ANTARES COMPASS REPORT 2021

A unique, triangulated perspective on the middle market from our portfolio companies, private equity sponsors and loan investors.

Compass points to resilient confidence in the U.S. economy as the Coronavirus pandemic ebbs.

Confidence in the U.S. economy among middle market participants remains resilient having emerged largely unscathed from the pandemic and back to pre-Covid levels or better heading into 2021. Odds of a U.S. recession in 2021 appear remote, and confidence in the global economy has picked up sharply. Deal activity looks poised to rise with fiscal and monetary stimulus and infrastructure spending driving against the potential headwinds of rising taxes and regulation. Revenue and EBITDA growth prospects look favorable, although supply chain management and the potential for raw material and labor cost inflation has become an increasing concern.

Confidence in U.S. economy generally appears to have been more than fully restored heading into 2021, but pockets of pessimism and uncertainty remain.

Our 5th annual Compass survey of sponsors, borrowers and investors completed in late January / early February 2021 suggests that optimism for the U.S. economy has been fully restored following the onslaught of the coronavirus pandemic with 79% of investors, 75% of sponsors, and 65% of borrowers "confident" in the 2021 U.S. economic outlook. The percentage of those that are "very confident" actually rose across each segment vs. early 2020's pre-Covid reading. Borrowers optimism remains the most mixed with 20% "pessimistic" and 15% "uncertain" - likely reflecting the lingering impact of the pandemic on specific industry segments.

sponsor confidence

investor confidence

borrower confidence

SPONSORS

INVESTORS

BORROWERS

How confident are you in the U.S. economy over the next 12 months?

Massive stimulus appears to have inoculated the U.S. economy from the ills of Covid, with a higher majority of respondents viewing the odds of a U.S. recession as unlikely in 2021 than in our prior pre-Covid 2020 survey.

The percentage of respondents seeing a 2021 recession as unlikely or very unlikely rose to 83% from a 71% reading in 2020 for sponsors and to 73% from 56% for borrowers. The reading for investors slipped 4 points year-over-year but still remains high, with 84% seeing a 2021 recession as unlikely or highly unlikely.

of sponsors see as unlikely

of investors see as unlikely

of borrowers see as unlikely

SPONSORS

INVESTORS

BORROWERS

In your opinion, what's the likelihood a U.S. economic recession will occur in the next 12 months?

Data not collected in 2018

Confidence in the global economy has rebounded sharply vs. a year ago.

59% of sponsors and 74% of investors are confident in the global economy over the next 12 months, up sharply from a reading of only 24% for sponsors and and 55% for investors in early 2020.

of sponsors are confident in the global economy

of investors are confident in the global economy

SPONSORS

INVESTORS

How confident are you in the global economy over the next 12 months?

Data not collected in 2018

Most expect M&A activity to rise albeit against a rather easy/depressed 2020 comparison.

On the deal front, most sponsors (65%) and investors (53%) expect M&A activity to rise in 2021 vs. 2020, with the balance in both segments expecting activity to remain about flat. Within the mix of M&A activity, a roughly equal percentage of sponsors expect LBO and add-on activity to rise (64% and 69%, respectively). On the leveraged loan front, 74% of loan investors polled expect volume to rise in 2021 vs. only 19% who expected an increase in our early 2020 survey.

SPONSORS

INVESTORS

Over the next 12 months, how do you see the middle market M&A environment shifting vs. the last 12 months?

Big pickup in overall M&A activity expectations, with 65% seeing a pickup in activity vs. 17% a year ago.

What do you expect M&A activity to do over the next 12 months?

53% expect M&A to pick up over the next 12 months with the balance expecting activity to stay near current levels (which had surged at the time of this survey). This is up sharply from only 21% expecting increased activity in 2020.

lbos

add ons

of sponsors expect more LBO activity

of sponsors expect flat LBO activity

of sponsors expect less LBO activity

of Add Ons are seen as more active

of Add Ons are seen as less flat

of Add Ons are seen as less active

What is the principal factor driving middle market M&A volume in the next 12 months?

Liquidity in Capital Markets and high dry powder remain key factors driving M&A in 2021 - supplemented by a backlog of delayed processes due to Covid.

Is your firm planning to sell businesses in your portfolio in the next 12 months?

Big pick-up in sponsor portfolio company sales - 67% expect more exits in 2021 vs. 2020.

Sponsors: 2021 Key Takeaways

Opportunity to deploy capital picks up. The percentage of sponsors indicating their levels of dry powder is "lower than expected" actually ticked up to 19% from 10% in 2020. Conversely, those having "higher than expected" dry powder fell to 64% from 71%. This may simply reflect the surprising surge in deal activity at year-end 2020. Looking forward, sponsors' expectations for deploying dry powder has shifted slightly to the near term, with a plurality (65%) now expecting to deploy within 2 years vs. 62% in the previous reading.

