It is ironic that CVC is leading efforts to keep hedge funds from acquiring loan assets in its portfolio companies in the secondary market. In fact, hedge funds are leaving the market at the moment, making issuers more dependent on traditional investors to fund the incoming round of LBO financings.
It is still early days to say how individual buyout deals will be affected, but bankers and investors are looking ahead to prospects for upcoming LBOs including Travelex, Amadeus and Sanitec, and deals that recently entered the market such as Grupo Coin.
The emerging consensus is that high-yield liquidity will be around at the right price and that the window of opportunity for cheaply priced second lien loans may be closing. The net effect for private equity is that portfolio companies face higher financing costs, while opportunities for top of the market dividend deals like Debenhams’ are receding.
The auto sector downgrades sent the iTraxx immediately wider by 40bp, to 350bp, on May 4, a pre-emptive move after a week of soft trading in the high-yield market. The move compounded an already uncertain demand picture, with ongoing mutual fund outflows and the retraction of the hedge fund bid. About €20bn of euro-denominated Ford debt and €30bn of euro-denominated GM/GMAC debt is set to disturb the roughly €100bn European high-yield market.
“The anaemic new issue market in Europe is vulnerable to closure in the near term, at least until a market repricing has occurred,” BNP Paribas said in a research report on May 5. Single-name CDS in European high-yield had already been pushed 15bp to 20bp wider on the downgrade news.
Bonds to help finance Lindsay Goldberg and Bessemer’s buyout of German steel trader Kloeckner were early casualties of the conditions. While a €520m loan had already closed successfully, the bonds were delayed then rejigged as market sentiment started to weaken.
The issuer had to rehash covenants, size and pricing ahead of the close. Kloeckner downsized the 10-year, non-call five senior notes to €260m from €350m after the €50m dividend payment carve-out was scrapped, and the sponsor agreed to pump in an extra €40m of equity, upping the total equity contribution to 29%.
The restricted payment general basket was also reduced, from €25m to €15m, while the permitted investment basket was cut from the greater of €65m or 3.5% of total assets to €50m. Price guidance, which started at 9.75%–10%, was also widened to 10.25%–10.5%. The B3/B– rated deal came at the top end of talk at par, equal to a spread of 715bp versus 3.75% DBR due April 2015.
A number of traditional high-yield accounts revealed that they had placed orders for the original deal, albeit on a small scale, and the leads suggested that the order book was half covered before the amendments were made. In the end, the book was 1.5x subscribed and anchored by a handful of traditional high-yield buyers.
The high-yield market is also reacting to cash outflows from the asset class and fears over the performance of the global economy. Iesy postponed plans at the end of May to sell its €525m 10-year, non-call five bond due to the stormy market conditions. Unsurprisingly, investors are also placing smaller orders for deals than they were a few months ago.
The loan market has been typically less volatile, but the focus is also shifting to traditional investors there, with the hedge funds in retreat. Investors sensed a slight correction last week at the more volatile second-lien end of the market. Second lien is also softening in the aftermarket, with telcos generally moving down a couple of points.
The next casualties?
The reaction in the bond market means that Apax and Texas Pacific might want to reconsider plans for a bond-heavy deal in support of the €1.1bn purchase of an 81% stake in TIM Hellas, the Greek-based telecom.
Citigroup and Deutsche have also been pre-marketing a £150m–£200m bond for Apax’s €1bn buyout of Travelex for more than a week. Feedback has been lukewarm, high-yield sources said.
LBOs are driving the bulk of more plentiful deal-flow in the leveraged loan market. If there is any deal that will test reactions there, it is Debenhams’ £2.05bn recapitalisation facility.
Debenhams has been a fantastic result for CVC, Merrill Lynch Private Equity and Texas Pacific, which paid £1.9bn for the retailer in 2003. The sponsors had already extracted a £200m dividend ahead of the latest £800m payout, courtesy of underwriters Citigroup, CSFB, Morgan Stanley and Merrill Lynch. Those banks are now in the firing line with the ensuing loan deal. They are banking on the company’s strong track record and investor following to offset conditions on what has been universally dubbed “a challenging structure”.
