Fitch Ratings says in a new report that notwithstanding credit market developments since June, European leveraged buy-outs ("LBO") in H107 continued to be refinanced by sponsors at a similar pace as they were in 2006 and 2005 with the investment horizon averaging just 2.5 years. H107 recap activity indicated a marginal slowdown in the actual number of recycled deals compared to the same period in 2006 although H107 reached a new record in terms of volumes relating to dividend extraction and sales to another sponsor.

"It comes as no surprise that sponsors continued the frenzy of LBO recycling activity in H107, with EUR6.1 billion in dividends returned to them in an average of just 20 months," says Pablo Mazzini, Director at Fitch's Leveraged Finance team. "However, in Fitch's view, sponsors will most likely have to focus on operational performance over several years in order to de-leverage their assets to new, more conservative risk profiles. Given the anticipated reversion to more conservative leverage, structure and pricing levels in H207 and beyond, it is unlikely that sponsors will be able to seek dividend returns and exits via the credit markets again any time soon."

A representative sample from the recycled deals observed was used in a separate analysis comparing a range of assumptions used for the financial projections provided in recycled credits against the same assumptions used for their previous transactions. Findings showed that the level of refinancing risk is high in recycled LBOs, which demonstrated weighted-average total leverage of around 5x by year 3 under the management case. This means that sponsors may have to hold LBO assets for longer periods than they have been accustomed.

The number of dividend recaps taking place continued to grow, albeit at a slower pace in H107 (18% on a year-on-year basis) against 100% in 2005 and 42% in 2006. Recycled LBOs now account for 40% of the total number of LBO transactions rated by the agency, which is the highest proportion yet seen.

Fitch analysed 47 recapitalised LBO transactions in H107, of which 19 were dividend recaps and 28 underwent a sale to another sponsor. Of the 19 dividend recaps, sponsors were able to return on average 81% of their original funds invested (EUR6.1 billion) in an average tenure of 20 months compared to EUR5.3bn in 1H06.

Recycled LBOs were completed at an average 10x enterprise value ("EV")/EBITDA in H107 compared to 7.3x in their preceding buy-outs. This figure is above the LBO market average of 8.2x seen for new initial buyouts in H107 and 9.7x seen for recycled LBOs completed in 2006. Total financial leverage for dividend recaps increased in H107 to an average of 6.1x from 5.6x at the original buy-out date, and to 6.8x from 5.1x for SBO/TBOs. Fitch also notes the heightened 'buy and build' activity as sponsors have accumulated sizeable portfolios of European leveraged companies over the last few years. Potential upside from cost savings through mergers helped to fuel higher EV multiples than on a standalone basis. Recent examples can be seen in the bolt-on acquisition of SBS Broadcasting by ProsiebenSat1 and Tussauds by Merlin. Fitch notes, however, that a lower risk appetite in the leveraged credit market could lead to a decline in sponsor-led M&A in the short-term, at least for those deals which result in higher than average leverage levels.