How private equity is behind the recent loss in the London stock market

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The UK's undervalued stock market is a tempting target for private equity buyers. Companies in the midst of cyclical downturns make the best bites ever.

This thinking should apply to strategic buyers as well, except that they may suffer their own economic downturn rather than sit on dry powder. the solution? Get a private equity fund to finance your bid.

This is the path that Nasdaq-listed Viavi has chosen to take. The $2.3 billion telecommunications equipment maker has made a recommended £1 billion bid for London-based Spirent, which will be partly funded by a $400 million convertible switch loan from Silver Lake. Such private investment in public equity deals – or PIPEs – are relatively common in the United States, providing private equity firms with a downside-protected path to a company's capital. Silver Lake itself made a similar investment in, and ended up acquiring, German company Software AG.

The attraction on Fiafi's part is clear. Spirent, which sells equipment for testing communications networks, is a strategic fit. The products are complementary, meaning they can be sold jointly to the existing customer base of the two groups. Operating costs could be reduced by up to $75 million – equivalent to about half of Spirent's EBITDA in 2023.

This is the time to pounce. Spirent stock was in free fall. While Viavi's offer represents a premium of more than 60 percent to Monday's close, the British group had been trading at that level until last summer.

However, Viavi would have struggled to fund the bid if it had taken on direct debt. The US group is experiencing its own pressures, with EBITDA in 2024 expected to reach $165 million, down from $260 million in 2022. It doesn't have a lot of leverage. But the £1bn it is spending on Spirent means the combined group will have a net debt to EBITDA ratio of around 7 times, according to Lex's calculations.

This is where Silver Lake comes into play. Its $400 million convertible looks relatively cheap, with a return of 4 to 4.5 percent for 7.5 years. Viafi would have had to pay perhaps 8 percent for a loan of the same size and term. The telco can also pay interest in kind, which adds flexibility.

Silver Lake extracts a pound of meat. Its loan is convertible into Viavi shares at $10.22. Viavi stock opened even higher on Tuesday. This gives it an in-the-money option to acquire 15 per cent of the new group, which could be very valuable if the communications cycle changes.

Another win for private equity; Not so much for London.

camilla.palladino@ft.com