Let’s ride. Exercise equipment concern Peloton Interactive, Inc. managed to sell a $750 million, five-year first lien term loan with ease yesterday, as investor demand registered at a cool $2 billion, Bloomberg reports. That torrent of interest helped underwriters price the floating-rate loan at an effective yield of just over 8%, compared to price talk north of 9%. What’s more, the loans broke higher in early trading this morning, jumping towards 98 cents on the dollar after being priced at an original issuer discount of 95.5 cents.
A decisive factor in that now-rare financing success story: The mushrooming private credit sector. As the Financial Times notes today, mega lenders such as Blackstone and Apollo helped fortify Peloton’s loan book, marking a signpost “of how lines are crossed between two distinct capital markets.” Then, too, brisk demand allowed the company to bypass some conventional steps. “The deal concluded so quickly that Peloton did not get a rating on the debt, which is typically necessary to draw in investors,” the pink paper relays.
Those eager lenders are facing an uphill battle, as the pandemic-era darling does not exactly boast an envy inducing financial profile. Peloton counted 2.96 million subscribers on its global fitness platform as of March 31, up from 712,000 at year-end 2019. In spite of that feverish growth, adjusted Ebitda registered at minus $194 million during the recently completed quarter, compared a $28.4 million adjusted Ebitda shortfall during the final three months of 2019.
Non-cash charges excluded from that ultra-forgiving profitability metric continue to percolate. During the first three months of 2022, Peloton doled out $117 million in stock-based compensation, up 181% from the same period last year. Back in February, the firm announced plans to lay off 2,800 staffers, equivalent to 20% of corporate headcount, while CEO Barry McCarthy warned last week that the company is “thinly capitalized” after unrestricted cash and cash equivalents slipped to $879 million as of March 31, from $1.6 billion at year-end.
As that experience suggests, private credit’s rapid ascent is increasingly difficult to ignore. The industry counted $1.6 trillion in assets as of March, a report from Netherlands-based Intertrust Group finds, up 53% over the past five years. “There was a time when [private debt] sounded more exotic to institutional investors, but now, it’s a standard part of the conversation” Randy Schwimmer, senior managing director at Churchill Asset Management, told Institutional Investor last week. Indeed, an early April survey of 62 such funds from capital markets newsletter The Lead Left found that 95% of respondents plan to increase their private debt allocations over the following 12 months.
The ultimate utility of that wholesale migration remains up for debate. A report yesterday from Moody’s Investors Service shone a harsher spotlight on the nascent financing class, contending that private credit providers are less attuned to rate volatility than their publicly-focused brethren. However, the rating agency cautions that such funding is typically directed towards “leveraged buyouts and perceived higher-return investments [rather] than on operational funding needs for the rising tide of lower-rated underperformers. This could accelerate default risk for those that need funding support.”
Firms rated the equivalent of single-B or lower constitute almost 60% of the overall speculative grade universe, Moody’s finds, compared to about 40% during the previous LBO party in 2006. Those rated single-B-minus or worse account for a quarter of the total speculative-grade debt realm, double the pre-crisis population.
Then, too, Moody’s analysts led by Christina Padgett find that roughly 80% of that single-B-minus cohort are sponsored by private equity firms. Accordingly:
Rising investor flows into private credit will bolster liquidity for leveraged transactions, but with so much capital chasing already leveraged, sponsor-owned companies, underwriting standards have deteriorated.
Looser lending terms provide borrowers financial leeway as rates rise, but the effects may be temporary and will likely result in lower ultimate recoveries than in prior credit cycles.
Mounting evidence, meanwhile, suggests that the cycle may indeed be turning. This afternoon, benchmark credit protection costs as measured by the Markit CDX North America Investment Grade Index rose six basis points to top 90 for the first time since May 2020, placing that gauge comfortably above its 30-year average of 78 basis points.
For more on private credit, including a representative “recurring revenue” loan underscoring the prolific deal activity seen during the halcyon days of 2021, see the Nov. 12 edition of Grant’s Interest Rate Observer.