EUROPE - YELLing about debt

YELL's current credit conundrum may illustrate the lag between doing deals and truly encountering debt woes, and may thus prove a harbinger for deals structured in the heyday of 2006-2007. Never mind that the £3.8bn debt mountain it is looking to restructure is being done via scheme of arrangement owing to some feisty creditors, meaning the majority (there are 300 in all) are likely worse off than if majority had ruled initially - what about the company? The consent fee alone for this is more than £40m.

How did YELL get here? Eight years ago, BT's spin-off of directories business YELL marked Europe's largest-ever LBO. Apax Partners and Hicks Muse paid £2.14bn for the company, shelling out another $600m the following year to bolt on McLeod. While eyebrows were raised over the lofty sums being thrown about, the investors more than doubled their money with a successful IPO in July 2003, fully exiting in January 2004 - less than two years after the initial acquisition.

A true private equity success story, which catalysed a slew of directories buyouts across Europe. The 2006 buyout of France Telecom's directories business PagesJaunes by KKR and Goldman Sachs Capital Partners was the first deal in Europe to contain leverage equivalent to 10x EBITDA.

YELL's backers' returns came, unsurprisingly, off the back of a lot of leverage. Earlier this year a former Merrill Lynch exec (Bob Wigley) was named NXC and tasked with restructuring. He was quoted as saying "It has got the wrong capital structure but Yell is a fundamentally good business." Shortly after he was appointed, it was reported that YELL was considering a rights issue to raise funds after suffering a loss last year of £1bn, and writing down its Spanish arm by even more. That issue looks set to raise £500m to bring down debt.

This is not surprising. The buyout was funded with £950m of debt, £500m of high yield and £549m in equity. A capital structure containing 'just' 25% equity was deemed heady back in 2001 - such a sum would have been standard or even high in 2005-2007. But they have far to fall.

Earlier this year PagesJaunes saw its CEO replaced after 13 years at the helm, and there is no exit yet in sight for its backers.

The most unfortunate aspect of these deals is that they may serve as a barometer for the health of those done more recently. Unfortunately, despite signs that deal-doing is picking up and widespread headlines of an autumnal glut of IPOs, YELL's experience indicates that more defaults and write-downs lie ahead.

Moreover, the deal is a cautionary tale of the long term prospects of businesses that are exited at a profit for private equity, but without debt being reduced. This is particularly prevalent now, with the private equity backers of three LBO-acquired UK businesses announcing plans to float in the coming months: Pets at Home (Bridgepoint), New Look (Apax, Permira) and Gartmore (Hellman & Friedman).

These businesses are performing well, but they remain heavily indebted and will need to begin repaying loans in the next few years. By then they may already have gone down in history as private equity success stories as was the case with YELL, but their legacy for the industry may be considerably different. At a time when the asset class is under intense political scrutiny over its impact, the long-term health of portfolio companies post deal could become all important.

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