Hudson Hill's Stacy says buyout leverage has fallen to 4x-5x

Debt capacity on a typical buyout has fallen from roughly 7x-8x EBITDA to 4x-5x, Hudson Hill Capital co-founder and partner Alexander Stacy writes in Institutional Asset Manager. That is a 35% to 45% cut in the debt available to fund a transaction. He calls the shift structural rather than cyclical and argues it ends the era in which buyout returns came mainly from financial engineering.

The mechanism is leverage arithmetic: with base rates near zero, Stacy writes, a sponsor could pay 11x-12x EBITDA. A sponsor could write a thin equity check and still underwrite a return because cheap credit did most of the work. Through the early 2010s, a PE-backed platform could keep buying add-on EBITDA without putting in more equity, making returns largely a function of how much M&A a sponsor completed inside the hold. He puts peak leverage at roughly four times what public market investors typically tolerate.

For allocators, the change imposes a specific diligence test: a return case built on a 2021 balance sheet now rests on 35% to 45% less debt than it did then. The question to put to a GP is how much of the projected return depends on EBITDA growth and how much on leverage and multiple expansion, because one of those inputs has been cut by a third or more.

What Stacy says replaces the old engine is long-duration ownership of operating businesses, with operational improvement doing work that leverage used to do. With rates moving toward 4%, he writes, operational excellence is coming back into focus as the source of returns.

His evidence for the turn is the market's verdict on listed peers: over the past year, he writes, share prices at the largest publicly traded private equity firms fell by as much as 75%. The corollary he draws runs through the credit stack as well as the equity; private credit funds that finance deals are pricing against the same smaller capacity.