Fitch highlights growing risks of recapitalised European LBOs

Fitch Ratings, the international rating agency, says lenders to recapitalised European leveraged buyouts and secondary buyouts are facing increasing refinancing risk. This is being caused by back-ended senior debt amortisation schedules and larger non-amortising junior debt tranches, both of which are facilitating increasing leverage multiples. In a sample of recent secondary deals, the proportion of senior term loan B and C (TLB/C), typically eight and nine-year non-amortising loans, has increased to account for 53% of drawn senior debt, relative to 37% for their original buyouts. Meanwhile, average total debt/EBITDA for the sample increased to 4.8x from 4.3x.'Increasing appetite from institutional investors has translated into larger B and C senior debt tranches and high levels of demand for mezzanine and high-yield bonds. The increase in financial debt is outpacing EBITDA growth in many secondary deals,' says Pablo Mazzini, associate director in Fitch's leveraged finance team. The agency highlights the medium-term risks of delaying debt repayment, particularly when the majority of secondary deals have occurred in industries characterised by a high degree of cyclicality. Despite the short-term cashflow flexibility they afford, back-ended debt amortisation profiles, coupled with more limited potential to cut costs and improve freecash flow generation, are likely to translate into slow de-leveraging. When Grohe, the German sanitary fittings manufacturer, was sold in September 2004, its strong recent operating performance enabled the new sponsor to increase total financial leverage to 6.3x, a significant step-up from the 4.2x in the April 2003 recapitalisation. The TLB/C accounted for 71% of the senior debt package, significantly higher than the 18% in the 2003 deal. Grohe also issued a €335m high-yield bond to refinance the existing €200m high-yield bond.Picard Surgeles, the French food frozen retailer, was sold by Candover to BC Partners in December 2004 (Page 17, November/December). Total debt/EBITDA stood at more than 7.0x and included a proposed mezzanine loan that is three times larger than the previous junior debt facility. While recognising the stability of food demand, total leverage was, however, much higher than the 5.9x seen at the time of the refinancing in April 2004. Secondary transactions are also occurring more frequently. Of the 98 European buyout transactions that Fitch has rated in the first 10 months of 2004, 42 were secondary deals, more than double the number seen in the same period last year. This is being driven by the ability of sponsors to increase financial leverage multiples in the current leveraged credit markets. Moreover, the timescale between the first buyout and the secondary transaction has been very short in a number of instances in 2004, notably Grohe (18 months), Linpac (14), Rodenstock (12) and Picard Surgeles (7).

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