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Foreign Exchange

Investors gorge on mezzanine debt

European mezzanine finance is growing fast in absolute terms and as a proportion of the financing of individual deals. With hedge funds and CDO structurers eager for the paper there's a fear among some traditional mezzanine investors that pricing is not taking proper account of risk and that innovative structures are an unhealthy development for the market.

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TIME WAS, NOT so long ago, that big buyouts necessitated a call on the high-yield bond market. How things change. At the beginning of July this year, CVC Capital Partners and Permira announced that they were buying the Automobile Association (AA), the UK car breakdown, insurance and finance business, for £1.75 billion ($3.25 billion). The financing package included a whopping £400 million of mezzanine debt arranged by Barclays Capital.

Charterhouse Capital Partners got similarly impressive support from mezzanine investors for its £1.35 billion management buy-out of Saga Group, the UK provider of products and services to the over-50s, raising £325 million.

Mezzanine finance, which combines elements of subordinated debt and quasi-equity, traditionally provided a thin extra layer of funding for deals sandwiched between the base of straight equity and senior debt on top. Now the filling is bursting out of the sandwich.

"Mezzanine debt is available in huge numbers," says Nigel Ward, head of international finance at law firm Ashurst. Ashurst lawyers advised on the financing of both the Saga and AA deals. "Offer letters go out north of €400 million, which was unheard of, and the pricing is coming down to a level where some players are saying it is too low," he says.

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