While dealmaking slowed in 2023, private debt providers see reasons for optimism in 2024.
By Rahman Vahabzadeh and Steven Ruby, Managing Directors and Co-Heads of Originated Debt
Much has been made about the dropoff in deal activity across private equity in 2023. PitchBook documented that the value of new deals in Q3 was down by more than 50% from the market peak less than two years earlier. And the popular “hot take” among pundits is that M&A activity will stay muted until the Fed begins lowering rates -- a scenario many don’t expect to play out until the second half of 2024. So why, against this less-than-stellar backdrop, is there so much enthusiasm across private debt?
From the point of view of private debt providers, sponsors have not necessarily been sitting on their hands for the past 18 months. In fact, many have been incredibly active, even if the focus has shifted from acquiring new platforms and securing realizations to building out and growing assets already in their portfolios. Add-ons, as a proportion of all PE activity, represented 54% of dealflow through Q3 2023, according to Preqin.
To provide additional context, over a TTM period ending on November 1, 2023, Audax Private Debt had registered a roughly 55% increase in the total number of transactions completed year over year, and supported 94 different sponsors, a more than 80% increase. This surge was in part driven by add-on activity among PE firms.
Still, it begs the question, what does this mean for private debt and the alternatives space in 2024?
For private debt lenders, particularly those operating in the middle market, it bodes well. Many have capitalized on the environment to forge new relationships, as commercial banks remain sidelined by tighter regulatory frameworks and the BSL universe copes with ongoing volatility. At a time when sponsors need flexibility, private debt has distinguished itself with a range of capital solutions, while the emergence of jumbo-unitranche deals -- in some cases exceeding $5 billion in size -- underscores the depth of the private credit market today.
For sponsors, the current slowdown merely reflects their discipline amid a mismatch between buyer and seller expectations. It’s telling, for instance, that purchase price multiples have proven resilient, and in the first half of 2023 stood at 11.6x EBITDA, according to Refinitiv LPC, whose data also quantifies that equity cushions have increased considerably and now represent approximately 60% of the total capitalization. Sponsors are focused on quality and willing to commit more capital when they find it.
Unlike past slowdowns, this is not a liquidity-driven pause. Capital remains in abundance, and financial sponsors, themselves, are sitting on record levels of dry powder.
Ironically, the same discipline that is behind the slowdown in 2023 is what instills confidence that the broader M&A market will bounce back. Make no mistake, investors in private debt typically benefit from higher yields, and that has helped to stoke the enthusiasm for the asset class throughout 2023. But with elevated base rates, lenders have placed even greater emphasis on credit underwriting to better protect against cyclical swings, which supports lower default rates and higher recoveries in more volatile and uncertain market conditions.
This discipline amid the uncertainty of 2023 will position the market to pick up where it left off once buyers and sellers regain clarity around the economy. In the meantime, there’s plenty of add-on activity to stay active and put capital to work.