Leveraged investors have criticised the use of second lien debt instead of higher-yielding mezzanine finance in structures backing the recapitalisation of Debenhams and the secondary buyout of Sanitec.
The pushback comes shortly after the release of a Fitch report “Second Lien Debt in European Leveraged Financings”, in which the ratings agency claimed that second lien was an opportunistic tool that did not fill a natural gap in the European market, as it did in the US, because that gap was already filled by mezzanine. A combination of high liquidity and cheap pricing had made the product popular among arrangers keen to structure and sell more aggressive deals.
Debenhams’ £300m 9-1/2-year tranche pays a fixed 450bp, whereas Sanitec’s €135m 9-1/2-year piece is offered using a bookbuilding approach ranging from 425bp to 550bp.
Following the recent uncertainty in the high-yield market, the mood among investors suggests pricing should be closer to the 600bp mark.
The uptick is supported by the fact that the Sanitec piece is attracting support at the upper end of its range, although one investor said both deals would need to offer more than 9% to gain his interest and that the paper was mezzanine in all but name and price.
Concerns on both deals centre on high total leverage, at 5.6x and 5.75x respectively, and performance issues. In Sanitec’s case, that performance is historical, as the precedent set by two other bathroom product sector MBOs have been unexciting at between two and three per cent. In contrast, Debenhams has been performing well, but the weakening retail climate and £800m of additional equity being taken out by sponsors CVC, Merrill Lynch Private Equity and Texas Pacific are cited as negative factors by investors.
While buy-side grumbling could be dismissed as the unavoidable consequence of the supply/demand dynamic, second lien appetite has been weakening recently as short-term investors have moved out of loans in pursuit of recovering yields on the bond side.
Consequently, these tranches may struggle as many of the buyers around the 450bp mark have disappeared. If, as one investor put it, the paper has been priced according to demand and not credit risk, the leads may be in for a rough ride in general syndication.
Furthermore, secondary trading of Eutelsat’s second lien shows just how brutal the market can be with weaker credits. Paper has traded in the 97s for two weeks now, so buyers may be tempted to hold off and buy at a discount later.
Responding to the criticism, Debenhams leads Citigroup, CSFB, Morgan Stanley and Merrill Lynch said the loan was likely to be taken out in the next two years through an IPO, so the risk was considerably reduced and the second lien therefore offered good short-term value. On Sanitec, lead RBS justified the absence of mezzanine on the grounds that EQT’s 33% equity stake already provided a large buffer for creditors.
Senior debt on both deals is receiving a good response from sub-underwriters, although the fee had to be upped by 15bp to 150bp to secure the all-important seventh sub on Debenhams. Total debt on Debenhams is £2.05bn and on Sanitec €1.015bn