Current Dry Powder Levels

Interestingly, the percentage of those having lower than anticipated dry powder rose vs. prior 2020 pre-Covid reading, though this may simply reflect strong deal activity at the end of 2020.

Time Frame for Deployment of Dry Powder

Expectations for the deployment of dry powder have shifted slightly more towards nearer term vs. prior reading.

When do you expect your firm will raise its next fund?

Pace of fundraising is largely unchanged from prior reading, with 63% expecting to raise their next fund within the next 2 years.

	Yes, significant increase	Yes, modest increase	No or few inquiries
ESG
Policy
KPIs
Diversity within:
Management
Board

Have you experienced an increased focus from LP's on sponsor ESG policies and ESG KPI's and Diversity within the management and board of your portfolio companies?

On ESG, almost 90% have seen at least some increased focus by LP's on policy and almost half have seen a significant increase. 80% see at least some increased focus on ESG KPIs and about one-third have seen a significant increase.

On diversity, 73% see at least modest increase in LP interest in diversity within the MANAGEMENT team of portfolio companies and about two-thirds see at least modest increase in LP interest in diversity within the BOARD OF DIRECTORS of portfolio companies.

In light of the current interest rate environment, how do you plan to manage interest rate risk over the next 12 months?

Two-thirds of sponsors plan to leave their portfolios unhedged against interest rate risk – largely unchanged from the last two years' survey readings.

Top Five Industries Expected to See Growth

Tech/Media/Telecom, Healthcare and Business Services remain top 3; however, cyclical and Covid-impacted industries such as Construction, Retail and Restaurants show a significant pickup in growth expectations vs. last year's reading.

What is the most representative range of EBITDA add-backs forecast in your lender agreements during the past 12 months?

EBITDA add-backs have grown more conservative with those seeing EBITDA add-backs exceeding 25% dropping to only 15% of respondents vs. 29% of respondents in our early 2020 pre-COVID survey.

To what degree has the level of financial stress (e.g. a concerning miss of financial projections) been rising or falling in aggregate across your portfolio over the last 12 months?

Financial stress in portfolios has risen, with 58% noting a rise in financial stress within their portfolios in the last 12 months vs. 48% in the reading from a year ago; however, most have seen only a modest rise in stress underscoring the resiliency of sponsor portfolios in the face of severe Covid-related economic impact.

What % of each loan structure/channel do you expect your firm will employ for its financings over the next 12 months?

Direct lending options continue to dominate among survey respondents, though syndicated share is expected to rise modestly in the next 12 months.

Loan structure/channel used to finance your deals	% of total deal count last 12 months	% of total deal count next 12 months
Unitranche
Club Deal
Syndicated

Do you have or plan to launch a private debt fund?

Most sponsors (61%) do not have a debt fund and don't plan on launching one in the next 2 years. However, 32% of respondents do have a debt fund - up from 24% last year - and 7% that don't have one plan to launch one within the next 2 years.

Which if any regions do you expect to expand into in the next 2 years?

34% of respondents plan on expanding abroad into one or more of the regions listed. Almost one in four of survey respondents plan on expanding in Western Europe within the next 2 years.

Percentages don't amount to 100% because sponsors can select more than one region for expansion.
34% selected some region for expansion, and 66% said no expansion. This was down modestly from 40% looking to expand in last year's survey.

Which prospective new policies / regulations do you view as a threat or opportunity for private equity under the new administration?

Opportunities

Infrastructure spending

Environmental / clean energy investment

Stimulus / relief and low rates to boost consumer spending

Increased access to healthcare

Threats

Higher taxes (corporate, capital gains, carried interest, interest deductibility)

Increased regulation and related costs

Wage inflation

Have your fund's IRR goals changed from prior fund's expectations?

Respondents indicate a slight downward drift in IRR goals, but less so than last reading.

When do you expect the U.S. economy to fully emerge from the Coronavirus pandemic and return to normal?

One-third expect the U.S. economy to fully recover from the Coronavirus impact in 2021 and 83% by H1 2022.

Which strategies does your firm use to distinguish itself in an auction process?

Industry expertise ranks as the top strategy for differentiation in the auction process, but the #2 response is to avoid auctions to begin with and focus instead on proprietary deal flow. Leveraging operating partners ranks third.

Regarding special purpose acquisition companies (SPACs), over the next 12 months, we expect to:

Only 13% expect to raise funds for a SPAC, but 27% say "maybe," with the balance responding "no." More foresee potentially selling a portfolio company to a SPAC (14% "yes" and 66% "maybe").

