ABFJ: Can you please comment on the state of the market and how the level of bank liquidity, for example, has impacted private equity firms and their portfolio companies?
TH: There is currently an array of sources of capital available for private equity firms to get their deals financed. And I think there are a lot of people who have come back to the market over the last year, so it hasn’t just happened overnight. But, compared to a year ago, there is a lot of CLO money available in addition to many of the regional lenders like PNC, SunTrust, etc. — they’re all back. And finally, I would say a lot of the European lenders are back in the market as well now that they’ve worked through some of their issues.
JK: I think a number of the traditional lenders (banks, FinCos, etc.) and, let’s call them non-traditional or newer lenders (BDCs, CLOs, etc.), have found or realized that the risk-adjusted returns for middle-market, private equity backed LBOs or recaps make those transactions a great place to invest their money. It suggests that credit risk may be a bit less than the smaller market opportunities, but it certainly, on a risk-adjusted basis, provides far superior returns compared to other alternative investments.
ABFJ: As a follow-up question, are there other aspects of current market liquidity that are causing private equity firms to behave in a manner that they wouldn’t have otherwise, say, a year or two ago?
TH: Another trend that we are seeing is many of our private equity clients are actually starting to sell the businesses in their portfolios now, so they’re sort of in “harvest mode.” That will enable them, once they sell a business — there’s strong demand currently with lots of capital available — to realize good returns and that, in turn, will allow them to raise their next fund. So, we see a lot more of our successful clients, people who have put good portfolios together, starting to sell right now.
ABFJ: So, the market is more conducive now than it has been for a while to sell — can you expand on that?
JK: I would agree with that. I think that we had a stampede of private equity shops trying to sell businesses to take advantage of the tax benefits in 2012, so it left the pipeline fairly dry heading into Q1 and Q2/13 as we’ve all seen — at least from CIT’s perspective. If you look at M&A activity over the first six months year-over-year, it’s down a meaningful percentage. I think, to Tom’s point, after six months of inactivity, a number of our better clients are positioning the businesses in their portfolios for sale.
TH: It makes sense, if you look at the calendar. These were companies that were bought five, six years ago — remember how the markets were in ’07, ’08 — there were a lot of deals that got done. So it’s time for them to be sold now.
ABFJ: Are you expecting the M&A market to pick up?
JK: In speaking to the investment bankers in and around the marketplace, they’re saying their pipelines are filling with new opportunities. That has not yet necessarily translated into new deal books hitting our desks or the private equity sponsor’s desk, but there certainly appears to be positive momentum.
ABFJ: What are some of the key industries that CIT Sponsor Finance and its clients are investing in?
JK: CIT focuses on verticals which encompass communication, media and entertainment; healthcare; energy, aerospace and defense; and commercial & industrial (C&I), which is our non-sector specific vertical that focuses on old economy manufacturing, distribution and service businesses. There are four sectors that have enjoyed the benefit of industry tailwinds that have created a lot of recent deal activity — the energy, aerospace, healthcare and business service sectors (which falls under the C&I category).
TH: I agree with Jeff particularly around the energy story. I was here for years and really never saw much energy interest by private equity firms. However, over the past six months, we’ve closed more than a half dozen energy deals with private equity firms originated out of our group. More broadly, our energy team has been very active; originating its own deals, but there’s been a ton of interest in sponsor-related energy activity, such as oil field services type business.
ABFJ: From a marketing perspective, can you provide some insights into how you target the private equity firms you want to do business with — what’s the basis for selection?
JK: First, let me say we spend a lot of time talking about that. There are a number of factors that we look at when doing an analysis, but essentially there are two factors at play: the size of the fund and the vertical crossover to CIT. The former translates into the size of the business they can buy because there is a direct correlation between the size of the equity check they can write and size of the company they can buy. More specifically, we tend to focus on the firms that are buying companies with $10 million to $50 million EBITDA — that fits into our sweet spot. Secondly, we look at firms that share expertise in as many of CIT’s verticals as possible with the thought process being that the greater the sector crossover with CIT the higher the probability of success with that firm.
TH: In addition to overlap, we also look for people who think about credit the same way we do.
We don’t want to work on deals that are “out there” on the risk spectrum. We want people who have had good track records for owning and managing their businesses; people that we’ve had good experience with in the past. So when you think about the number of private equity firms there are — we estimate roughly 2,400 — and start narrowing down and see where the overlap is, you come to a reasonable number of people in the space that you can get to know. At this point in our evolution we’re well past this exercise and much more into the active relationship building and management side of things.
ABFJ: Can you provide our readers with an example of how this synergy with CIT’s expertise in a particular vertical market led to a successful outcome?
TH: A deal that we did close on the aerospace side and also did with The Jordan Company was a company in the helicopter leasing business. CIT is very active in the helicopter finance world because of its aerospace expertise, but it’s also a business that The Jordan Company started a few years ago and has been actively growing. We continue to support that business and our industry expertise has been instrumental in facilitating that growth. That’s one of those connections where the equity firm is familiar with all the industries we’re involved with and, as a result, called us knowing we would be a good lender to help them support the business.
We’re also busy on the transportation side. Surprisingly, there have been a number of deals that we have been looking at with clients that are related to the rail industry. CIT is one of the largest lessors of railcars in the country. And because we have a very experienced rail group, we’re able to connect our private equity clients with those in our transportation group that have industry expertise in rail to help them evaluate an investment opportunity in that vertical. By contrast, a more traditional middle-market lender may not have the resident expertise that we have. It’s a good synergy, and we’re taking advantage of this.
ABFJ: In closing, please provide a commentary on the outlook for CIT Sponsor Finance — how you see the business unfolding for the remainder of this year.
TH: We always try to be helpful with our industry knowledge, so if there is anything else we can add that our industry teams can help with on the due diligence side, of course, we try to do that. But, most of our business is done with our relationship clients, people with whom we’ve done repeat, multiple business. With some clients, we’ve closed seven or eight deals over the past two years. So almost all of the new business that these firms have done, we’ve been involved with. We talk about how important relationships are when we’re out with clients. And we try to prove that by getting their deals done, which sometimes requires stretching a bit beyond the market. We have a lot going on so we’re really pleased with the year we’ve had already and it looks like the outlook is very strong for the remainder of the year for our business.
JK: I think the private equity community places a great deal of emphasis on certainty in a partner. It is one thing to say it, but quite another to actually do it, which we can prove through the sponsors with whom we work and the new ones with whom we are re-engaging. We are a lender that provides certainty to closure or certainty to allocation when it comes to committing to a club deal for an opportunity they are looking to buy. So having the resident vertical expertise, having the broad calling network throughout the private equity community and having the certainty and commitment to the middle market is what differentiates CIT in the sponsor finance space.
Thomas Hobbis is co-head and managing director of CIT Sponsor Finance. Prior to CIT, he was a director in the Acquisition Finance Group at ING Capital.
Jeffrey Kilrea is co-head and managing director of CIT Sponsor Finance. Prior to CIT, he was the co-president of the Corporate Finance Business for CapitalSource.