LAST MONTH, SIG, a specialist supplier of insulation and other materials to the UK and continental European building and construction industries, announced a £325 million ($469 million) placement of equity to existing and new shareholders to strengthen its balance sheet for the worrying and highly uncertain times ahead.
The Sheffield-headquartered company, which grew rapidly from 2003 to 2007 partly through acquisition, employs 13,300 people operating from 800 sites. It spent 2008 hunkering down as trading deteriorated. It cancelled planned acquisition spending, closed 80 sites, cut 7% of its workforce, and improved management of working capital.
It remains to be seen, though, if this will be enough to preserve it through an economic downturn of unknown duration and severity.
In June and July this year, SIG faces debt maturities totalling £78.8 million, which it must either roll over or repay. Although it has the cash to do this, it then faces debt maturities totalling another £184 million in May and July 2010 and runs the risk of breaching covenants on leverage ratios on those bank facilities. Seeking waivers on those covenants risks encumbering the company with high fees and higher interest service costs, even if the debt maturities are extended.
SIG’s challenges typify those of many medium-sized UK companies and their European SME peers. It’s a decent enough company and its share price bounced on news of the equity raising. But orders are declining from the house builders and remain hugely unpredictable. The banks are hovering. Demand for insulation products has outstripped the pace of new building construction and is an obvious play on the green theme. The company could have decent long-term prospects: the question is, does it have medium-term ones?
There’s one other eye-catching thing about its equity offering. On the prospectus for the deal, nestling between the two joint sponsors and brokers, JPMorgan Cazenove and Panmure Gordon, is the name of another of the company’s joint financial advisers, one with no equity brokerage operation at all: Lazard & Co.
Lazard, of course, is more renowned as a leading adviser on big-ticket M&A deals, a position it had to fight to protect even as the universal banks used their importance as providers of finance to boost their M&A advisory credentials, and traditional investment banking advisers, such as Goldman Sachs and Morgan Stanley, buttressed their advisory franchises by building a capacity to co-invest large amounts of equity and make loans.
Those loans are now largely a matter for regret, as are many of the equity investments.
Just one product
Lazard stood aside from this rush. It chose to retain the business model of a purely independent advisory firm – albeit a large one, with global industry practices and partners in New York, London and Europe. One banker describes its franchise as “a mile wide and an inch deep, with just one product: advice.”
In the boom times, Lazard went through extraordinary change of its own: it restructured its ownership; brought in new executive management led by Bruce Wasserstein; went public; replaced external private equity investors with conventional public investors. Through it all, Lazard stuck to its business model.
Aside from a consistent offering of independent advice, it has a couple of other guiding principles. The senior people do the work. Managing directors don’t just turn up for the opening and closing meetings with clients: they develop and deliver the advice.
There is a shared partnership-style responsibility to the franchise. That sounds warm and fuzzy. In practice, it isn’t. Whenever an assignment becomes tricky, and the solution that a partner has devised for a client is open to question, that partner is forbidden to deliver that advice before it has been reviewed by other senior members of the firm. This happens in what are known as managing directors’ meetings, in which no fewer than three and often many more partners will review and comment on the advice a Lazard banker is proposing to give. Once you’ve been through one of those, no client meeting, no board of directors, is ever quite as intimidating again, say Lazard bankers.
While Lazard stuck to its model, other firms grew big. When an M&A deal came along with a $5 million M&A fee up for grabs, the big firms saw potential earnings 10 or 20 times greater with the chance to grab a slice of $50 million to $100 million in fees from all the leveraged loan financing, interest rate and currency hedging, commodity and FX hedging and debt capital markets take-out.
Lazard just concentrated on earning its share of the $5 million M&A fee. It convinced new public shareholders that M&A fees are inevitably lumpy and, even as it reported quarterly earnings, pleaded with investors not to judge it by these but by annual results.
Many of the firms that grew big are now becoming small again. The good news for Lazard is that, unlike the vast majority of financial services firms, it faces the present uncertainties overwhelming the sector unencumbered by toxic assets, bad loans or souring principal positions. It hasn’t had to delever for the simple reason that it didn’t lever up in the first place. Even better, the fear now engulfing corporate boardrooms brings a new appreciation for the value of genuinely independent, high-quality advice.
This was not always obvious in the boom times. When money was easy to come by and asset prices were rising, investment banking was a simple facilitation business. Clients decided what they wanted to do and asked investment bankers to help them achieve it, often by providing the financing at low cost. Chief executives didn’t spend so much time asking whether they should be acquiring assets in the first place.
