Lenders did more than help Thomas H. Lee Partners and Bain Capital leverage their recently agreed-to acquisition of Clear Channel Communications Inc. They also took equity in the transaction.
It’s just the latest example of the trend, though a particularly high-profile one since it’s the largest media buyout ever. It’s a movement already well-established in the mid-market, where lenders—in the face of massive competition and with less control over terms—are placing equity bets to whip up flattening returns. According to some lenders, these equity co-investments can cover more than one-fifth of a deal’s entire cash component.
The attraction for lenders is that they stand to earn a premium if the deal goes well. But with exposure on both sides of the balance sheet, equity-investing lenders are taking bigger risks on a per-deal basis, and run the chance—as both a lender and a shareholder—of having conflicts of interest if a deal goes south. For the general partner, meanwhile, having a lender co-invest means that they can take on larger deals without having to bring in another equity sponsor. They can also sleep better knowing that the lenders will at least be partly on their side should a portfolio company run into trouble and need flexibility on repayment terms.
Lenders known to co-invest include
That the trend has begun extending to the mega-deals may well have to with the sheer size of the deals getting done. One recently agreed-to mega deal with an apparent gap in the equity structure is The
The Clear Channel buyout, agreed to last month, gives the San Antonio, Texas-based company an enterprise value of approximately $26.7 billion, including the assumption of about $8 billion in debt. For advice and debt financing on the deal, Bain Capital and TH Lee tapped a syndicate of banks including Morgan Stanley, Citigroup, Deutsche Bank, Credit Suisse, RBS and Wachovia. All the banks but Wachovia agreed to provide equity commitments as well. Just how much isn’t entirely clear.
In the mid-market, it’s been the lenders who have driven the trend. Jeff Kilrea, a managing director on the Media and Communications team at
CapitalSource, which provides asset-based, senior, cash flow and mezzanine financing, has made a push over the past two years to increase the volume of its equity co-investments, asking every general partner it transacts with for a piece of the deal’s equity. Five years ago, Kilrea says, the firm co-invested on a one-off basis. “We try to make a co-investment in every deal we do. It could be as small as $250,000 or as great as $3 million, but most sponsors are willing to offer it,” says Kilrea. “It’s a great show of support for both parties and it helps to solidify our relationships with equity sponsors.”
“Clearly everyone is trying to put out equity dollars,”
Equity placements put lenders in a position to make between 3x and 5x on “lucky” deals, and serve as a counterweight for occasions when they get hit with eight-figure losses. Steuerman added. “We try to put in as much [equity] as we can that’s prudent relative to the balance,” Steuerman said. “I don’t think we’re unique, but I’m always shocked at the ones that don’t ask. I think it’s pretty standard in the playbook for most middle-market lenders at this point.”
How much capital is prudent to devote to equity co-investments remains a point of debate. One middle-market mezzanine lender says that on typical transactions his firm looks to buy anywhere from 10% to 20% of a deal’s total equity. CapitalSource, by contrast, generally caps its co-investments at five percent.
In the independent mezzanine market, where the lender invests capital from a privately raised fund, the limits are discretionary and based on the liquidity needs of the lender. Mezzanine lenders rely on the regular cash income generated from the repayment of their debt investments. If they tie up too much of their money in equity, they’d run the risk of not being able to meet their scheduled distributions to limited partners.
For their part, institutionally-backed mezzanine lenders tend to leverage their regular cash income to expand their business; hence too much exposure to equity would hinder growth. Regardless, the rule of the day for lenders is to not lose sight of their main business. “You should be comfortable with the debt investment and the equity investment on individual terms,” the mezzanine lender says. In other words, a lending practice should never depend on equity co-investment returns for financial health. “A lot of firms, in my opinion, do cross that line, but it’s my belief that you’re mixing apples and oranges when you do,” he says.
And needless to say, GPs aren’t always so willing to play ball. “Sometimes they just really believe in the promise of the deal and they don’t want to share any of the equity upside,” Kilrea says. “Other times they might just want to put a lot of money to work quickly, so they’ll take the whole thing themselves.”