Eurazeo eyes less competitive lower-mid market for direct lending
Eurazeo’s private debt team expects a gradual recovery over the next 12 to 18 months, set to boost the European lower-mid cap direct lending segment.
In a report, managing partners François Lacoste and Eric Gallerne noted that the demand for lower-mid cap direct lending was increasing in Europe as banks continue to retrench and most funds move up in terms of deal size due to profitability metrics.
“The ECB is carefully calibrating its monetary policy to control inflation while avoiding any negative impact on economic growth,” they wrote.
“Although interest rates remain restrictive, the commencement of a new phase of global monetary easing in June 2024 is anticipated to foster a more favourable climate for investment and consumption. This shift should also have a positive effect on the cost of debt for borrowing companies.”
As the direct lending becomes more competitive, with large funds looking to deploy their dry powder, Eurazeo has found that there is less competition in the lower-mid market segment, giving players in this part of the spectrum an advantage.
The managers are looking to invest in market leading companies with strong growth fundamentals, backed by private equity funds. They also require 100 per cent covenanted documentation and board observer seats, they noted.
The pair highlighted that the leverage ratio in lower-mid market is 4.9 times, versus 5.6 times in upper-mid market and 6.7 times in large caps. Meanwhile, the annual default rate for lower-mid market has been 2.5 per cent, compared with 3.3 per cent for larger deals.
“Our conviction remains that the lower-mid cap segment offers the most attractive direct lending investment opportunities in terms of risk/reward relative value,” they said.
Read more: Eurazeo doubles private debt fundraising to €1.6bn in H1
It comes as no surprise that the market activity in the first half of the year was dominated by lower-mid-cap deals, representing around 75 per cent of transactions, according to Reorg data.
“Due to their market positioning, innovation and strong development potential, mid-market enterprises constitute the engine of the European economy,” they added. “These companies have strong client bases as a result of their partnerships with larger firms and are frequently incorporated into their supply chains.”
They prefer unitranche instruments due to several factors. They provide execution speed and certainty; are typically only done with a single lender, meaning the negotiation of terms and documentation is easier; can be extended to support add-on deals; and can have bullet structures without amortisation of the principal amount.
Read more: Eurazeo sees private debt AUM rise by 26pc to €8.8bn in Q3
Read more: Ares, Eurazeo and Goldman top European direct lender rankings