Pricing is an unremarkable 225bp over Libor on the £150m revolver and £480m term loan A, 275bp on the £560m term loan B and 325bp on the £560m term loan C. The £300m second-lien tranche has raised eyebrows, however, at 450bp over Libor.
“The arrangers have got their hands full on this one,” said a CLO investor. “The market has cooled and, with hedge funds drawing back, they will need traditional investors more than ever before. We’re also inclined to be more selective ourselves about second-lien lending.”
The arrangers accepted that the deal was aggressive, although they argued that pricing was “on-market” and that the company and management had a strong following. Leverage is also aggressive for a company operating in the notoriously difficult UK retail market. Total net debt to Ebitda is 5.6x, while senior net debt to Ebitda is 4.7x.
There is even more mileage for the sponsors going forward, as Debenhams is considered a strong IPO candidate. Only selected existing lenders have been approached to sub-underwrite the deal for an MLA title and the deal will launch to a wider syndication next week.
Sanitec could be an even bigger second-lien flashpoint. EQT mandated RBS to arrange €1bn for its secondary buyout of the bathroom products manufacturer from BC Partners. Mizuho Corporate Bank and HVB Group joined as MLAs ahead of launch, and Nordea as a JLA.
There is €880m of senior debt split into a €340 seven-year term loan A at 225bp over Euribor, a €225m eight-year term loan B at 275bp, a €225m nine-year term loan C at 325bp, a €40m seven-year revolver at 225bp and a €50m seven-year restructuring line at 225bp.
The remaining debt comprises a 9-1/2-year €135m second-lien piece, for which pricing has not yet been fixed. Market talk suggests that original plans to price the tranche around the 425bp mark have been revised to allow the deal to flex upwards to as high as 550bp. Leverage is 5.75% total, 4.9x senior, reflecting the sponsor’s 33% equity in the deal.
Sanitec already has an investor-friendly feature on the senior tranches too. Unlike most LBO facilities, pricing on the term loan B does not ratchet down with leverage improvements. The outcome was applauded as a win for investors.
Sponsors face a more daunting environment if the correction in the second-lien loan market solidifies for any significant period of time. Debt investors are hoping that prolonged volatility will close the second-lien window altogether, sparking a return to higher-yielding mezzanine debt.
“There have been a number of cases where arrangers have sold cheap mezzanine and called it a second-lien loan. Let’s hope that there are some aggressive upward flexes from here on in and that mezzanine will be sold as mezzanine as a result,” another CLO manager said.
For a snapshot of the mezzanine market, look no further than Grupo Coin. Barclays, Calyon and Mediocredito are arranging a €600m loan for PAI’s buyout of the Italian retailer. Senior debt comprises a €120m seven-year term loan A at 225bp over Euribor, a €100m eight-year term loan B at 275bp, a €100m nine-year term loan C at 325bp, a €150m seven-year revolver at 225bp and a €40m seven-year capex line at 225bp. There is also €90m of mezzanine debt.
Total net debt to Ebitda is 4.3x, while senior net debt to Ebitda is 3.4x. Two tickets are offered. Co-arrangers committing €25m will receive 75bp and managers committing €15m will receive 60bp.
The deal has been compared with PAI’s previous buyout in the retail sector, when the firm acquired Vivarte, the French-based fashion chain, in April 2004.
“I’ve heard mixed opinions on the deal. We have questions about the management team’s track record because they are right at the start of their turnaround,” an investor said.
A couple of lenders said they would like the mezzanine tranche to contain warrants to provide a share in upside on top of the 10.5% coupon.
Another investor acknowledged PAI’s experience and track record in the sector, but added that Grupo Coin’s market share was poor in comparison to Vivarte’s and that the latter company was further advanced against its turnaround at the time of buyout.