sc credit advisors middle market capital edge 2013 q1

www.sccreditadvisors.com

Middle Market Capital Edge

Q1 2013

SC Credit Advisors Recapitalization Advisory For the Middle Market

A Stone Carlie Company

Table of Contents

2 www.sccreditadvisors.com

Summary 3

Stats and Commentary

Cash Flow Lending 5

Asset Based Lending 8

Business Development Companies 9

Private Equity 11

Capital Options: Pricing, Leverage, Trends 13

About SC Credit Advisors 15

Terms of Use 16

Contact 17

Summary

• SC Credit Advisors, LLC is pleased to present the first quarterly Middle Market Capital Edge, providing our observations and insights regarding the debt and equity capital markets for private middle market companies.

• This edition of the Edge discusses:

– Statistics and commentary regarding senior cash flow and asset based loans

(pp 5-8)

– Financing alternatives offered by Business Development Companies (pp 9-10)

– Valuations and capitalization in Private Equity buyouts (pp 11-12)

– Pricing, leverage and trends for various capital options (pp 13-14)


(continued)

See Terms of Use on page 16

Summary (continued)

• In this first quarter of 2013, despite the considerable uncertainty regarding the economy and the capital markets, there is currently a favorable financing environment for private middle market companies:

- Competition among traditional and non traditional lenders, coupled with a modest economic recovery, has driven up leverage multiples, especially for borrowers with attractive credit profiles

- Borrowing costs are at historically low levels

- Business Development Companies are providing flexible financing alternatives where conventional lenders (such as commercial banks) are not an option

- Purchase multiples remain elevated as Private Equity firms seek to deploy their available capital


See Terms of Use on page 16

Cash Flow Loan Multiples Approach 2007 Highs

• The modest economic recovery, lender liquidity and competition all increase leverage multiples

– Recovery has improved borrower fundamentals

– Competition among banks and non bank senior lenders (Finance Companies, Business Development Companies (BDCs), Unitranche funds) has increased leverage multiples

• Leverage availability depends significantly on size and credit quality of borrower:

– Borrowers with predictable revenues and EBITDA, limited customer concentration and experienced management teams garner higher leverage

– Leverage is lower as EBITDA declines, with limited cash flow loan options for borrowers with less than $10 million in EBITDA

– Mezzanine (sub) debt is under pricing and term pressure from aggressive senior lenders

www.sccreditadvisors.com 5

Chart Source: S&P LCD

4.76

4.25

3.41 3.66

4.23 4.16 4.50

0x

2x

4x

6x

2007 2008 2009 2010 2011 2012 4Q12

Total Debt to EBITDA Multiples of Middle Market Loans

(Issuers with EBITDA of $50 Million or Less)

First Lien Debt/EBITDA Second Lien Debt/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA

2.00x

2.20x

2.40x

2.60x

2.80x

3.00x

3.20x

3.40x

3.60x

2.50x

3.00x

3.50x

4.00x

4.50x

5.00x

2007 2008 2009 2010 2011 2012 4Q12

EBITD

A C

apex / C

ash In

terest

Deb

t /

EBIT

DA

Debt / EBITDA vs. Cash Flow Coverage

Debt/EBITDA [EBITDA - Capex]/Cash Interest

Corporate Cash Flow supports Higher Leverage


• Cash flow coverage is very strong for high leverage cash flow loans:

– Cash Flow Coverage [(EBITDA – Capex ) /

Cash Interest] is stronger than pre recession 2007 levels, at 3.30x now vs. 2.50x then

– Lenders are aggressive, but want to maintain essential underwriting parameters

– Availability of cash flow loans declines as cash flow coverage drops



23.2%

19.1%

5.8%

16.6%

11.3%

7.0% 5.7%

0%

5%

10%

15%

20%

25%

30%

35% Percent of Institutional Term Loans with Pricing Grids

20.5% 21.4%

10.9%

44.6%

68.3% 71.3% 71.8%

0%

25%

50%

75%

Percent of Institutional Term Loans with Prepayment Penalties

• Prepayment penalties appear in almost 3 of 4 deals as lenders move to retain borrowers in a competitive environment

• Pricing grids, which typically lower interest costs as leverage decreases, diminish as lenders move to preserve loan pricing in an already low rate environment

Lenders Act to Retain Borrowers and Maintain Pricing

Source for both charts: S&P LCD

Asset Based Loan (ABL) Volume Back to Normal Levels


• ABL Volumes are off their 2011 highs, as the senior cash flow market rebounds:

– Cash flow lending options were more

limited for the middle market in 2009-2011

– ABL’s, however, are more important to borrowers with limited cash flow loan options

– Key factors driving the ABL market:

• Significant liquidity among lenders

• Limited demand due to moderate economic growth

• Relatively low volume in the M&A market, a traditional source of new ABL deals

– ABL interest rates mimic the rate declines in the overall credit markets

0

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120

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5

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35

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2Q

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3Q

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De

al Co

un

t (Synd

icated

Cre

dits)

Issu

ance

($)

ABL Volume and Deal Count

L+0

L+100

L+200

L+300

L+400

L+500

20

07

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12

Average Pro Rata Spreads for Asset-Based Deals


Chart Source: Thompson Reuters

Business Development Companies (BDC’s) fill the Gap in Middle Market Financing


• BDC’s are investment companies with a wide range of investments: Senior Secured Loans, Second Lien Loans, Mezzanine Debt, Convertible Debt, Preferred and Common Stock, and Structured Products

• Each BDC has its own investment criteria and targeted borrower profile

• When bank lenders pull back, BDC’s can step in as senior lenders; when bank lenders are aggressive, BDC’s can supply junior capital

