Don't bank on it

According to sources, around £90bn of leverage loans are up for refinancing this year in the UK. A sizeable figure, and one for which there is insufficient liquidity. "People assume that if the business is performing well operationally, the institution will roll over funding. But the liquidity may not be there - particularly in the case of European banks. Not everyone realises the true refinancing risk, and it is likely some very good businesses will go down this year and next as they run out of money," says Martin Bishop, partner in the banking and finance team at law firm Pinsent Masons.

Without adequate funds to refinance existing deals, leveraging new deals will also inevitably face challenges - where will the debt come from? "Banks have pipelines, but getting real traction and building volumes with private equity is taking longer than this time last year, so many are likely to have some dry powder entering the second quarter," says Ian Sale, managing director at Lloyds Corporate Markets, who is responsible for the bank's mid-market leveraged finance team in London.

There is precious little now, and even that may not last. One practice being employed by investment-grade products (which buyout houses may do well to look at) is a forward-start facility. This is when a company approaches its lenders well ahead of its refinancing deadline to lock in commitments, allowing the borrower to avoid missing the boat (or having unfavourable terms forced upon it), while simultaneously allowing the lender to get fees early on.

Relationship management

This is assuming you'll get the funds - a risky assumption in today's market. Where they do lend, the terms are very different: pricing increased; maturities shorter and amortisation back. There is also a widespread belief that if you're not already 'in bed' with a bank, you're not likely to get near them. This is partially true, though a strong sponsor relationship can supplement a non-existent target one. "If we have a strong relationship with a sponsor and they introduce us to a new business, we are happy to look at it," says Neil Rudge, managing director at RBS Corporate and Structured Finance. "It's important to us to back both our existing corporate clients, and those sponsors we have worked closely with for many years." In fact, RBS has backed half a dozen deals so far this year, half of which were with new clients. RBS's recent announcement to retrench from leveraged lending does not affect its mid-market service (see cover).

The need for relationships has some shaking in their boots, with a few reporting large buyout houses wining and dining banks more than ever. "Most banks are standing by sponsors they feel have stood by them in the good times, because the trust is there," Bishop says.

But even if you are cosy with a bank you're not guaranteed entry. In fact unquote" has noticed a marked increase in queries for GP performance as banks re-assess relationships with sponsors. So if you have a company that has breached a covenant and you're at loggerheads with the bank over how to handle it, that bank is unlikely to back another one of your deals anytime soon. One debt adviser points out: "It is no longer simply about gaining market share, as was the case in 2006 and 2007 - now it is about ensuring you are partnering with a buyout house with a solid track record - not just for previous funds, but for its current fund. How much of it is under water? How does it behave when a company is struggling?"

Banks as vendors...

Banks will come to the fore this year - as a source of dealflow, with an increasing number of targets coming under the ownership of their lenders as sponsors' equity is eroded. HBOS, for example, took over West Coast Capital's 40% stake in Wyevale garden centres over Christmas after pumping a hefty £360m into the company in the original buyout in 2006. Discussions are currently underway with a number of other private equity-backed companies to do something similar. But to what end?

Debt-for-equity swaps are unlikely to result in many companies well placed in the arms of their erstwhile lenders, since few leverage teams are experienced at growing a company. In the few instances where banks have an equity arm, assets can be re-homed there (a number of industry players cite Barclays parking assets in Barclays Ventures as an example). This could allow the venture arm to work closely with the assets and potentially extract some upside while saving the businesses.

But most banks lack this resource. "Banks are only just beginning to realise what they're up against," one corporate financier comments. "As a result, many erstwhile leverage lenders are being re-sprayed as recovery and restructuring specialists."

And it is not just bankers changing their spots; their advisers have to adapt, too. Says Bishop: "Clients we advised in a leverage capacity are now sitting in recovery units. We are following them, just as in the previous downturn." In the last slump Bishop worked on a number of administrations. "Many skills of bankers and their advisers are perfectly suited to restructuring. New security has to be put in place, new documentation put together. Leverage lenders and their advisers are all qualified to do this alongside their insolvency specialists," Bishop says. Sale concurs: "The skill set is complementary; both roles require negotiation skills, structuring capabilities and the ability to have commercial and sometimes robust conversations with private equity."

Industry players thus predict a swathe of banks selling companies they've acquired in such loan-to-own scenarios. While this could prove rich pickings for hungry houses - prices offered by banks are likely to be less pie-in-the-sky than founder-owners, whose expectations often lag reality - it's worth remembering banks are now choosier about their partners, likely to reward deals first and foremost to their most loyal (and best performing) sponsors.

... and pension funds as lenders

On the investment side, some of the gap left by banks could be filled by untraditional lenders, with debt funds scoring high in the popularity ranks at the moment. European intermediate capital lender ICG reached a sizeable first close of EUR875m in October 2008 for its Recovery Fund, which will invest in leveraged loans on the secondary market. It has already done a couple of deals. There are also indications that Santander is entering the UK leverage market, with Abbey having pumped money into the Smollensky's deal at the end of last year, just months after Abbey hired RBS's business banking head Steve Pateman.