Raise funds for a SPAC

Sell a portfolio company to a SPAC

Investors: 2021 Key Takeaways

Asset allocation mix is expected to hold steady. As we enter 2021, most (65%) investors don't anticipate shifting their asset allocation mix, with only 10% expecting change, and the balance uncertain. Of those few that do expect change, there is a shift toward middle market loans and away from broadly syndicated loans and high yield bonds vs. last year's reading. This may reflect a reach for more yield premium, favorable middle market performance through the stresses of 2020, and a desire to tilt toward floating rate assets as a hedge against a possible rise in inflation.

Do you expect to change your asset allocation mix?

Most respondents (65%) do not expect to shift their asset allocation mix in 2021.

If yes, what will the new mix be?

A shift towards more middle market exposure vs. prior reading, although sample size was small for this answer (so could be off).

Leveraged Loan Volume Over 12 Months

74% expect leveraged loan volume to increase this year vs. only 19% in 2020. A plurality (42%) expect an increase in the range of 3-10%.

Spreads appear likely to narrow moderately over the next 12 months across both Broadly Syndicated (BSL) and Middle Market (MM) loans.

A slight majority of investors — both BSL investors and MM focused investors — expect spreads to narrow by 50-100 bps in 2021, with the balance expecting spreads to hold steady (i.e. +/- 50 bps).

Broadly Syndicated Loan Spreads

Middle Market Loan Spreads

Over the next 12 months, how do you expect spreads for Broadly Syndicated Loans (with a deal size >$500MM) to change?

Most (58%) see BSL spreads declining by 50-100bps, while 37% expect spreads to be flat (+/-50bps).

Over the next 12 months, how do you expect spreads for Middle Market Loans (with a deal size <$500MM) to change?

Most (53%) see middle market spreads declining by 50-100bps, while 47% expect spreads to be flat (+/-50bps).

Expectations for Lender Terms in the Broadly Syndicated Market

Most see BSL market terms holding steady (58%), but 37% expect markets to loosen further in the next 12 months vs. 21% a year ago.

Over the next 12 months, do you expect unitranche loans' share of the sponsored middle market to:

Almost half of respondents see unitranche share rising further in 2021; with only 11% seeing a decline.

Do you expect to raise funds in the next 12 months?

Fundraising continues to be strong with 85% intending to raise funds in next 12 months.

If yes, do you expect your level of fundraising activity to ____ compared to last 12 months?

100% of those raising funds expect to increase their level of fundraising vs. prior year.

Which vehicle(s) for fundraising will you use?

Strategic investor programs and BDCs have gained modestly in their share of responses as future fundraising vehicles at the expense of CLOs.

When do you expect the U.S. economy to fully emerge from the Coronavirus pandemic and return to normal?

Only 11% of investors expect the U.S. economy to fully recover in H2 2021, but 90% expect a full recovery by the end of H1 2022.

By the end of 2021, WHAT DO you expect the trailing twelve month (TTM) leveraged loan default rate to be (was ~4% at 2020 end for S&P/LSTA LL index):

53% of investors expect defaults to end 2021 below 4% (i.e. at or below current levels) and 85% below 5%.

In your opinion, current middle-market sponsored total debt to EBITDA multiples are:

Most (58%) see sponsored middle market total debt to EBITDA leverage as high (53%) or very high (5%), though that is down from 88% in 2020 and the lowest reading since we started this survey five years ago.

Do you have requirements around deploying capital into funds or deals with the following initiatives?

Almost 70% have a formal or informal ESG policy and related KPI metric requirements around deploying capital, with another 5-11% planning to have a policy and metrics.

37% have a formal or informal POLICY related to deploying capital into funds or deals with regard to diversity within the management and within the board of directors of the target investment, with an additional 11% planning to develop such a policy. However, a plurality of respondents (42%) do not see this as an area of focus.

Environmental, Social and Corporate Governance (ESG)

Diversity (e.g. Gender/Race, etc.) within

When evaluating your loan investments, are Environmental, Social and Governance (ESG) considerations part of your due diligence and hold size determination?

63% of investors claim they always consider ESG in their DUE DILIGENCE while 11% often do and 16% sometimes do.

A lesser 32% of investors claim they always consider ESG in their HOLD SIZE size while 11% often do and 21% sometimes do.

Borrowers: 2021 Key Takeaways

With regard to revenue and EBITDA, how is your company's LTM performance, pro forma for acquisitions, tracking to management's original budget?

