Will Boots walk?

Leveraged financiers turned out en masse for the bank meeting at Gibson Hall, London, as syndication proper of the more than £9bn Alliance Boots LBO debt package got under way.

Just a few weeks ago, the leads could perhaps have been easily confident of a successful deal but with a palpable investor pushback in the face of a US credit downturn, success of a deal of this size can no longer be taken for granted.

One institutional investor’s immediate response was particularly unimpressed. “It’s fair to say our initial reaction is not great,” he said. “It looks like a stretch too far.”

Another well-known investor was more positive, adding: “The credit is well-liked and investors want to do the deal, but I will be surprised if it gets through the market without some pushback.”

The challenge of syndicating such large, overwhelmingly sterling denominated tranches adds to the difficulty.

“Most sterling buckets are full; investors will have to exit existing investments to buy the deal,” said one investor.

The bookrunners, however, remain sanguine, with one saying: “The market is fundamentally healthy and European liquidity is not under threat.”

While conceding that “the current technical correction will see some smaller deals struggle”, he insisted: “Alliance Boots is offering good yield and good call protection. It is also well sponsored by banks.”

The leverage itself is 5.2x Ebitda through senior debt and 7.2x through total debt – a record for a retail buyout. And with an Ebitda of just 1.7x interest, there is little room for underperformance.

However, there is some comfort for investors with the inclusion of debt to Ebitda maintenance covenants, a vital and expected concession in an otherwise covenant-lite structure.

Bookrunners, though, have been at pains to reiterate that the company is not a pure play retail offering.

Richard Ratner, a retail analyst and vice-chairman of Seymour Pierce, agreed, saying: “There really are no leveraged businesses comparable to Alliance Boots. It is not a straightforward retailer, so it is incorrect to compare it to New Look for example.”

Ratner is less convinced by suggestions the business is not to some degree cyclical. “Half of the retail business does have steady Ebitda, so it is certainly less cyclical than an ordinary retailer,” he said. “On the other hand, the wholesale division is a low margin business.

“Even that side of the business can be subject to regulatory pressures – as has been the case with the French drugs distribution business. This kind of leverage is still pretty mind-blowing.”

The breakdown of Alliance Boots revenues in the year to March 2007 showed £9bn or close to 54% of revenues came from the group’s wholesale operations, compared with £6.6bn or 39% from the retail business.

In terms of profits, the wholesale business generated just 26% of group profits compared with the whopping 70% of profits generated by the much higher margin high street stores.

Pricing wise, the senior debt looks attractive, offering term loan B lenders a margin they could only have dreamed of on a major LBO financing just weeks ago. The huge £5.05bn eight-year bullet Term Loan B pays 275bp over Libor with call protection making it non-call 18 months than at par.

Fees to bank lenders are also fairly chunky. For a £100m ticket bank lenders earn 50bp on the bridge and 100bp on the TLB and revolver, £75m for 42.5bp and 85bp or £50m for 35bp or 75bp. (For full breakdown see IFR 1690 p65)

Junior and subordinated facilities offer far less generous margins and could be the focus of any resistance. A £1bn nine-year bullet second-lien facility pays 400bp over, with call protection making it non-call two year, then at par.

The most junior piece, a £750m 10-year bullet subordinated facility, pays 600bp, non-call three years then at par. Bookrunners may find themselves glad of the equity bridge, which may well be offered as a sweetener to get anxious investors over the line.

Secondary concerns

The pressure to gain commitments in the primary market will be made more difficult by the ongoing credit correction, which has hit European secondary loan markets especially hard.

Falling secondary levels have meant real pain for some investors over the past two weeks, which will have disabused anyone of the notion that deals will inevitably trade up to 101 on the break.

With secondary prices under pressure and the size of debt to be syndicated, there is little likelihood of huge oversubscriptions and investors are likely to be extra disciplined in placing orders.

That in turn will take some more heat out of the potential secondary market, with one source suggesting that a 1-1/2 times oversubscription is necessary to ensure real secondary liquidity.

Prosieben’s recent €7.9bn debt package is a key case in point. Once freed into secondary the deal traded down quickly to a sub-99 context, priced as it did on the cusp of the credit crunch after arrangers secured agreement to a reverse price flex.

After some recovery the junior pieces are back above par but the senior holdco and opco tranches continue to trade in a sub-99 context. The deal was just one among many affected in a fortnight of volatility in the secondary loan market.

The arranging team of Alliance Boots MLAs make for a formidable line up. Deutsche Bank, JPMorgan and UniCredit (HVB) are mandated as global co-ordinators and physical bookrunners on all facilities.

Barclays is physical bookrunner on the senior facilities and bookrunner on the subordinated facility. Citi is bookrunner on the subordinated facility. The MLA group also includes Banc of America, Merrill Lynch, RBS and Morgan Stanley.

However, one leading investment banker noted darkly that with the secondary market in turmoil such a large group could mean no-one takes the lead on the break.

“Investors should now look at who is syndicating deals and look at who is showing leadership in secondary,” he said.