Growth in buy-out activity and high-yield debt deals this year has been steady rather than spectacular, despite contributing factors that suggest a worldwide surge in leveraged finance.

Money continues to pour into private equity funds from investors searching for ever higher returns. In the US, Kohlberg Kravis Roberts is said to be raising a fund worth up to $10bn, while strategists at KPMG estimate that there is up to E35bn of private equity money available in Europe.

Leading investment banks are putting more staff and capital to work on their strategies for leveraged finance, hoping that the "one-stop shop" approach will be the most lucrative.

They are jostling for position in the race to cash in on the many corporate restructuring opportunities. As old-style conglomerates break up under pressure to generate shareholder value, the options for spin-offs of non-core assets seem endless.

Availability of capital and the worldwide development of a private equity culture has yet to translate, however, into a surge in leveraged buy-out deals. Such transactions are complex, and there is a lag time between the idea taking hold and the deal hitting the markets.

Recent equity market volatility has caused confusion over what a business is worth - even those in the old economy - and buyers and sellers frequently disagree on company valuations.

Stung by expectations of over-optimistic returns that failed to materialise, investors have become more conservative. Caution caused them to sell many investments in the equity and bond markets. While this has purged their portfolios of more speculative elements, it has also slashed the value of some leveraged companies that analysts assert are still a good buy.

"The markets have swung from a high level of concentration on rewards to an over compensation to account for risks," says John Hatherly, director of global analysis at M&G Investment Management.

Stock market fluctuations have been reflected in the bond markets, with high-yield bond sectors in Europe and the US having entered a state of virtual hibernation. Companies planning LBOs can no longer be sure that the capital markets will be available to finance them and banks have grown wary of highly leveraged transactions, especially in the volatile technology, media and telecoms sectors.

"High-yield debt has been presented as some sort of panacea for leveraged finance, but it often falls short of that," says Simon Collins, head of debt advisory services at KPMG.

Next year is likely to usher in a greater flow of deals, especially in growth markets for leveraged finance such as Europe and Asia, as new ways of financing buy-outs are tested.

The high-yield market will continue to play a central part, but mezzanine debt is filling some gaps left by the malaise in junk bonds.

Cash-rich private equity houses are likely to commit more cash than ever to leveraged buy-out (LBO) deals, with some transacted without going to the capital markets. Other financing methods such as securitisation are being tried out.

In the £1.1bn buy-out of food group Ranks Hovis McDougall by Doughty Hanson, the financial sponsor avoided the skittish junk bond market for cash. Instead, it is thought to be planning to refinance the acquisition through a securitisation of the company's stable cash flows.

Geographical expansion will continue to be the mantra for private equity investors in the coming year. While the sophisticated leveraged finance markets in the US and the UK are in good health, they are mature and growth is tailing off.

Amount invested by lines of business
North America			cWestern Europe							cNorth America
9	US	40%	1	Sweden	201%		8	Spain	41%	3	Taiwan	60%
15	Canada	24%	2	Switzerland	119%		10	UK	39%	13	Singapore	28%
			4	Italy	59%		11	Netherlands	32%	16	Hong Kong	13%
Middle East			5	Belgium	58%		12	France	30%	17	Korea	4%
& Africa			7	Germany	42%		14	Norway	25%
6	Israel	54%									Source: Global Private Equity 2000

US banks and venture capitalists have put a lot of money and effort into their belief that Europe will in time mirror the size and depth of the US buy-out market. Having put teams on the ground first in London and then in the main continental cities, they are confident of success.

The UK has been stable this year, generating an average of £3bn-£4bn of LBO deals each month, according to analysts' estimates. The stand-out deal of the year has been the £1.3bn LBO of United Biscuits, sold to the Finalream consortium in March. Financing the deal has dominated the UK markets for many months - a leveraged loan worth a reported £800m is being syndicated in the bank market, while a large high-yield bond deal is in the pipeline.

A UK deal currently in the market is KKR's $1.2bn buy-out of chemicals group Laporte. KKR is thought to be planning a $325m high-yield bond to refinance bridge loans from Chase Manhattan, Merrill Lynch and Goldman Sachs.

The confidence of the UK buy-out market has, however, been shaken by the collapse of car parts distributor Finelist, leaving loan and mezzanine investors unsure whether they will recover their money.

The Finelist fiasco has highlighted the risk of public-to-private transactions, where a company with an underperforming share price is taken private by an equity sponsor and then restructured. The challenge for equity houses is to carry out sufficient due diligence checks on a quoted company without news leaking and jeopardising the deal by pushing up the share price.

Continental Europe is set to be a surging market in the next 12 months as corporate restructuring gathers pace. Investment banking and private equity culture is rapidly developing in most European countries, and bankers have predicted growth of between 20 and 30 per cent in volumes of LBO deals next year.

Germany is tipped to be a hot spot. The traditonal structure of German industry, a complicated web of cross-shareholdings at the top end underpinned by the mass of family-owned firms, is breaking up. Crossholdings are being unwound and non-core businesses are rapidly being sold, encouraged by changes in the law governing capital gains tax.

After the success of the United Biscuits and RHM LBOs in the UK, the food sector is predicted to be a rich source of deals across Europe. In France, supermarket chain Carrefour is selling its E1bn frozen foods business with private equity houses likely bidders.

Although deal flow is still light, Asia is poised to become a fertile ground for leveraged finance. This potential was best illustrated this year by the $28bn leveraged takeover of Cable & Wireless Hong Kong by Pacific Century Cyberworks.

Analysts report that the average levels of leverage in US and European buy-out deals has fallen. "Deals are getting done on the basis of higher credit quality," says Tom Walker, head of financial sponsor coverage at Chase Manhattan.

The move away from agressively-leveraged transactions has come from investors lacking confidence in the ability of capital markets to finance such deals. The trend is supported by increasingly conservative views on the level of economic growth and the size of corporate profit margins.

Bankers say this is a positive development which lends itself to the emergence of larger deals. The size of deals means they need to be structured to attract a wider investor base.

As this trend towards higher quality deals takes hold, the wave of investor caution could be short-lived.