The gap may also soon be filled by pension funds, according to Rafael Stone, Board of Regents, Washington State University. He claims that a handful, particularly in the US, are looking to invest in this space. These pension funds should have a leg up: while traditional fund managers will have to seek third-party funds over the course of this year with a view to investing (at the earliest) in 2010 and beyond, the pension funds can invest their own money, meaning they can begin investing now, during what many deem is the strongest window of opportunity. To boot, pension funds will likely invest alongside GPs they know intimately from previous funding commitments, meaning the relationships are already there. Finally, it may be that returns from their debt investments will outshine those from their private equity commitments of the last couple of years.

Upping the stakes

For now, though, funding remains scarce. Buyout value in the UK in the last three months of 2008 was down 93% to less than £400m and things are not looking any better now. "Right now, we see very few deals happening above the £250m EV mark, partly as it remains very tough to raise more that £100m in the debt markets," Rudge says. "However, there is still appetite up to that level, and we are seeing improved levels of introductions in the up to £100m EV range."

As a result, equity proportions are on the up. LDC's latest deal illustrates the increasingly equity stake sponsors are putting in buyouts: LDC pumped in £14m towards the £32.5m buyout of Quantum Specials last month, with senior debt and working capital provided by Yorkshire Bank Corporate and Structured Finance.

Some equity stakes may even increase to the tune of 100%. In the second half of last year, RJD Partners bridged a buyout by underwriting the entire enterprise value for IPES, bringing Lloyds TSB on board with the debt just a couple of weeks later. "The vendor wanted to see the money on the table and just negotiate with private equity," said Sale.

Indeed, all-equity deals are flavour du jour, comprising 40% of all the buyouts done in the UK in the fourth quarter of last year. These are not new - they used to be done to bridge the debt funding, a la IPES, or with existing debt rolled over from incumbent backers. However they're now increasing as sponsors realise that now is the time to acquire quality businesses at low multiples, with or without leverage.

A lack of debt isn't the only reason to underwrite the entire enterprise value - sometimes doing so expedites things and so wins over the vendor. UK mid-market buyout house Dunedin reports average gearing on its portfolio of a modest 3x EBITDA. Nevertheless it has explored going it alone, and did the first of four all-equity deals back in June 2007, when debt was still plentiful.

"We offered to fully underwrite the Fernau Avionics transaction in order to win the deal," Giles Derry, director at Dunedin, says. "The vendor was Glendale, a listed Canadian company, and needed to sell within a certain timeframe. We put the structure together, without any debt offer, putting in a notional amount of senior, and 8-10 weeks later refinanced with Lloyds." The £16m deal saw Dunedin ultimately put in £8m for a significant majority stake, and traded "ahead of plan" throughout the holding period, ultimately resulting in its £32m sale to US trade buyer Moog Controls last week. Another of Dunedin's all-equity deals remains debt-free: the buyout house pumped £9.3m into Formaplex in December 2007 for a large minority stake.

Just as efficiency and certainty of execution can persuade a vendor, all-equity deals can help lenders. "If you've written the whole cheque, you can often get better terms on the debt at the recap, since the lenders are impressed with the confidence you've demonstrated and have more time to get to know the business and look at due diligence and actual results." Derry points out. "I think this does support the confidence of the private equity house, and also allows time for the buyout house to implement some of its initial business plans and demonstrate the robustness and potential of the business, both of which should improve the ability to raise debt in the market," Rudge adds.

Where a business will support an element of leverage but the GP wishes to fund the deal all on equity on day one, Sale recommends getting the bank funding in place as quickly as possible. "Run the banks in parallel, sharing things like due diligence, so that the leverage comes in just a couple weeks after completion. If you approach banks only after you've completed, you could lose valuable momentum and with a dip, say, in the company's current trading you might end up with less debt than originally envisaged, with a consequent impact on returns.

Despite the apparent benefits of all-equity deals - certainty of execution being at the forefront - they remain scarce. "There are a lot of people talking about them now, but we haven't seen many others in our space do them," Derry says.

The rest of this year is thus likely to see more equity - in the form of lower debt multiples in capital structures, as well as these all-equity deals. Behind the scenes, those dealing with banks will therefore be focusing on terms and conditions. "It is extremely important to get terms and conditions right at the onset," Bishop stresses. "There has been a mindset that you could go back to the lender for consent later, if need be, and it was largely true. But now waivers will cost you, potentially a lot, if they're available at all. Things have really changed."

Rich pickings

Stock markets are increasingly attractive for deal sourcing, as the depressed valuations make for rich pickings. A recent study conducted by BDO Stoy Hayward reveals that a staggering 94% of private equity houses will consider take-privates in the next two years, with the consumer sector appearing particularly popular. Permira has just done this (and broken the size barrier) with its $3.6bn take-private of set-top box maker NDS Group. With revenues of $820m for 2008, the multiple appears refreshingly healthy - and the sponsor was able to secure senior and mezzanine for the deal, due to be syndicated this month.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Financing
• UK / Ireland