Two recent LBOs in the US market, the $1.3 billion buyout of retail company Linens ‘n Things by Apollo Management and the $1.8 billion buyout of school supplies company School Specialty by Thomas H Lee partners and Bain Capital, have both been structured to give the sponsors a way out.
The School Specialty deal fell apart in October, partly because the sponsors inserted a rare clause in the buyout agreement that made its completion contingent on extremely favourable financing conditions. The sponsors could get out of the deal if Libor went above 4.5% for three consecutive days between September 15 and October 30. The Citigroup high-yield index spread could not go over 430 basis points for three consecutive days in that period either. The weakening of the leveraged markets, and particularly the high-yield bond market during that time, allowed them to walk away.
Margins must have been tight for the deal’s success to be conditional on the leveraged market providing such cheap financing, as it has done for much of this year. But it could also indicate that the sponsors were not convinced of the merits of the company and wanted an excuse to get out of the deal between announcement and completion if its financial performance got any worse.
This is certainly the case with Linens ‘n Things, announced in November. The successful completion of the transaction is conditional on its earnings performance. The company must achieve Ebitda of at least $140 million in 2005, while its sales cannot drop more than 6% in the third quarter.
Leveraged bankers say that a combination of more and more sponsors chasing too few deals, increasing leverage multiples and less certain conditions in the leveraged markets have led to sponsors agreeing to takeover targets, but then inserting clauses that allow them to get out of commitments if things turn sour.
It could be a sign that the sponsor community is now more discerning about the merits of individual companies and are not prepared to plough their money into dubious or highly geared transactions without conditions attached. Or the inclination to invest in companies they suspect already to have weak financials suggests sponsors are becoming desperate to get ahead of an increasingly large pool of competitors and put their money to work.