Private equity milks the debt markets

At least one institutional investor has cried foul at the plan to take a dividend out of Demag, the German industrial group that KKR acquired in 2002. He is turned off by lower than standard pricing, extra leverage and concern about the remaining assets after a selling spree at the company.

“The main things they have left are Mannesmann Plastics and some crane businesses. The crane units are really scary, we wouldn’t want to up our capital there,” the investor said. The Demag portfolio comprises Mannesmann Plastics Machinery, Demag Cranes and Components, Gottwald Port Technology and Argillon.

Despite this, KKR (which reportedly paid US$495m in fees last year to banks) will probably find sufficient takers elsewhere in Europe’s highly liquid debt markets. “Do I like the deal? No. Will I do it? Probably; most things are getting done in the present environment,” a bank investor said.

KKR is taking €430m in equity out of Demag with the recapitalisation, but the company has a track record of generating cash and reducing leverage. The all-senior buyout deal was leveraged at 3.6x, while the recap stretches total leverage to a still conservative 3.9x. A deal source denied speculation that further units were about to be sold, adding that if that were the case the deal would be re-done.

Dividend recaps have been the fashion for the last year. Sponsors are boosting returns ahead of ever-larger fundraisings, but the extra leverage makes the companies riskier as the buyout firms gradually exit them. It could be argued that businesses where they have limited or no equity are hardly likely to rank as operational priorities for buyout firms.

The recap of Demag launched on January 27 via Commerzbank and HVB Group. The facility breaks down into a €240m seven-year term loan A at 225bp over Euribor, a €130m eight-year term loan B at 250bp, a €130m nine-year term loan C at 300bp, a €275m seven-year revolver at 225bp, and a €65m acquisition facility. There is also a €100m mezzanine tranche.

Pricing on the B and C tranches is 25bp tighter than the market standard. This reflects hard bargaining from KKR, as well as the growing maturity of the European loan market.

Celanese was a predominantly US deal from dividend specialist Blackstone. European investors subscribed to a €120m term loan as part of the senior debt manoeuvring that accompanied the IPO. Dubbed an aggressive deal on account of a margin that ratchets down from 250bp to 225bp, the loan was very heavily oversubscribed, but was criticised because of insufficient due diligence.

“The reality is that this is a US-style syndication and you are buying off public ratings,” said another institutional investor. “They don’t do nearly as much due diligence in the US.” Nevertheless, the investor conceded he would probably do the deal because he did not want to sit on cash.

High-yield bond investors are also increasingly tolerant of dividend deals. Madison Dearborn’s Jefferson Smurfit became the late issuer to tap the market for non-cash pay securities. The packaging company priced a €325m PIK dividend at par to yield 11.5%, the tight end of 11.5% to 11.75% talk, equal to a spread of 794bp over the 3.75% DBR due April 1 2015.

But Smurfit’s lead banks had to backstop the deal at 12% to avoid a repeat of last year’s failed sale of €250m in euro and dollar discount notes. The PIK priced alongside €217.5m and US$200m in senior sub cash pay bonds, which were backstopped at 8%. It was increased by €25m based on real money demand from European non-hedge fund investors.

Secondary traders report heavy selling of dividend deals in the secondary market, however. One hedge fund bought a €50m piece of Cognis, which it has already offloaded, a trader said.

And it is not just the high-yield markets where sponsors can exploit strong demand to their advantage. KKR is using liquidity in the investment-grade loan market to cut interest costs at another portfolio company, Legrand.

KKR and Wendel aim to reduce interest costs by about €16m, refinancing €2.8bn in LBO debt with a €1.4bn five-year investment-grade deal.BNP Paribas and RBS are arranging the new facilities at 60bp over Euribor on any drawn proceeds. This compares favourably with the standard leveraged loan pricing of 225bp, 275bp and 325bp over Euribor that was applied on the LBO tranches.

At this level, pricing on Legrand is far cheaper than previous deals for businesses that have crossed over from high-yield into investment grade. Premier Foods, C&C group and Halfords have tapped the market for post-IPO financings. Premier and Halfords paid 100bp margins, while C&C paid 140bp.

Demand is driven by banks, which are flush with liquidity and tired of the paltry fees typically offered by European corporates. Relationship pricing dominates high-grade loans. Well-known issuers that have other fee-yielding business to distribute to banks regularly clear with wafer-thin margins. Additionally, since most of the deals are backstops and rarely drawn down, yield depends mainly on the undrawn commitment fee, which is often in the low single digits.