All eyes on Scientific Games LBO bond: IFR

That means players will be closely watching the reception given to a $3 billion-plus high-yield bond for Scientific Games to get clues on investors’ appetite for risk.

The technology-based gaming company may launch its three-part bond next week following third-quarter results on November 3. Proceeds will partly finance the company’s $5.1 billion acquisition of Bally that was announced in August.

The deal has garnered attention because of its big size and high leverage, but also because the three underwriters – JP Morgan, Bank of America Merrill Lynch and Deutsche Bank – met a lukewarm reception from investors when they tried to sell the bridge loans backing the acquisition a couple of weeks ago.

Bankers away from the deal are watching the transaction closely to get a gauge on a market that has seen strong buyside demand for high-quality issuers such as Charter Communications, but less interest in tougher credits. Four high-yield bond deals have been pulled this month alone.

“It’s a very bifurcated market right now, and this deal will tell us more about risk appetite in a market where high-quality deals are going well, but where riskier credits are getting a lot of pushback,” said one senior leveraged finance banker.

“It’s going to be a good data point for where highly leveraged buyout paper comes.”

Moody’s puts the deal’s leverage at over six times EBITDA, and S&P calculates it at closer to seven times.

“Pricing will depend on the function of what market conditions look like a week from now, and the other piece is that if earnings are favourable, that will create a positive catalyst,” said Steven Oh, global head of credit and fixed income at PineBridge Investments.

The roughly $1 billion bond backing the buyout of Tibco by Vista, backed by JP Morgan and Jefferies, is another deal on bankers’ radar. Several say the EBITDA adjustments significantly underestimate real leverage.

“That deal is interesting for two reasons. It’s likely to be Triple C, but we’re also looking out to see how the regulators view it,” said the banker, referring to leveraged lending guidelines that banks have been warned to stick to when underwriting deals.

MORE FLEX PLEASE

While it’s not a huge surprise that banks on the Scientific Games deal couldn’t sell the bridge loans, it underscores how underwriters can quickly find themselves in a position where they stand to lose money when the markets turn against them.

And terms on new commitments will quickly reflect that risk. Cap rates, the maximum yield at which banks can price a bond, have moved closer to 200bp-250bp above where a deal is expected to clear – from below 200bp in the summer.

Any bonds not bought by investors at the cap must be bought by the underwriters, potentially eating into fees and resulting in losses if a big discount on the bonds is also offered.

“If banks underwrote deals a few months ago with a fixed amount of price flex, it is fairly safe to say those deals have less cushion in them today given wider levels in the market. Deals underwritten now, however, reflect the current wider levels,” said the banker.

“So in effect, despite more volatility, current deals for banks may in fact be better than a few months ago.”

In the case of Scientific Games, the banks have been left holding the risk and are close to the caps.

One market source said the cap on Scientific’s $475 million secured bonds was 7.5 percent and between 9.5 percent and 10 percent on the much larger $2.7 billlion unsecured portion, expected to be split into two bonds.

It’s the latter bonds that are the major concern as the caps are lower than the 11.5 percent yield on Scientific Games’ 6.625 percent 2021 senior subordinated bonds that are trading at a cash price of 80. Just a couple of weeks ago, as the sell-off in the market intensified, that yield had risen as high as 13.5 percent.

Although the new senior unsecured bonds are ranked higher in the capital structure, investors are sure to be mindful of the recent volatility.

DON’T ASSUME

At least three bankers said, however, that it was wrong to assume that a bond deal would not go well just because the bridge risk was not sold. Bankers also pointed to the fact that Scientific Games had managed to place a separate $2 billion leveraged loan last month.

“Investors buy bridge risk for a lot of reasons, and one is for allocation on the bond. For a deal of this size, they might think that is less of a problem,” said another senior leveraged finance banker.

Some bankers also said technicals in the bond market are better than those in the leveraged loan market, where buyouts for deals such as Toms Shoes and SourceHOV have struggled and retail cash continues to leave the asset class. High-yield funds, meanwhile, are attracting investor money, with Lipper reporting a $1.567 billion inflow for the week ended Oct. 29.

And some even welcomed the change.

“When the market is popping, sponsors just say to all the banks ‘give me the best terms’,” said the first banker. “That is not the case now.”

By Natalie Harrison and Mariana Santibanez for IFR magazine, a Thomson Reuters publication

(Reporting by Natalie Harrison and Mariana Santibanez; Editing by Matthew Davies)