Private equity firms are looking to take advantage of liquidity in the debt markets to lock in recap provisions in new LBO facilities.
Recap lines, effectively delayed draw term loans, have been common in the US loan market and are expected to emerge in Europe because competition for mandates is fierce and liquidity is strong. The facilities will finance, in whole or in part, the refinancing of shareholder loans and the distribution of dividends.
Sponsors, which are driving demand for the structure, benefit as they lock in early dividend terms while the market is bullish. Lenders get fees on liabilities that fall away if performance criteria are not met.
Bankers have warned that the provisions should be approached with caution, however. Ahmed Arif, of BNP Paribas’s leveraged syndications team, said that availability should be linked to demonstrable equity value creation. That would mean the loan to value cushion would remain comfortable after the recap lines had been drawn down.
Low costs of funds combined with plentiful liquidity have driven down spreads and fees in the loan market this year, producing an environment that is highly conducive to equity take-outs. For the first time in Europe, more than 100% of initial equity has been taken out on average, according to estimates from S&P. This is up from just under 80% last year and just over 60% in 2003.
With recap volumes still lagging behind LBO volumes, the recap trend has probably not yet reached its peak. The public equities market has improved as an exit route for sponsors, but execution risk remains, as exemplified by the cancellation of Eutelsat’s €1.8bn IPO and the fact that Telenet priced at the bottom of its range.
Recaps also provide certainty of a cash sale. Goldman, Apollo and TowerBrook recently sold Cablecom to Liberty Global, although the IPO proceeds were expected to have been higher.
The time to recap has not changed that dramatically in Europe in the last few years. Bankers estimated that the average time to recap is about two years, slightly down from an average of about 2-1/2 years in 2002.
Investors said they were more likely to accept an earlier recap if there had been a slight overcapitalisation in the original LBO and if their initial syndication and trading experience had been successful. They also said that they would look more favourably on the move if management was incentivised appropriately.