Senior debt For cash-rich LBO players valuations are at last moving in the right direction and for them to make the most of these opportunities, senior debt must remain on tap.

Banks are keen to keep lending but deal flow is still slow. This seems to be the general consensus coming from the debt market. Factors contributing to the slow pace include lack of visibility, vendor pricing, corporate earnings and a lack of available debt for the larger buyout transactions.

Many describe 2001 as a year of two halves with the first half one of the biggest the LBO market had seen for a long time. This faded dramatically in the second half, following the events of September 11, as investment banks were hit hard by the collapse in deal making. Many loans issued by IT and telecoms companies went into default and banks and institutional investors lost large sums of money. As a result credit committees were wary of taking new debt onto their balance sheets.

But the debt markets are witnessing signs of recovery and both lenders and private equity players are adamant that banks still have a healthy appetite for LBO exposure. Graeme White, managing director Barclays Private Equity, says: “In the mid-market, the debt market certainly hasn’t closed down at all. It is almost as deep and as aggressive as a year ago.” Of course this is only true for good quality transactions. “There is still an appetite for the right sort of deals,” says White.

Siemens’ sale of seven of its businesses to Kohlberg Kravis Roberts is one example that shows lenders are willing to back larger deals of a certain quality. The transaction marks the US private equity firm’s biggest European buyout to date. The assets are being transferred to Demag Holding, a Luxembourg-based vehicle in which Siemens will buy back a 19 per cent stake. The balance will be held by KKR. CIBC World Markets, HVB and JP Morgan are providing @800 million in senior debt financing.

Monitoring the market

According to a report by Ernst & Young titled “The Banking Market for Leveraged Buy-Outs: Seeds of Hope” Q1 was very quiet in terms of introductions and completed deals in Europe. But the survey does reveal that market capacity has increased with the ability to underwrite around GBP1.5 billion on a single deal, and sometimes higher.

There was a significant increase in activity during April and May, although deal completion rates are still poor. But according to the report given lengthening lead times and a greater emphasis from financial buyers on an exhaustive due diligence process, the increase in opportunities will not translate into completed deals at least until the end of the year.

Across Europe there have been varying levels of activity in terms of completed deals. While the UK LBO market has been quiet, there has been more activity in France, Benelux and Scandinavia. The change in German tax legislation has not resulted in the increase in deals that many people anticipated and so Germany is perceived by many as not having lived up to its promise.

Who’s in the money?

The amount of senior term debt typically provided to a company depends on the type and quality of its collateral and the stability of its cash flows, says Matthew Cottis, partner at law firm Lovells. A senior lender’s first priority is to analyse the value of the assets. In uncertain climates, lenders are more likely to commit to businesses that don’t suffer big sales and trading cycles. Solid cash flows attract funding and there is a high level of demand in the debt markets for participations in the right deal, says Cottis. He cites Dignity Caring Funeral Services transaction, which closed in February this year, (lead equity investor HSBC Private Equity and lead debt arranger CIBC World Markets advised by Lovells) as a typical example of a sought-after deal in the current climate. This type of business, he says, is perceived as highly recession-proof. The same can be said of Cinven’s recent GBP820 million acquisition of National Car Parks.

The acquisition price of Dignity Caring Funeral Services was just over GBP220 million. Over 75 per cent of the purchase price was funded by borrowed money – a senior bank debt facility of GBP130 million and a mezzanine debt facility of GBP40 million. The mezzanine debt instrument did not carry a warrant entitling the mezzanine lenders to a fixed percentage of the equity value of the company, which is unusual, says Cottis. He adds that prior to CIBC’s debt syndication there were murmurs in the market that the ratio of bank debt to the purchase price was very high and that the absence of a warrant might be a problem. In fact syndication of both the senior and mezzanine facilities were successful with both said to be over-subscribed.

New twists

The growing CDO market has also helped diversify risk in LBO debt structures, adds Matthew Cottis of Lovells. He says CDOs are a relatively new entrant to the syndicated loans market, but they are already a significant player and will be important for liquidity. However, he says it remains to be seen whether borrowers and banks will have concerns in the future about whether in practice CDOs will approach decisions about proposed changes and deal with default scenarios in the same way as traditional senior and mezzanine lenders.

Michael Berry, managing director and head of leveraged finance global structured finance at West LB, says progress being made in terms of interesting deal structures is limited. “It is very hard to be imaginative to win a mandate in the light of a conservative syndication market. Being more imaginative in the 1990s, meant bringing in high yield bonds,” he says. But this has not quite taken off in the same way as in the US. Standard deal structure hasn’t radically changed. “You are still looking at a rough split of 50 per cent senior debt; 25 per cent mezzanine debt and 25 per cent equity although in today’s market, equity might be slightly higher and mezzanine a bit lower,” adds Berry.

