Vintage Debt Is Just As Good As New

In economic downturns, it’s a natural for people to stretch the lifespan of certain products or shop at second-hand stores for items they might otherwise have bought new.

Now, thanks to the drawn-out credit crunch, buyout shops have been inspired to do the same when seeking acquisition financing. Rather than attempting to line up a new debt package with a new lending club, some firms are striking deals with their target’s existing lenders—getting waivers on change-of-control covenants that would otherwise trigger repayment of the debt once the company’s ownership changed—and simply rolling over the on-hand leverage into the new deal.

A recent example is Court Square Capital Partners’s June acquisition of Wyle Laboratories from Littlejohn & Co. Rather than lining up a new lending syndicate to acquire the company, Court Square Capital obtained approval from a majority (51 percent) of Wyle’s lender group, led by Wachovia and CIT Group, for the company to be sold—leverage and all—in exchange for increased pricing on the debt.

“It’s something we think more firms with capital to put to work will be looking to do as the credit markets remain weak,” said James Westra a partner at law firm Weil, Gotshal & Manges LLP, who regularly represents private equity firms on the buy-side.

Though it depends on the individual agreement, obtaining a waiver on a change-of-control covenant typically only requires approval from 51 percent of a company’s debt holders, said Douglas Warner, a partner and senior member of the private equity practice at Weil, Gotshal.

“That’s the nice thing—you don’t need 100 percent approval,” he said. “You can, in effect, drag along the non-consenting lenders, assuming you get the requisite majority.”

Attractive as these deals might be for prospective buyers in today’s market, there are some natural constraints—perhaps the biggest of all being debt maturity. It typically only makes sense to do a debt change-of-control waiver deal when the maturity on the debt in question is still another four to five years out, otherwise firms run the risk of hitting refinancing problems shortly after they make the acquisition.

While the incentive for the sponsor is obviously the fact that they don’t have to try to cobble together a financing package in today’s market, the motivation for the lenders is primarily around better rates. In exchange for a change-of-control covenant waiver, lenders stand to receive a typical rate increase of a few hundred basis points, the imposition of a Libor floor if there wasn’t one before, and other changes to tack on additional covenants.

According to Warner, sponsors might have the best luck convincing lenders to waive the change of control covenant if the target company currently includes covenant-lite loans in its capital structure.

“If there are no current covenants, then it’s a further inducement for the lenders to agree to the deal because, in addition to the better economics, they can add covenants.”

In the case of Court Square Capital change-of-control deal, pricing on Wyle’s $166 million first-lien term loan due 2014 increased by 175 basis points to Libor + 600, while the company’s Libor floor remained unchanged at 2.5 percent, according to Thomson Reuters LPC. The deal also included an amendment fee of 25 basis points.

Court Square Capital declined to comment for this story.