Mezzanine lenders have billions of dollars of desperately-needed debt capital at their disposal, having raised $26 billion from limited partners in 2008, their biggest fund-raising year on record, according to data collected by Buyouts Magazine.
Among the larger mezzanine funds to hold final closings last year include
But mezzanine debt is largely an LBO-driven product, with many providers specializing in filling the ever-shifting gap between senior financing and equity. And that means deals are scarce right now. In the second quarter of 2009, U.S. sponsors closed a total of just 114 control-stake deals, marking a year-over-year decline of more than 50 percent from the 236 deals that closed during the same period in 2008, according to Thomson Reuters, publisher of Buyouts.
“We don’t think the sub debt market will start to pick up until new leveraged buyouts start getting done,” said Lawrence Golub, president of
When the senior debt markets first collapsed, “traditional mezzanine lenders initially rejoiced that it was a great time” to invest, said David Blair, partner and founder of
This might strike some buyout shops with transactions in the pipeline as good news—an apparent build-up in mezzanine firm war chests given strong fundraising and weak dealmaking. But it doesn’t appear that buyout firms have been able to inspire much in the way of bidding wars. Alternative sources of financing, such as second-lien-wielding hedge funds and business development companies (BDCs), have all largely taken to the sidelines, or succumbed to even worse fates. The overall leveraged loan market has dried up so much that mezzanine firms still have the upper hand in negotiations.
Bigger Tranches, Better Terms
“We’re seeing deal after deal where people cannot get the senior debt they’re looking for and they need to go back to the mezz guys asking for more,” said Ronald Kahn, a managing director and head of the debt advisory group at investment bank Lincoln International. It’s gotten to the point today that debt structures are shared almost 50/50 between senior debt and mezzanine, he said.
To help illustrate the state of the market, Kahn pointed to a deal in which his firm is helping to raise $65 million in senior and mezzanine debt to support the sale of a services provider with EBITDA of $23 million to an LBO shop. The proposed leverage multiple is just 2.8x, yet Kahn said he doubted that the company would be able to raise the level of cash flow debt it was seeking. Rather, it would probably have to substitute asset-based senior debt at a lower senior-leverage multiple than desired, leaving a larger, less risky portion of the capital structure for mezzanine lenders to fill.
Indeed, for the second half of 2008, Standard & Poor’s said the average mezzanine multiple for LBOs of companies with up to $50 million in EBITDA stood at about 1.4x, compared with 3.3x senior debt and total leverage of 4.7x. That’s way up from 0.9x mezzanine (and 3.6x senior) for full-year 2008 for comparable deals, and just 0.4x mezzanine (and 5.4x senior) in 2007.
Meantime, all-in pricing for mezzanine loans today—including fees, current-pay interest, PIK interest and equity warrants—tends to fall somewhere between 16 percent and 19 percent, though it can get as high as the mid-twenties, according to lenders. Golub Capital earlier this year closed a mezzanine deal to help back an add-on acquisition for a sponsor-backed company. Pricing on the tranche included a 3 percent upfront funding fee, a 12 percent coupon and warrants for an undisclosed “single digit percentage” of the company’s equity, according to Golub.
Across the market, industry players told Buyouts, pricing for an all-coupon (no warrant) mezzanine deal would likely include the following:
• 3 percent closing fee;
• 17 percent to 17.5 percent coupon (including PIK);
• One-year to two-year no-call provision;
• 5 percent step-down prepayment fee (typically beginning in the second year of the loan).
Pricing for mezzanine deals with warrants might include the following:
• 3 percent closing fee;
• 11 percent to 14 percent cash coupon;
• 1 percent to 8 percent equity warrant;
• Prepayment fee (typically less than prepayment fees for all-coupon mezzanine deals).
Pricing and terms have grown so favorable to mezzanine firms that some providers have been able to secure their sub-debt products with liens. Whereas senior lenders typically balk at secured mezzanine loans, which could prove meddlesome to them in workout situations, they have recently become more willing to accept secured mezzanine since they themselves are less levered.
“When the mezzanine lender gets lien, it gives them a seat at the table,” said Kenneth Jones, managing partner at
To be sure, a second lien does not guarantee reimbursement in the case of a workout. But it does give the mezzanine lender more tools at their disposal other than the old standby of loan payment acceleration.
For instance, if a company wants to sell its collateral to pay off the senior lenders, it could only do so if the mezzanine lenders agree to release their lien on the assets—which is sometimes done for a fee. It also gives the mezzanine lenders the option to buy out the senior debt if they deem it worthwhile to put more money into the company in order to attempt to right a listing ship.
The upshot: The power that mezzanine firms are showing at the bargaining table today in new deals is likely to translate into a greater influence at exit time.
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