Incredible levels of investor liquidity are allowing private equity funds to weaken loan covenants, maintain high levels of leverage and obtain extremely attractive price terms on deals despite concerns about when the credit cycle will turn.
Barclays Capital research estimates that private equity firms have $160 billion to invest this year, which translates into potentially $500 billion to $750 billion of leveraged buyouts. Already this year more than $120 billion-worth of LBOs have been undertaken, compared with $360 billion in the whole of 2006. But despite the threat of huge supply, pricing is increasingly taut. First-quarter volatility has been quickly forgotten as loan and bond spreads return to all-time lows.
So in mid-April there was much optimism about the European pipeline of announced deals, with more being readied. The largest announced transaction was the $1.2 billion financing for the buyout of the UK’s Coryton Refinery by Petroplus. Morgan Stanley, Credit Suisse, UBS and Barclays Capital bookran a two-tranche (seven-non-call four and 10-non-call five) deal worth $1.2 billion in conjunction with a $565 million equity offering. Another sizeable leveraged buyout that entered the bond pipeline was that of Countrywide, which will involve £1 billion ($2 billion) of high-yield bonds being issued via Credit Suisse, Deutsche Bank and Goldman Sachs.
There were also a number of modest-sized transactions such as the €200 million perpetual hybrid for Pfleiderer, a German wood products manufacturer, via ABN Amro and Barcap.
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"The whole capital structure is provided by institutional investors in the form of credit and hedge funds – from the senior secured debt to the synthetic equity – a dream for institutional placement" Andrew Watkins Ball, Citi |
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Hungarian Telephone and Cable Corp lined up a €200 million floating-rate offering, via BNP Paribas, Merrill Lynch and Calyon – the remnants of its LBO of Invitel. Nexans announced a €300 million fixed-rate bond via BNP Paribas, SG and UBS.
One of the more interesting deals involved a South African casino operator called Peermont Global. This deal has a highly interesting structure and credit story. Brought by Citi, the deal is the first public-to-private black empowerment deal and the latest in a round of buyouts in South Africa. It is also one of the first emerging market PIK notes and the first public local currency PIK.
International investors’ continuing reach for higher-yielding assets plays a large role in explaining the success of this deal. Pricing at 7.75%, it offered something in the region of a 12.5 to 25 basis point premium according to Citi. Comparisons with similar rated gaming operations based in Europe, such as Codere, show a premium in the region of 100bp. But such assessments are not straightforward given Peermont’s unique credit.
Because South Africa’s institutional bank market is not developed, these early LBOs will be funded entirely by equity and high-yield bonds sold to hedge funds in search of alpha.
"The whole capital structure is provided by institutional investors in the form of credit and hedge funds – from the senior secured debt to the synthetic equity – a dream for institutional placement. We replaced the need for local bank debt, which has historically had highly restrictive terms for issuers," says Andrew Watkins Ball, head of high-yield syndicate at Citi.
Peermont was bought by a group led by the Mineworkers Investment Company. The LBO package included a rand-denominated structured equity portion (R1,086 billion – $153 billion). The refinancing had two tranches – split €520 million of senior secured B rated seven non-call three notes and R887 million of eight non-call three PIK notes rated B3.
There are other LBO financings in the works and high-yield bonds from South Africa should total between $5 billion and $10 billion equivalent in dollars, euros and sterling between this deal, the recently completed Consul Glass, and others lined up for the next couple of months. (See Private equity: Bain and Actis hunt big game in Africa, Euromoney, April 2007)
"I think investors have recognized that traditional high-yield supply is limited. The conventional western European market is producing far fewer high-yield bonds than investors would like and they have welcomed a new source of high-quality issuance," says Watkins Ball.
Behind the pace
"In Europe we are slightly behind the pace of last year – €5 billion has been issued in high yield so far compared with €7.5 billion [during the same period in 2006] but I think we are going to catch up very quickly with the seven deals in the market currently. What is also important is the fact that the US is running ahead of last year. US issuers are responsible for around $44 billion equivalent of debt compared with $32 billion by mid-April," says Tanneguy de Carné, head of leveraged capital markets Europe at SG.
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The picture for Europe |
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European second lien average pricing and total leverage |
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Source: Fitch |
Euro high-yield issuance has also been supported by a wave of PIK transactions. A lot of these are done on the loan format and therefore don’t go into the standard bond league table statistics. PIK issuance of €3.5 billion year-to-date 2007 is a massive increase on the first quarter in 2006 (€750 million only), explains de Carné.
Another big theme in leveraged finance is less mezzanine issuance. Mezz supply too has been squeezed by structural product trends, with greater leverage at the senior level from second lien and from below by PIK notes.
A recent example of this is provided by the leveraged loan on the buyout of Capio, a Swedish healthcare company, which was so heavily oversubscribed that a mezzanine tranche was scrapped and additional debt added on to B and C loans.
"There are signs that investor appetite for leverage may be stabilizing. However, in the first quarter of 2007 Fitch recorded the second-highest quarterly total issuance volume yet for this essentially opportunistic second-lien instrument," says Michelle De Angelis, senior director in Fitch Ratings’ leveraged finance team.