No lift from Europcar

Eurazeo’s exclusive negotiations with Volkswagen to buy out 100% of car rental subsidiary Europcar will bring little comfort to the leveraged market, despite the deal’s large headline numbers. Banks are reporting an unexpected lull in primary deal flow and, with demand from CLOs and institutions still strong, the slowdown means secondary traders can expect a busy quarter.

Although the shape of the financing has not yet been made clear, Europcar’s enterprise value is around the €3bn mark, leading to expectations that the deal will involve debt of about €2.5bn in addition to the expected €500m equity slug.

While this may appear to be a very aggressive debt-to-equity ratio, it continues the trend of shrinking equity contributions in leveraged deals, which has fallen from an average of around 33% to about 25% in the past few years. Moreover, it is still well above the 10% seen on the buyout of telecoms business TDC, the lowest level seen to date.

While the three arrangers have several strategies open to them in financing the deal, the strong frontrunner appears to be the securitisation route, backed by Europcar’s fleet of about 220,000 vehicles. This follows the example set by fellow rental company Hertz, which came to market at the end of 2005.

Despite the US$15bn price tag on that deal, only US$3.85bn of loan debt ended up being syndicated, with the remainder of the financing taking the asset-backed route. Despite the complexity of securing finance against assets that move between multiple jurisdictions, the secured debt route brings clear advantages for the company in terms of cost of funds.

Using the same rule of thumb as the Hertz deal, market sources estimate that any supporting loan is unlikely to be larger than €400m, although a partial financing using a high-yield bond remains a possibility. Keeping overall leverage levels down will also be a key concern for the sponsor, as a heavy debt burden would restrict Europcar’s flexibility in how it sets its prices.

While the smaller loan element might suit the sponsors, it will do little to alleviate the growing technical pressure caused by the shortage of new paper. The reasons for the drop-off in primary activity have multiple causes, although the current stage of the business cycle is one of the key factors.

Many of Europe’s larger corporates have been divesting non-core assets over the last few years. Now that balance sheets are clearer, they are returning to the acquisition trail in pursuit of strategically beneficial assets, which means sponsors are being edged out of auctions by trade buyers’ additional will and financial fire-power.

Although sponsors have been able to supplement their deal flow by recycling deals through the secondary buyout or recapitalisation routes, these tactics frequently require the possibility of additional growth or another turn of leverage in order to make the deal sufficiently attractive to the new buyer. But with leverage already high enough to weaken demand from traditional bank investors, these options are becoming more and more difficult to execute, particularly now that interest rates are once more on the increase.

Given the dearth of primary market opportunities, the buy side is expected to focus strongly on the secondary markets to meet its investment targets over the next quarter. Encouraged by the continuing low default rates, the “wall of money” from CLOs and institutions shows no sign of abating, raising concerns that values could become inflated as the liquidity tries to find a home.

Adrian Simpson