credit lbos

8/9/2019 Credit LBOs

1/3

credit OCTOBER 2002 41www.creditmag.com

LBOs

With share prices struggling, interest rates

at rock botto m and comp anies looking

to spin off non -core b usinesses, it was

only a matter of time before the leveraged buyout

(LBO) retu rned in force.

Observers say the situation now is reminiscent of

the late 1980 s when LBOs the tactic of using bor-

rowed m on ey secured against a target comp anysassets to launch a takeover exploded in the U S.

David Aberle, credit analyst at Baring Asset Manage-

ment in Boston, says: Equity valuations now look

very similar to the values that led to the first round

of LBO activity in the U S in the late 1980 s.

The tr end started emerging over the summer: in

August, Rod inheights bou ght Irish pro perty com-

pany, Green Property, for more than 1 billion in a

management buyout (different from an LBO in that

the t arget firms management are involved in th e

buyout ). T he d eal was backed with private equ ity

from Merrill Lynch and Bank of Scotland. Another

Irish company, packaging manufacturer Jefferson

Smurfit, was acquired in late September for4.5 bil-

lion by Madison Dearborn Capital Partners

(MD CP) Acquisitions, an affiliate of the Ch icago-

based private equity firm Madison Dearborn.

O ther d eals are in th e pipeline. Th e private

equity firms Kohlberg Kravis Roberts (KKR) and

Wend el Investissement are bu ying Legr and, a

French electrical equipment manufacturer, for 5

billion from parent company Schneider Electric.

And bankers are working o n LBO deals for airline

catering company Gate Gourmet of Switzerland,

Germanys H aarmann & Reimer, which pro ducesflavours and fragrances, and UK food distribution

company Brake Brothers.

This bustle of activity is not only welcome news

for the m ergers and acquisitions department s of

investment banks, which have struggled to justify

themselves since the technology boom turned sour,

but will also provide a much-needed bo ost to t he

European high-yield market. Analysts expect that

deals totalling as much as 4.2 billion might come

to t he euro and sterling h igh-yield markets to

finance US and European LBOs. In the first half of

2002 only

1.9 billion was raised in the Euro peanhigh-yield market and only 250 million in the ster-

ling market.

In fact, the LBO d ebt supply in September is so

large that investment bankers are said to be tr ying to

squeeze roadshows around one anoth er, hoping that

deals do not get overlooked with so many vying for

investor attention. As Barings Aberle says: The cal-

endar is the busiest I ve seen it for years.

Investors are also encouraged that many of the

buyouts involve large private equity firms such as

KKR, which was involved in the largest-ever LBO,

the $ 25 b illion acqu isition of tob acco firm RJR

Nabisco in 1989. It is always good to see sponsors

with deep p ockets in case th e deal goes awry and

needs supporting, says one high-yield fund man-

ager in London .

And mo re is expected. There are still plenty of

deals to be do ne on the lower end of the size spec-

trum, such as small regional companies with a very

focused business and a good asset base, says Marino

Valensise, head of credit at Baring Asset Management .

But as the saying goes, every silver lining has a

cloud, so while high-yield investors welcome the

new supply, not everyone in the investment commu-

nity is happy abou t a r esurgence in LBO activity.H olders of any bond s that the comp any may have

issued in t he past may see their investments dwindle

as the company takes on substantial amounts of new

debt to finance the buyout.

A wave of leveraged buyouts is on the horizon, but while private equity firms, investment banks

and high-yield investors are rubbing their hands at the prospect of a raft of new opportunities,investment-grade bondholders fear they might end up paying the price. Lisa Cooper reports.

Jumping on thebandwagon

Elder, JPMorgan: credit

protection now greater


2/3

42 credit OCTOBER 2002

Of the firms with recent o r imminent LBOs, both

Jefferson Smurfit and Legrand have bonds outstand-

ing. Jefferson Smurfits financing arm, Smurfit Fund-

ing, has a $250 million bond due 2005 and a $350million bond due 2025. These will both become sub-

ordinate to the new debt. As a result Standard &

Poors downgraded the company from BBB+ to BB+

at the start of September and left it on watch nega-

tive. Moodys has kept the company on Baa2.

Legrand h as a $400 million 30-year Yankee bond

issued in 1995. Standard & Poors current ly rates the

notes A- and Moodys Baa1, but both ratings are on

review for possible downgrade. Xavier Buffon, S&Ps

Legrand analyst, says that if the takeover is successful

a multi-notch downgrade is likely, though he will

not speculate on where th e rating will end up.

The acquisition of Legrand, due to close late this

year, will use 2 billion of equity, 2.2 b illion o f

senior bank debt and a 60 0 m illion high-yield

bond issue. Ho ward Sharp, director, leveraged syn-

dications at Royal Bank of Scotland, o ne of th ebanks involved in the deal, estimates that the bonds

will be rated in th e single-B range, Th erefore any

outstanding bo nds will be downgraded t o th e same

level. And wh ile the o utstand ing bo nds include a

change o f contro l provision, t his only takes effect in

the event of a ho stile takeover. With t he m anage-

ment of parent company Schneider backing the deal,

it does not qualify as hostile.Sharp says: The b onds are non -callable, so we

dont have the option to refinance them. But he

admits that even if bondholders asked the company

to red eem the debt , it would be unlikely to d o so

since it is not ob liged to.

Some investors are so incensed by the way exist-

ing bondholders can be t reated when an LBO takes

place that t hey are taking d rastic action. I f any bank

issues bon ds in connection with an LBO and we

already ho ld bo nds in t hat com pany, we will ques-

tion our trading levels with that bank, says Bernard

H unter, director of fixed income at Merrill Lynch

Investment Managers. I ts a message weve made

quite clear to our o wn count erparties and I kno w

others have too,

Another senior Lo ndo n-based credit research

analyst agrees: O ur high-yield investors would

invest in new issues from leveraged buyouts, bu t no t

if this would hurt existing bondholders; just as I

wouldnt buy a stolen Rolex even th ough it wasnt

stolen from me.