“Advice has become more valuable and more valued,” agrees William Rucker, chief executive of Lazard London, and deputy chairman of Lazard’s European investment banking business. “At the height of the bull market, the M&A market became rather predictable, and it was clear that it was unsustainable. For many firms, particularly private equity firms, the amount of debt that could be raised often became the major factor in setting an offer price. Therefore investment banks were often hired primarily for their ability to provide debt, with the advisory role being a secondary service.”
The firm was not renowned for its private equity coverage, rather the name of Lazard is typically associated with the big corporate transactions. Its recent list is impressive: lead adviser to InBev in its $52 billion acquisition of Anheuser-Busch, the largest cash M&A transaction in history; adviser to Gaz de France on its €44.6 billion merger with Suez, forming a world energy leader in gas and electricity; adviser to the Haas Family Trusts in the $18.8 billion sale of Rohm and Haas to Dow Chemical; adviser to Acciona SA on the $14.2 billion sale of its 25% stake in Endesa SA to Enel.
Counter-cyclical business
The bad news for Lazard is that the M&A business has gone into marked decline. It is a business of the boom times, where deal volumes rise in line with rising stock markets and high confidence among chief executives. It doesn’t much help that assets are cheap now: no one can afford them. According to Dealogic, quarterly revenues to the global investment banking industry from M&A fees rose from $6.4 billion in the first quarter of 2007 and peaked in the fourth quarter of 2007 at $8.3 billion. They declined through 2008 to $4.5 billion for the fourth quarter. From January to mid-March 2009, two weeks short of the end of the first quarter, they were just $2.2 billion.
As one M&A banker says, with arch self-deprecation: “I have discovered that our business is rather counter-cyclical. Clients now value independent advice far more than they ever used to, just when their ability to pay for it has reduced markedly.”
But companies need advice today for more than just M&A. They need it for survival.
And that means in addressing the financing markets, whether from a position of relative strength or one of weakness. Look around and Lazard is appearing increasingly frequently as a lead adviser on rights issues. As well as advising SIG, it advised property investment company Segro on its £500 million rights offering announced last month; it was sole financial adviser to property company Hammerson on its £584 million rights issue announced in February; it was an adviser on industrial materials company Cookson’s £240 million rights issue in January.
Inevitably, its bulge-bracket competitors are rather sniffy about this. “They get named on deals but they don’t do much,” says the head of European ECM at one large firm. “I don’t know what firms like Lazard and Rothschild have ever done, except maybe introduce the competitive IPO process which was a great way of making banks even more inclined to over-promise and more likely to under-deliver.”
That’s not how Lazard sees it, of course. Rucker says: “We are finding we have to take an increasingly active role in structuring and executing some of these deals because the commitment of banks to underwrite and even their capacity to distribute is highly volatile and unpredictable. On one recent deal, we found ourselves having to assemble an underwriting group of predominantly lending banks and even circling up orders from institutional investors, with the support of the lead banks.”
Rucker recalls: “If you go back five years the integrated banks questioned our business model as to whether being independent meant being isolated from the capital markets. I think that debate is effectively over now. Far from being isolated, we are very much in the flow of deals in the equity and debt markets, whether advising, for example, on equity capital raisings or renegotiating the terms of a client’s debt with its lenders.”
Perhaps even more surprising than Lazard’s regular appearance on the recent spate of balance sheet repair equity deals is how some of the assignments have come about. The firm’s role in the SIG rights issue and share placement came about after a long advisory relationship with the company, including work on its debt facilities, according to Michael Grayer, head of UK debt advisory, who joined Lazard in April 2008 from GE.
Lazard’s industry sector teams, and equity and debt advisory specialists had been in preliminary discussions with the company and its lenders about how to extend the term of its debt facilities in conjunction with an equity capital raising. In the end, the decision was taken to raise equity first.
Debt advisory
But hold on a minute: debt advisory and Lazard? Why would any company turn to Lazard for debt advice, when it has never been a debt provider?
“That’s precisely why you would turn to us,” says Grayer, who worked in debt markets at UBS before joining the leveraged finance team at GE and coming to Lazard while the primary debt markets for takeover finance were still just about open.
“Right now you have borrowers with declining earnings and too much debt on their balance sheet confronting potential troubles at exactly the time when lenders themselves – from loan funds and CLOs, through to hedge funds and banks – are in enormous difficulties with their own business models. The banks are trying to avoid more write-offs and at the same time to rebuild their own income statements and balance sheets by re-pricing debt wherever they can.
