The multibillion-dollar sale of Britain's biggest pharmacy chain was set to be among the UK's largest PE-backed take-privates of 2022—but it didn't happen. The deal for Boots had Apollo Global Management and Indian conglomerate Reliance Industries named as potential buyers.

In a statement, the parent company, Walgreens Boots Alliance, blamed the buyers' inability to raise financing amid volatile market conditions created by the war in Ukraine and monetary tightening from central banks.
 
It's a high-profile example of dealmakers struggling to secure financing from the public debt market, and it's unlikely to be an isolated case. Indeed, the failed deal could be an indication that the cheap money era, which fueled the most recent private markets renaissance, is over.

Private debt funds—particularly in Europe—will be keen to pick up the slack left by the traditional leveraged loan market, but doing so could involve taking greater risks.

In spite of the macroeconomic headwinds, PE funds are still eyeing take-private opportunities. These types of deals offer a great opportunity for fund managers sitting on a veritable mountain of dry powder. Valuations are attractive in public markets, as falling share prices create a bargain bucket of targets for well-capitalized investors.

Take-private activity got off to a slow start in 2022. PitchBook's Q1 2022 European PE Breakdown shows that in the first three months of the year, just three take-privates were completed—among them the buyouts of UK-based Universe Group and CloudCall, which closed in Q1—compared with the 45 deals worth a total of €44.8 billion (about $47 billion) that closed in 2021, a record year for both deal count and value.

The problem for would-be buyers isn't a lack of opportunities, but a lack of financing for leveraged deals available on attractive terms. As such, Europe's broadly syndicated loan and bond markets are being undercut by private debt funds, which, in the current environment, offer an attractive low-cost alternative to deal financing for big leveraged transactions.

"We've seen the market shutting down, especially the high-yield bond and term loan B market, but direct lending has been to some extent insulated," said Floris Hovingh, a London-based managing director with investment bank Perella Weinberg Partners. "Part of the reason is that it's locked in capital. It doesn't have any mark-to-market pricing."

According to Deloitte's Alternative Lender deal tracker, which follows private debt deal activity in Europe, there were 179 private debt deals in Q1. Leveraged buyouts were the motivation for 41% of this activity, while bolt-on M&A and refinancing were behind 27% and 16% of deals, respectively.

Not only does the deal pipeline remain robust, but deal sizes are getting bigger than ever. Earlier this year, The Access Group, which is backed by Hg and TA Associates, was the recipient of Europe's largest-ever unitranche facility. According to LCD, the company's £3.5 billion (about $4.2 billion) debt financing was composed of a £2.3 billion unitranche and a £1.2 billion acquisition tranche.

Like their private equity counterparts, private debt funds are sitting on a lot of dry powder. PitchBook data shows that private debt funds raised $191.2 billion in aggregate last year, the most since 2017, leaving these lenders with a lot of firepower to deploy in ever-larger deals.

But dependence on private debt comes with new risks. European private lenders, with a lot of dry powder to deploy and competing for bigger financings, are already leaning more on so-called cov-lite deals. This is essentially financing that comes with fewer demands on the borrower—i.e., debt covenants—and fewer protections for the lender.

What's more, cov-lite loans have persisted even though there is a growing demand for private debt because their use has become an industry standard, and is expected by borrowers.

"One has a lot more leverage as a direct lender over the terms, and the pricing is going to go up by 50 to 75 basis points, but in terms of cov-lite deals,  I think the dam has burst and too many funds are now willing to do it," Hovingh said.

And yet, this is arguably the worst time in the cycle for lenders to be giving up protections. If private debt funds are willing to surrender safeguards to meet a demand for alternative sources of acquisition financing, who else is going to be picking up the slack when those safeguards are needed?

Featured image by Joey Schaeffer/PitchBook News

This article originally appeared on PitchBook News