Mezzanine: a market that is not what it was

The entry of hedge funds is creating a dichotomy in the European mezzanine market. Traditional mezzanine suppliers may think that risk and reward is out of kilter, but the new low of 8% is attractive for hedge funds because opportunities are drying up in distressed investing.

“The mezzanine market appears to be splitting into different segments. Certain assets are being priced and structured to appeal to distinct types of investor,” said Katharine Belsham, at specialist mezzanine arranger and investor ICG. “We perceive that there maybe a future competitive threat from hedge funds, but at the moment they are not getting any paper which we haven’t seen.”

To counter any potential conflict, ICG and its ilk emphasise their track records as long-term investors in debt facilities for private equity deals. The firm did not participate in Coral’s current deal, although it was invited and is an equity investor in the business.

Support from hedge funds enabled Charterhouse to place £200m in mezzanine as part of a £1.245bn recapitalisation of Coral Eurobet. It acquired the UK’s third largest retail bookmaker in 2002 and recapped the business last year.

Several CLOs and traditional mezzanine providers also joined the facility, a portion of which has been set aside for banks. If those banks choose not to participate, arrangers Bank of Scotland and Lehman Brothers will be able to make up the full amount from the existing syndicate.

Priced at 4% cash pay and 4% PIK, the facility is one of the tightest and most aggressive mezzanine deals to date. The only other deal to have closed inside 8% is a much smaller facility arranged for Dignity Funeral Services. That was sold to banks at 700bp over Libor.

Coral’s mezzanine tranche is also one of the largest warrantless mezzanine deals, just short of Elis’ €290m record. Although pricing is always credit specific, a fairly large warrantless tranche could be expected to clear at 10% to 10.5%. That level has fallen from around 11% because of the influx of liquidity from hedge funds in the last 12 to 18 months.

ICG participates in warrantless mezzanine when it is able to secure call protection or has the ability to take an equity position in the corresponding deal.

It is unlikely that there will be a series of mezzanine deals at 8%, however. Coral is well known in the leveraged finance market, has an enthusiastic following and is exceeding performance expectations.

Nor are hedge funds challenging mezzanine arrangers at the moment. But, in the US, they have on occasions taken three figure tickets in associated second lien loans.

Coral’s senior debt tranches launched at a bank meeting on January 12. Deutsche Bank and UBS joined as MLAs during the sub-underwriting phase. The loan is structured as a £485m seven-year term loan A at 225bp over Libor, a £245m eight-year term loan B at 275bp, a £245m nine-year

term loan C at 325bp, a £60m seven-year acquisition facility at 225bp and a £10m seven-year revolver, also at 225bp. Leverage is high at 6.3x total/5.2x senior.