“We’re in the strange position now where, even if you are basically a sound borrower, the banks will be very tough with you on financing terms, whereas, almost perversely, if you are struggling and facing distress, they may be more lenient just to keep you out of administration or insolvency. It’s a very unusual situation, but why would you take advice on all of this from a bank with a clear vested interest?”
Companies with bank facilities negotiated before the credit crunch struck are sitting on a very valuable asset. Many, such as SIG, will make the case to shareholders that raising equity to protect those bank facilities – to prevent the banks using a technical covenant breach to reprice them up to today’s higher margins – although painful, is well worth doing.
Grayer and his team have been kept busy – even as the primary financing markets that they arrived at the firm to navigate have frozen over – working with a range of credits. A key deal negotiated last year was an extension on the terms of debt for Premier Farnell, a mid-market electronic and industrials company. Grayer says: “This is a great company, profitable, very far from any distress, but that could see debt maturities coming over the next 12 to 18 months that it wanted to term out.”
Even good companies are struggling to cope as banks that are being propped up by taxpayers in the country of their headquarters are pressured to concentrate new lending commitments close to home. Foreign banks are withdrawing, leaving companies that had previously negotiated large syndicated loans to try to roll over facilities with a smaller group of lenders.
For Premier Farnell, Lazard put together a club of existing lenders to provide new four-year money on a deal concluded at the end of 2008. Since then, the market has deteriorated further and Grayer suggests that it has become more difficult to raise longer than three-year financing today.
Stern tests ahead
Lazard might face an even sterner test with petrochemicals company Ineos, one of the largest private companies in Europe, which it advised last year on seeking a two-quarter covenant waiver from banks while it compiled a new business plan. That is about to expire and the future for a commodity company exposed to the downturn in orders and de-stocking that proceeded from the end of last year into the start of this is uncertain. It remains to be seen whether Ineos will pass fully into the hands of what promises to be Lazard’s growth business for the next year or two.
Lazard has been building a business hedge against the M&A downturn: an industry-leading restructuring franchise to advise companies on negotiated and voluntary capital restructuring – typically debt-for-equity swaps with bank lenders designed to preserve the most value possible from a clearly distressed business – all the way through to formal insolvency.
Lazard has been retained on many of the largest Chapter 11 bankruptcies in the US, including those of Lehman Brothers, Tribune Co, Nortel and Smurfit-Stone Container, while also working for the trustees of Bernard L Madoff Investment Securities, and Fannie Mae in its US Treasury-led restructuring.
In Europe, it made an early mark last year when the Spanish property market crumbled, advising quoted Madrid-based developer Metrovacesa and the Sanahuja family, which owned an 80% interest in the company, on a debt restructuring.
It was a restructuring with an element of grim humour attached to it. Metrovacesa had sprung to prominence in 2007 when it bought HSBC’s headquarters tower in Canary Wharf for £1.1 billion and leased it back to the bank. In the process, it had taken out a bridge loan from, of course, HSBC. In 2008, that bridge loan blew up and HSBC got its tower back, crystallizing a hefty loss for Metrovacesa. Meanwhile the holding companies through which the Sanahuja family had held shares in Metrovacesa were unable to service their debts and Lazard helped negotiate a debt-for-equity swap whereby a group of mainly Spanish banks ended up owning 65% of Metrovacesa and several properties previously owned by the family holding companies.
“It was a very complex transaction,” says Richard Stables, co-head of global and European restructuring at Lazard, “which in sum amounted to a significant de-leveraging sufficient to stabilize the ownership of MVC. It also demonstrated the strength of the Lazard platform because the skills of our real estate and restructuring teams were brought to bear due to the ability of our Spanish business to gain the trust of the Sanahuja family and the Spanish banks involved.”
The deal burnishes Lazard’s credentials partly through comparison with Martinsa-Fadesa, another large quoted Spanish property developer that filed for insolvency last summer. It is a truism of restructuring that a negotiated settlement, in which lenders typically give up some principal in exchange for equity but are left dealing with a company that can at least continue as a going concern, is far preferable to administration and a firesale of the remaining assets of a destroyed business or even a protected form of insolvency during which customers and suppliers might desert it.
Getting to such an outcome is becoming increasingly complicated as more and more different parties to the negotiation argue from conflicting points of view. It is no longer just a handful of banks and equity owners: it is hedge funds, CLOs, many different types of lenders, holding different pieces of the capital structure, acquired at different prices, some with and some without economic hedges, some hoping to maintain high levels of debt payments, some wanting equity conversion and some there just to hold everyone else up in the hope of being paid to walk away.
