Nordic Capital became the latest sponsor to push the envelope with the ever-accommodating debt markets with a €969.6m recap of portfolio company Ahlsell. The electrical and heating products supplier is in the market through Morgan Stanley with a deal that aims to mitigate against underperformance in the run-up to a secondary buyout in the next 12 months. The idea is that the recap transfers debt to a future owner at current market pricing.
So if the company underperforms or pushes up against its bank covenants in the interim, the next private equity buyer would not necessarily have to pay up to finance its bid. Leverage is punchy too, of course, tipping the scales at 6.2x total debt to EBITDA of about SKr1.5bn (US$192m).
There is an obvious gain for the next private equity buyer, assuming that there is not a massive influx of further liquidity that significantly lowers pricing below the current standard. Even more significantly, the next buyer might also be able to save on fees on account of the structure. In the normal scheme of events, the purchaser in a secondary buyout would have to pay fees to its arrangers to refinance the target company’s outstanding debt.
The Morgan Stanley idea does away with those costs. The next private equity buyer of Ahlsell would have had its refi fees paid courtesy of vendor Nordic Capital.
These gains are assuming that the next buyer can meet the strict criteria laid down to satisfy inheritance of the debt under the terms of the credit agreement. One of those stipulations is that suitors must have invested at least €1bn in Europe, a demand that speaks to an exclusive club of blue-chip financial sponsors but limits potential buyers from among the private equity universe.
The feature is harder to swallow for the investment banking community as a whole. In the case of a one-off like Ahlsell, individual arrangers play ball in the name of the wider relationship with the sponsor. But, with those same banks also making up a sizeable portion of the lending community, the feature becomes a dead weight if and when it takes on regular occurrence. If the idea takes off, banks are effectively lending to the same level against highly leveraged companies, but the available fee pool they compete to share has been slashed. A case of robbing Peter, and not even paying Paul.
That dynamic could turn up and haunt Morgan Stanley as much as anyone else, but it is unlikely that automatic debt transference will become ubiquitous. Private equity firms are by their very nature secretive, individualistic and masters of their own fate. The next firm to tip its hat at Ahlsell may be loath to trust anybody’s figures but its own. How often do they take up staple financing after all?