H e continues: It shou ld be bad business prac-

tice to advise comp anies on ho w they can shaft

bo ndh olders. If they are fair and reasonable with

us, then well be fair and reasonab le with them.Frances H utchinson, head o f European credit

research at H SBC, says this policy can work. The ster-

ling market is dominated by a relatively small group of

investors who can make or break a transaction, she

The sterling market is dominated by a relatively

small group of investors who can make or break

a transaction

Frances Hutchinson, HSBC

Illustration:David

Lyttleton


3/3

says. This allows institutional investors to have more

influence on the terms and conditions of specific deals.

A recent example o f the influence investors can

wield in the UK is Green Property, which issued 150

million o f investment- grade, fixed-rate b on ds in

December 2001. As a result of this summers LBO, the

bon ds were downgraded to sub-investment grade.

H owever in this instance, existing investors should

not find themselves out of pocket. When t he bo nds

were launched in 20 01 b ond investors demanded

comprehensive covenants because property compa-

nies had become frequent t argets for t akeovers and a

previous attempt was made to bu y out t he company

in 2000. The implementation of change of control

covenants which state that in t he event of a

takeover resulting in a downg rade of bonds below aspecified level, the debt must be bought back and

new bonds issued means the debt is in the process

of being redeemed.

Green P ropert ys bon d issue was joint-led by

H SBC. H SBCs Hu tchinson says: We have long been

advocates of appropriate use of covenants, in particular

change of cont rol provisions. She adds: When were

advising a potent ial borrower, its important that the

debt is stru ctured and pr iced appro priately. Issuers

want th e mo st efficient source of fund ing, while

investors want the best deal. In the long run, its bad

for the investment b anks if deals are not structuredproperly or are detrimental to one group of investors.

It leaves a bad taste in investors mouths.

O ne o f the mo st not orious examples of existing

bo nd holders getting a raw deal in a buyou t was

N om ura Pr incipal Finances takeover of electrical

appliance manufacturer Thorn for 1 billion in 199 8

the b iggest LBO that year. In that instance, the

existing senior unsecured debt was made subordi-

nate to all new debt . Bond ho lders were left with

junk bon ds th at effectively function ed as venture

capital if the firm d id badly, bu t wou ld no t b enefit

from the company doing well. Although they did-

nt break any laws or th e letter of the bon d d ocu-

ment ation, it was a clear violation of the spirit o f the

bond covenants. You could call it daylight ro bber y,

says Bergq wist.

Even the rumo ur of an LBO is enou gh to set a

companys bond spreads widening. For example, an

article in a Sunday newspaper in 1998 hinted that a

private equity firm was eyeing up the UK leisure and

entertainment grou p Rank. The price of the com-

panys bonds dro pped from 102 to 8 8 and t heir liq-

uidity dried up.

But Fergus Elder, managing director and co-head

of loan capital markets at JPMorgan, which is involvedin the H aarmann & Reimer and Brake Brothers LBOs

this year, says times are different now. H e believes it is

unlikely that extreme examples like the Thorn deal will

occur again. Id be very surprised to see something

like that happen no w, as were in an era of greater

credit protection. Most buyers would want to revamp

the financing anyway and take out the senior bond-

ho lders. You really don t want a recalcitrant b on d

group in an LBO, as there will always be some issue

you need to tinker with, which will need bot h b ank

and bondholder approval.

Despite the examples outlined above, it must be

stated that n ot all LBOs are evil. In Euro pe, only a

small minority of companies und ergoing an LBO

actually have bonds ou tstanding. And when they do,

this debt is not necessarily structurally subordinated.

In most instances, existing b on dho lders will be

bought out.

And there are plenty of willing buyers of LBO debt

in the European high-yield market, where banks andhedge funds are vying with fund managers. In the case

of LBO financing, investors need to assess the type of

business, the quality of the equity sponsor and the man-

agement plan. As most bond launches originating from

LBOs are, by their very nature, large issues, any high-

yield investor would t ake an interest in them. For exam-

ple, around 1 billion of not es were offered in Septem-

ber via Deutsche Bank and Merrill Lynch as part of the

Jefferson Smurfit LBO. No manager of a European

high-yield port folio can afford not to look at this. It is a

big deal and will make up a sizeable port ion o f their

index, says Barings Valensise.

H owever other investors insist th at, un like invest-

ment-grade debt, very few high-yield funds are actu-

ally managed against an ind ex, so investment compa-

nies wanting to take a stand against what they see as

uneth ical behaviour are free to do so. By refusing to

participate in a deal in which existing bon dho lders will

be pen alised, investors ho pe th ey will be able to

encourage better m arket practice for the future.

A companys attitude to its existing bond holders

may depend on whether it is likely to need continued

access to the bond market. If the firm needs to issue

more bonds in future, it must be cautious in its treat-

ment of existing investors so that th ey wont refuse to

participate in any forthcoming issues.

As the Green Proper ty example shows, covenants

can help bondh olders assert t heir rights. As well as the

change of control clause, a second provision that canbe beneficial is a negative pledge. T his should ensure

that senior unsecured d ebt remains senior and unse-

cured, and is not subordinated by assets being

pledged to raise further debt finance.

LBOs

credit OCTOBER 2002 43

You really dont want a recalcitrant bond group in

an LBO, as there will always be some issue you need

to tinker with

Fergus Elder, JPMorgan

www.creditmag.com

credit lbos

Documents