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MUMBAI : The market for leveraged buy-out financing by private equity firms has seen a significant shift in recent months, as PE firms are making larger acquisitions, with valuations rising steadily since last year. In an interaction with Mint, Shantanu Sahai, managing director and head of debt at Nomura spoke about how the Japanese investment bank is ramping up its debt business on the back of rising deals by PE firms in India and the new products that are emerging in this space. PE firms use debt in addition to equity capital to make acquisitions as it reduces their overall cost of capital, thus improving the potential return that they can make, while also allowing them to make larger acquisitions. Edited excerpts:

What kind of growth has Nomura’s debt business witnessed in recent years?

In March 2016, when we had just started our debt business, we managed just one deal with a balance sheet deployment in single-digit millions of dollars and revenues of a few thousands. But the business has grown significantly in the last five years and pre-covid in March 2020 our balance sheet had swelled by 100x and revenues by 125x. Today, 8 out of every 10 deals executed in the Indian market by global tier-I financial sponsors have Nomura as part of them. We are also among the three-four shops on the Street that offer the full spectrum of debt financing and risk management products to the financial sponsors universe. Our balance sheet deployment and revenue CAGR over the last five years is more than 100%. And despite this aggressive growth, the total aggregate cumulative delinquency, which is either delays or defaults over this entire period, is nil.

We have closed six deals in the last one quarter, and we have a pipeline of close to 17 more deals for this year. We have had significant repayments in the first and second quarters of the last financial year – primarily on account of the equity market volatility which triggered repayments in our margin loan portfolio which we have subsequently redeployed across multiple deals completed in Q1 of FY21-22. We plan to double our balance sheet in the next 12-18 months.

Do you see buy-out and M&A activity increasing sharply going ahead?

We expect that in the next 12-18 months we will probably see an unprecedented level of M&A activity on account of both financial sponsors deploying more capital into the country as well as consolidation theme across sectors and therefore financing activity by private equity funds in India across not just the old favorite sectors but also a broadening or a widening of the sectors. So, for instance, we see that traditionally private equity activity has stayed within healthcare, consumer financial services but now we are also seeing industrials, auto components, renewable energy, and some degree of annuity projects as well.

PE firms are raising larger amounts of debt to fund their buyouts lately. What’s driving this trend?

Between November and March, there was a lot of demand for acquisition financing in the unlisted space, because while listed valuations had run up significantly, valuation expectations on the unlisted side were still reasonable. But after March that changed and even on the unlisted side, promoters started seeking valuation multiples comparable to listed peers. So a PE fund which was earlier paying say 20 times Ebitda valuation, was now having to pay 25 times or 30 times. At 20 times Ebitda, they were borrowing 4-5 turns of that from banks at 6.5-8.5% which would bring down their weighted average cost of capital, but with acquisition multiples rising, these 4-5 turns have become less meaningful for funds and their borrowing ask has gone up commensurately to 6-7 turns of Ebitda while paying higher yields.

How has this shift impacted the acquisition financing market?

This change has resulted in a significant shift in the leverage market. Earlier the acquisition financing was underwritten by banks like us and placed into the commercial bank space in Taiwan, EMEA, Australian and Southeast Asian banks etc. Now, these higher levels of leverage coupled with additional flexibilities sought by sponsors such as incremental covenant headroom’s, cash flow deferrals, higher operating leverage headroom’s and higher subordination render commercial banks unable or unwilling to subscribe to this paper per their own risk/investment policies.

Hence, the entire selling universe of such types of loans has shifted from commercial banks to credit funds and other institutional investor participants. This is an institutionalization of the acquisition and leveraged finance space that has happened in a widespread way in the last three to four months. This shift has happened for the first time in India. This is a new product on the block called unitranche and currently very few banks are servicing this need of the market. There are only two to three banks in the market, including Nomura, which are offering these unitranche loans to the clients. This is due to a bank’s ability to offer this product as a function of the bank’s ability to underwrite and subsequently distribute this risk to the non-bank institutional investor universe.

So while on the face of it this looks like a product, which is just a little bit different from the usual acquisition and leveraged finance product in the sense that maybe the leverage is a little more, covenants are looser, yields are higher, tenor is longer etc, but the consequence of that is a product which is not capable of being sold in the commercial bank space. So it needs a whole new investor base to sell it.

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