As a result of a shortage of both deals and exits, refinancing has become more commonplace, says Berry. But this was not always the case. “Refinancing was very difficult to achieve historically because people were very suspicious of anything that repaid equity before debt,” he says. This has changed and it is now more acceptable with seasoned LBOs.


One of the more negative developments in the senior debt market is the way it has been standardised, says Berry. “The whole method of syndicating deals has changed.” The syndicates used to court the individual banks. Nowadays you hardly see the individual approach and a deal is more likely to be presented to an audience of around 20 to 30 banks simultaneously. As a result, there is a lot of gossiping and indecision with regard to participating in a deal. This has had a harmful effect on the market. Berry likens the whole procedure to a group of children at a swimming pool on a cold day everyone hovers around the edge and no one actually wants to take the plunge.

Berry’s gripe with the senior debt market is that the syndication approach is trying to standardise everything. There is a refusal to take time to understand a business. “You get deals slipping through that have a low multiple, but don’t necessarily have a good cash flow as well as the converse,” he says.

One deal affected by syndication nervousness, he says, was EQT’s CHF245 million acquisition of Leybold Optics from Zurich-based Unaxis Group. Several banks looked at the deal and didn’t want to do anything with it, said Berry. The group develops, produces and markets vacuum coating equipment for optical components in the fields of precision and spectacle optics, medical technology and telecommunications. It was thought the telecoms aspect of the group clouded many lender’s judgements on the company. The deal eventually completed in December last year and ended up going to Royal Bank of Scotland and West LB as joint lead arrangers of CHF150 million senior debt and mezzanine facilities.

A prime example of securing debt in tough market conditions is Candover’s CHF580 million MBO of Swissport, the airport ground handling business of the troubled Swissair group, which completed earlier this year. Charlie Green at Candover said: “There were very specific reasons why that deal was hard to place. We started looking at the process in August prior to September 11 and the receivership of Swissair. It was a very difficult time to find credit for any business in that sector. RBS did a good job, but did it in a club because they weren’t prepared to take the underwriting risk.”

More sophisticated?

While continental deal structures have traditionally been more conservative than in the UK, using less mezzanine and high yield, this is beginning to change. Last year’s Messer Griesheim deal is a typical example of the growing sophistication of leveraged financing on the continent. The acquisition by Allianz Capital Partners and GS Capital Partners of the 66.6 per cent interest in Messer Griesheim held by Aventis was a highly complex transaction involving the refinancing of around EURO2 billion of existing indebtedness. This included a EURO1.5 billion leveraged loan, EURO550 million high yield bond, and EURO400 million mezzanine financing. Debt was provided by joint lead arrangers Goldman Sachs International, Royal Bank of Scotland, JP Morgan and Bayerische Hypo-Und Vereinsbank.

According to Ernst & Young, sponsors and lenders are looking to be more creative in structuring transactions and tailoring funding to match businesses’ needs. Integrated finance solutions continue to grow in popularity, particularly in the small- to mid-market and more institutions are looking to provide products of this type. For example, Commerzbank has expanded its financial sponsors business in Europe and has set up a new financial sponsors group with plans for a European fund-of-funds business and a private equity investing business. Commerzbank’s head of capital markets, Mark Eban, said: “We see significant scope to expand our financial sponsors business in Europe. The recent addition of syndicated loans, structured acquisition finance and private equity to our capital markets platform completes the creation of an integrated product offering which gives us significant competitive advantage in this area.”

Commerzbank has already been active in arranging and underwriting leveraged transactions both in Germany and across Europe to the value of EURO1.378 billion. The group’s most recent deal is as lead arranger (alongside JP Morgan) for EQT’s EURO1.7 billion LBO of Haarman & Reimer, Bayer AG’s flavours manufacturing business. This deal, if it completes, looks set to put Commerzbank’s name in the top ten if not the top five, by value, of European buyout transactions in 2002.

Stewart Livingston, head of European corporate business at the Bank of Scotland, says the dynamics of the European private equity market are very interesting at the moment. There have been huge volume reductions across Europe by over 20 per cent, he says. However, total deal value has not witnessed such a marked decrease down by just under five per cent, and there has been an increase in average deal size from around EURO140 million in 2000 to EURO170 million in 2001. The UK still accounts for around 50 per cent of European deal flow, he says.

Bank of Scotland Corporate banking recently expanded in France with the appointment of Olivier Boyadjian to head its 15-strong structured finance team. The appointment of Boyadjian follows the team’s move to larger offices in 2001 and marks Bank of Scotland’s success in building a loan book of EURO1 billion since the bank began trading in France in 1996.

