Recaps still under pressure

Sub-underwriting banks poured rain on CVC, Merrill Lynch Private Equity and Texas Pacific’s dividend parade, forcing the sponsors to increase fees on UK retailer Debenhams’ £2.05bn recapitalisation. The deal also came under pressure in general syndication, where pricing on the second lien tranche was increased by 75bp to 525bp.

The portfolio company’s operating flexibility will be impacted as a result, but the underwritten credit has already delivered a £800m dividend payout. That is on top of the £200m the private equity shareholders have already taken out since they acquired Debenhams in 2003 for £1.9bn.

Mandated lead arrangers Citigroup, CSFB, Morgan Stanley and Merrill Lynch flexed sub-underwriting fees up by 35bp in a bid to persuade the target seven sub-underwriters into the deal. Recruiting the group has seen sub-underwriting fees rise from 135bp at the outset, first to 150bp, and then again to 170bp. The leads are understood to be receiving a 175bp fee themselves, so the upward flex leaves them with small change.

The original plan was to have five sub-underwriters, but market expectations put the leads under pressure to increase that number to seven. The seven sub-underwriters are Bank of Scotland, Barclays, Bayern LB, Caja Madrid, HVB Group, Lloyds TSB, and RBS. Four of the seven reportedly wavered prior to joining due to credit concerns, with Barclays the last to commit.

The doom and gloom did not end in general syndication. Some bankers said that the leads still faced an uphill challenge to clear the market at 525bp. They pointed out that Sanitec’s €135m second lien loan – EQT is buying the company from BC Partners – has already been turned down by some accounts at 550bp and 98.5. They conceded that Debenhams’ management team has an exceptional track record, however.

Standard & Poor’s cast gloom on the deal by placing the retailer on CreditWatch negative. The agency said that Debenhams’ Double B– rating could fall by more than a notch, depending on the shape of the new capital structure, particularly if leverage was above 5.5x. Leverage is aggressive, at 5.6x total and 4.7x senior net debt to Ebitda. Between 5x and 5.5x, S&P said, the rating would fall only one notch to B+.

Although Debenhams has its growth story, underlying weakness in the retail sector may also prove too much for some investors’ risk tolerance. The leads have also been criticised for their use of second lien instead of higher-yielding mezzanine debt in the structure.

On a brighter note, the delay in completing the sub-underwriting phase may have bolstered demand for the second-lien due to improving conditions in the high-yield market. The prospect of an early take-out through an IPO in the next two years should also help to alleviate concerns.