simpler conversations about smaller amendments are at a very reasonable level.
What form will that pressure take?
Cannaliato: Interest rates, lingering supply chain issues, and the ability to continue to pass on price increases are current headwinds. We derive a lot of confidence from the fact that 100% of our portfolio is sponsor backed. We prefer solutions when everyone in the capital stack can contribute to solving a challenge. That’s what happened during the covid pandemic and in prior cycles, and we believe it will continue to happen if there are pockets of trouble in the portfolio or with individual companies. As the lead on most of our transactions we are usually an early participant in the dialogue – and our sponsors, who are a type of annuity customer, expect that early dialogue and for everyone involved to step up.
It must help to be selective in choosing deals.
Cannaliato: There are some players in the market more focused on chasing yield, but if a business or structure is outside of our credit box we’re not going to chase it by putting additional economics on it. Not to say other strategies aren’t valid. It’s just not what we do.
What have you seen and what are your expectations in terms of defaults?
Cannaliato: The default rate for the Morningstar LSTA US Leveraged Loan Index could rise to 2.5% by Sep 2023 as a base case vs. 0.7% today according to a report published on Dec. 7 by S&P Global Ratings. That’s a reasonable assumption on a go-forward basis. From an Antares perspective, our companies are market leaders with strong value propositions that we believe can weather storms – so we’re optimistic. If you look back over history, even a 2% default rate is a reasonable place to be.
What does a “classic” Antares deal look like?
Cannaliato: The deals in our sweet spot tend to be in less cyclical industries with good secular growth prospects. They’re companies that are leaders in their space with strong value propositions to their customers and strong private equity operational and capital support. For example, on the software or high-tech side, we’re looking for companies that are quite sticky. With a tremendous amount of equity behind our debt, we’re still able to enter at reasonable debt multiples, and often we’re writing a sizable check because those are investments that we find attractive from a senior debt standpoint.
Do you anticipate any shift in valuations after years of investors saying they are often way too high?
Cannaliato: I’m surprised we haven’t seen more of the purchase price multiples coming down. That said, I think the businesses that are trading today are very high quality. Private equity firms that have capital to put to work look at those businesses and see assets they want to own for maybe up to five years – and believe they can still find ways to grow and add value over that period. I do expect that purchase price multiples will come down marginally, but not as much as debt multiples, and that will provide more cushion than we’ve had in recent times.