There might be creditors with small balance sheet exposure that it is impossible to contact. And meanwhile balance sheets have become highly complex, with plenty of doubts as to whose claims are senior over what assets. “I’ve yet to see a set of credit documents that has worked in the way that people thought they would,” says one banker.
Stables says: “Restructuring usually involves a series of tough negotiations and parties may need to get to the tipping point and look over into the precipice before reaching agreement. Hopefully economic rationality will ultimately prevail, but there is also a temptation to keep negotiating. An assessment of a failure to agree is important and this will vary by country. In Spain, for example, the outcome from a free-fall insolvency process is far from clear-cut.”
The restructuring industry is its own little club within the financial services world and some of its members had been licking their lips in anticipation from summer 2007 as the horrors emerging at banks and the squeeze on credit led to economic contraction and rising corporate defaults. But at an industry gathering in March, many practitioners Euromoney spoke to were worried that there would be far fewer restructuring assignments to go round than they had first hoped for.
“There have been very few restructurings so far because there are simply too many counterparties to many of these deals,” said James Clarke, partner at Cabot Square Capital, at a distressed debt conference in London. “The only deals that are getting done are those where there is full administration and sale of assets or where one party takes control and forces a restructuring. The stalemate is extraordinary. There was a complete underestimation of the time, money and effort that would be involved in unwinding very complex structures.”
Unfortunately for the rest of us, however, Stables expects to be quite busy thank you very much. “It was only in the third and fourth quarters of last year that many core industrials saw their earnings and future order books start to miss budgets. And remember that you only go into restructuring when liquidity is the critical issue and you can’t raise capital or money from other sources. So we’re still at the beginning of this wave,” he says. “Creditable management teams and good companies will usually be supported and some have been able to raise capital, even in current markets, but it is also clear that some companies may be being kept on life support for now only to prevent new write-downs for the banks. If they are to have a sustainable future, most likely their balance sheets will in time have to be comprehensively restructured.”
There are plenty of career corporate financiers at Lazard who have spent much of the past 10 years working on M&A deals and who will spend more of the next few years working on restructuring. It can be reasonably lucrative. If an assignment takes from six to 18 months to work through, Lazard insists that it is paid monthly fees to cover its costs as a protection against the obvious credit risk of its own client. At the end, it takes an M&A-type fee based on the value of the surviving company. There is a subtle difference here between the incentives sometimes seen for lawyers and accountants in insolvencies where they can essentially charge as much as they want for as long as they want. “We are incentivized to preserve value,” says Stables.
It’s a reasonable bet that Lazard will spend a lot of the next couple of years in negotiations between private equity sponsors and bank lenders that threw debt at them to acquire companies on grossly stretched capital values. Banks will be pressing the sponsors to put up more equity as their portfolio companies hit the rocks. Stables asks: “But why would sponsors do that without some associated restructuring if the companies clearly have unsustainable capital structures or if the current debt burden is trading at significant discount?”
Tough negotiations
Lazard recently worked on the restructuring of British Vita, the chemicals company bought out by US private equity shop TPG in 2005. The business was very operationally geared, as well as financially geared. A lot of the business was funded out of working capital and when trade credit insurers withdrew cover that sparked a need for new money and a crisis. TPG hadn’t taken any money out of the investment and had added value through its operational partners. So when it provided new money, when there wasn’t much coming from anywhere else, it could drive a tough bargain with the banks, which may ultimately have to write off £600 million to £700 million. As Euromoney went to press, the restructuring, which in March gained the support of a large majority of mezzanine and senior lenders but not 100% agreement, was scheduled for court hearings in London for ultimate approval.
There are going to be many, many more such tough negotiations before all this is over. Lazard will take its seat at quite a few. The firm has another little-spoken-of advantage. It’s not just clients that appreciate its unbiased advice and ability to act genuinely as an agent taking care of their interests rather than as an exposed principal safeguarding its own. Banks like this as well.
The big banks might be sniffy about what value Lazard adds to rights issues and debt financings; they might chafe at the sight of Lazard bankers sitting beside the client on selection panels to choose banks for various assignments. But the big banks don’t dislike and mistrust Lazard as much as they do each other. If the big banks are being forced to accept a solution that entails some loss of debt principal or dilution of equity interest, they would far rather be seen to be accepting a deal negotiated by Lazard than one crafted by a direct competitor with its own interests at stake.
Update 3 April 2009:
Winners and losers in the scramble for investment banking revenue
Lazard breaks into the top 15 revenue earners at 14, up from 18 for the first quarter of 2008 and with revenues 2% higher due to its strong showing in M&A
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