The proportion of respondents that had revenues falling below their LTM revenue budget rose to 62% vs. 40% in early 2020 pre-Covid reading, with only 26% above their revenue budget. However interestingly, the split was roughly even on those reporting above or below budget for EBITDA on an LTM basis, suggesting strong cost management performance.

	Revenue		EBITDA
	Above	Missed	Above	Missed
2021
2020
2019
2018

	Distributor	Manuf.	Service Provider	2021 TOTAL
REVENUE
Flat (-2% < 2%)
Recovery from decline
Moderate growth (3% < 5%)
Strong growth (> 5%)
EBITDA
Flat (-2% < 2%)
Recovery from decline
Moderate growth (3% < 5%)
Strong growth (> 5%)

With regard to revenue and EBITDA, how would you describe your company's year-over-year performance goals for the next 12 months?

87%+ expect moderate to strong revenue and EBITDA growth over the next 12 months which is unchanged for revenues and up slightly for EBITDA vs. the prior year's reading.

By what % do you project your company's workforce to grow via new hires over the next 12 months?

Only 45% saw any increase in their company's workforce in 2020 - down from a reading of 85% for actual 2019 in the prior survey. However, looking forward to 2021, 96% anticipate at least some workforce growth and 30% expect greater than 5% growth.

	Over 0% growth	Over 5% growth
Actual 2020
Anticipated 2021

Compared to the prior year, how do you expect your company's IT spend to change over the next 12 months?

60% expect an increase in IT spending vs. 40% in last year's reading. 50% expect an increase of greater than 5%.

How do you expect growth in your company’s industry to trend in the upcoming year?

89% see moderate to high growth vs. a lower 73% in last year's reading.

	Flat	High- Mod	Decline
2021
2020
2019
2018

Top Areas of Spend

Similar to the last 2 years, acquisitions are a top priority, followed by hiring and investment in capital equipment. Distributors are more focused on digital and IT spend, manufacturers on capital equipment, and service providers on hiring.

ECF Spend	Distributor	Manuf.	Service Provider	2021 TOTAL
Acquisitions
Capital Equipment
Hiring Employees
Sales & Marketing
Digital Expansion
IT

The top five internal challenges remain consistent with last year's reading, but raw material costs and supply chain are increasingly in focus among external challenges.

For internal challenges, "adding new customers, expanding into new markets" remains at #1 across business models. However, challenges otherwise show some variance across business models with hiring/talent acquisition #2 on the list for service providers vs. supply chain management at #2 for manufacturers, and bringing a new product or service to market and acquisition integration being tied for #2 for distributors.

For external challenges, competition ranks at #1 for distributors and service providers as it has in prior years; however "supplier power / raw material prices" and "supply chain management" have jumped to the top of the list for manufacturers, suggesting fallout lingers from the Coronavirus on supply chains, with raw material inflation an increased concern.

Internal

External

Top Five Internal Challenges Facing Borrowers in 2021

The top 5 internal challenges in 2021 remain the same compared to last year's survey with "adding new customers" at #1 across business models.

Top Five External Challenges Facing Borrowers in 2021

The top anticipated external challenges over the next year include competition, Covid-related restrictions/regulation, industry headwinds, supply chain management and rising costs. Geopolitical events fell vs. last year's reading.

Has your company been impacted by Covid either directly or indirectly?

The bulk of respondents (54%) have been negatively impacted and continue to feel impact in 2021; however 23% claim to be back to pre-Covid levels and 19% were positively impacted by Covid and continue to benefit in 2021.

Which do you anticipate to be the primary drivers of your Company's organic EBITDA growth in the next 12 months?

Sales growth with new and existing customers and new products remain the top three drivers of EBITDA growth - same as in 2020.

Does your company have a focus on ESG and/or diversity related policies and measurement initiatives?

Almost 2/3 have a formal or informal ESG policy; but a lesser 43% have formal or informal KPIs. Almost 2/3 have a formal or informal focus on diversity within the MANAGEMENT team but only 22% for the BOARD OF DIRECTORS.

ESG

Diversity Within:

When do you expect the U.S. economy to fully emerge from the Covid pandemic and return to normal?

38% expect the U.S. economy to fully recover from Covid impact in 2021 and 79% by the end of H1 2022.

Survey was completed early-February 2021 and is based on responses from more than 160 private equity sponsors, middle-market borrowers and loan investors. The information in this report is for informational purposes only, is current as of the date noted and should not be used or taken as finance, legal or other advice.

The information presented should not be deemed as a recommendation to purchase or sell any securities or investments mentioned. Although Antares Capital LP believes that the information contained herein has been obtained from sources believed to be reliable, Antares Capital LP does not guarantee its accuracy and it may be incomplete or condensed. Nothing within this publication should be deemed to be a research report. Past performance is not indicative of future results.