Olivier Boyadjian says the French market has been mirroring patterns in the rest of Europe. The last six months have been difficult, but the French market is rich and there is a lot of money for mid market deals in particular. “It is a very competitive environment for senior bankers and debt providers, but debt multiples are now at a more acceptable level,” he says.

He adds that a major weakness in the French market is due diligence, but this is improving. Securing debt-backing for buyouts is almost impossible without formal due diligence he says – without it, it is almost impossible to get through credit committees. Boyadjian is optimistic for the future of the French LBO market. “We haven’t yet reached a peak in the French market. I think the end of 2002 will be the best year yet.”

He mentions the SIA transaction as an interesting French deal completed in the past months. 3i acquired a majority stake in the home furnishings group in a secondary buyout from Chequers, formerly Charterhouse France for over EURO80 million. The mezzanine and acquisition debt was underwritten by the Bank of Scotland arranged as a mezzanine layer, senior debt and a working capital facility. This was quite sizeable as SIA had a significant working capital requirement. Overall the leverage was split 45 per cent equity to 55 per cent debt.

Bank of Scotland has adopted an aggressive growth strategy within continental Europe and also has offices in Frankfurt (since 1997) and Amsterdam (since 1999), as well as in Paris and throughout the UK. It also recently opened a new office in Madrid, co-located with Banco Halifax, which has had a presence in Spain for many years. The market is quiet in Spain at the moment. There is a lack of deal flow, but Stewart Livingston expects things to pick up. “We are not there for the short term. We don’t expect real results until at least 2004.”

The bank is not yet present in Italy, but has been contemplating Milan, although Livingston says Italy is struggling in terms of origination of deal flow with around 10 deals completed in 2001, compared to just over 30 in 1999. It is hoped that debt-burdened Fiat, the country’s largest industrial group may boost deal flow as it attempts to sell its assets to offset losses at Fiat Auto. This has already started with the EURO460 million sale of Fiat’s aluminium business, Teksid to a consortium of investors comprising Questor, JP Morgan Partners, Private Equity Partners and AIG Funds. The sale is part of Fiat’s strategy to cut its EURO5.8 billion net debt pile by some EURO3 billion by March 2003.

Livingston says the recent NCP transaction is illustrative of deals going forward. Cinven beat Apax to the EURO820 million acquisition of the UK car park operator from Cedant, US hotel and real estate group. It was thought Apax had sealed the deal for EURO800 million. This is a prime example of the fierce competition in the private equity market, says Livingston. “There are too few deals at the moment for the availability of both equity and debt.”

Eric Mallaroni, head of leveraged finance at Royal Bank of Scotland, agrees deals have been few and far between in the last six months. However, in the space of two weeks this summer RBS won the mandate for three deals including the aforementioned NCP transaction, the GBP288 million acquisition of Priory Healthcare Group with Doughty Hanson, (which required the provision of a GBP255 million funding package) and the public-to-private of Kunick.

“There is no such thing as cheap debt in the LBO market. The only way you get better pricing is by meeting your forecasts,” says Michael Berry of West LB. Eric Mallaroni holds the same view: “Banks will only lend on the back of satisfactory forecasted cash flow.” He also lists debt multiple, equity injection and market standards as key deciding factors. But he is optimistic for deals this year: “There are some deals of Cognis and Messer size already in consideration.” He foresees more large ticket deals with the average deal size increasing in France and Germany. RBS achieved a significant step last year in increasing its focus on larger deals with the Messer and Cognis transactions, but Mallaroni stresses the bank still wants to retain an upper hand in the mid-market segment.

Mallaroni explains RBS’ positioning in the LBO debt market. “We are now more focused on large deals, but still want to continue our leadership in the mid-market because, particularly in Spain and Italy, you don’t find deals at the larger end of the spectrum.” He added: “If we want to be credible for private equity players in these markets, we have to be ready to back deals of any size.”

From London, Mallaroni and Euan Hamilton oversee the whole of RBS’ structured finance European operations and encompass the whole spectrum of deals with a 150-strong team. RBS recently made its debut in the US market where it set up office in New York last October. The mid-market is an attractive sector Stateside, says Mallaroni, as there are few US banks working in that space because they are all after the mega deals. This is where RBS hopes to step in.

Mallaroni concludes that the debt market is far from dormant, it is actually more of a clamour to get the right deal. He says: “We are entering a strange environment where there is not a good visibility of what is happening over the next few years. But the market is healthy, the banks still have to make money and the market is still attractive as long as you can manage money and risk.” Lenders are frustrated by the shortage of deals, but high competition for assets should encourage a steady deal flow.