Portfolio Breakdown by Investment Type For a Sampling of BDC’s

BDC Senior Debt

Subordinated/ Mezzanine Debt

Preferred, Common Equity, Warrants

Structured Products, Other

American Capital1 24% 31% 46% N/A

Ares Capital2 79% 7% 13% 1%

Apollo Investment Corp 40% 48% 12% 0%

Fifth Street Finance3 70% 26% 4% 0%

Hercules Technology Growth4 99% N/A Warrants w/ debt N/A

Main Street Capital 78% - 88% N/A N/A N/A • Data is from publically disclosed information for each of the respective BDC’s. Data for American Capital, Ares Capital, Fifth Street Finance , Hercules Technology Growth, Main Street is as of 9/30/12; Data for Apollo Investment Corp is as of 12/31/12. • Notes: 1) American Capital includes Private Finance Assets only. Senior Debt includes revolving credit facilities and senior term debt 2) For Ares Capital, Senior Debt includes a co-investment facility with GE Capital in first lien loans to middle market companies 3) For Fifth Street Finance, second lien loans are included in the Subordinated/Mezzanine total 4) Hercules Technology Growth provides venture debt (senior debt with warrants) to high growth venture capital backed companies

$18,289 $14,845 $14,789 $19,363 $21,974 $26,353

-19%

0%

31%

13%

20%

-30%

-20%

-10%

0%

10%

20%

30%

40%

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

2007 2008 2009 2010 2011 2012*

Invested Capital for a Representative Sample of BDC's at Year End($s Millions)

Total Investments

Annual Percent Change

Business Development Companies (BDC’s) fill the Gap in Middle Market Financing (continued)


• After being hard hit by portfolio losses during the recession, BDC’s have seen significant growth in loan and equity investments since 2009

• Invested capital for the BDC sample in the chart above increased by 20% in 2012 alone. BDC’s are flush with cash and aggressively seeking investments

• Data is from publically disclosed information for a sample of BDC’s including: Ares Capital, American Capital, Apollo Investment, BlackRock Kelso, Full Circle Capital, Golub Capital, GSV Capital, Hercules Technology Growth Capital, Main Street Capital, Medley Capital, PennantPark Floating Rate Capital, PennantPark Investment Corp., Prospect Capital, Solar Capital, TCP Capital, Triangle Capital. Note: Not all BDC’s have data available prior to 2011.

Secondary Buyouts become more important with M&A Deal Volume at Low Levels


• The decreasing number of middle market M&A transactions has increased the frequency of secondary buyouts (Private Equity group portfolio company selling to other Private Equity groups)

• Meanwhile, surveys show the Private Equity industry is sitting on nearly $500 billion in unused capital, a figure which has only declined slightly in the last three years – there is capital to put to work

$826 $359 $150 $337 $354 $190

3,084

2,286

1,4401,943

2,0421,214

0

500

1,000

1,500

2,000

2,500

3,000

3,500

0

100

200

300

400

500

600

700

800

900

2007 2008 2009 2010 2011 3Q12

Total Capital Invested and Number of Deals ClosedMiddle Market LBOs

Capital Investest

# of Deals Closed

0%

5%

10%

15%

20%

25%

30%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2008 2009 2010 2011 2012

Secondary Buyouts as % of All Buyouts

Source for both Charts: PitchBook

Purchase multiples at 5 year highs, supported by an abundance of Private Equity

• The economic recovery, return of leverage multiples, low cost of funding, scarcity of middle market deals and substantial Private Equity capital is supporting historically high purchase price multiples

• Equity contribution levels, while declining slightly from multi year highs, are above pre recession levels, reflecting the competition for deals and more stringent debt underwriting standards

9.30

8.28

6.61

8.40 8.18 7.898.59

0x

1x

2x

3x

4x

5x

6x

7x

8x

9x

10x

2007 2008 2009 2010 2011 2012 4Q12

Purchase Price Breakdown* (For Issuers with EBITDA of $50 Million or less)

Senior Debt/EBITDA Sub Debt/EBITDA Equity/EBITDA Others0%

10%

20%

30%

40%

50%

2007 2008 2009 2010 2011 2012 4Q12

Equity Contribution as a Percent of Total Capital*


*Includes only new equity

Source for both charts: S&P LCD

*Total Sources/adjusted Pro Forma Trailing EBITDA. Equity component represents total equity (new + rollover)

Capital Options for Companies with Less than $10 Million of EBITDA


Source: SC Credit Advisors, LLC

13

Pricing Leverage

• Generally no restrictions on leverage

-75%-95% of Accounts Receivable - • Loan amounts:

- 75%-95% of Accounts Receivable (<5% dilution)

- 50% to 70% of Inventory (blended for RM, WIP, FG)

• Varies widely depending on lender (institutional

vs.high net worth) vs. high net worth)

• L + 1000 (or fixed rate) and higher

• Equity participation possible

Private Equity • N/A • 35-50% equity contribution

Subordinated /

Mezzanine Debt

• 11% - 14% current interest

• 2% - 4% PIK

• Equity warrants possible

• Total Leverage of 3.0 - 4.0x

Second Lien

Loans• Total Leverage of 3.0 - 4.0x

Unitranche • 11% - 12% • Total Leverage of 3.0 - 4.0x

Senior Cash

Flow Loans• Varies

• Available only for strongest borrowers

• Up to 2.50x total senior leverage

• Available only for strongest borrowers

Asset Based

Loans• L + 250 and up

• LIBOR Floor: varies

• Borrower size and credit quality greatly influence terms • More ABL alternatives than cash flow loan options are available in this segment • BDC’s move aggressively into this market • Fewer loan covenants

• Looser lender restrictions on dividend payments / distributions • Growing frequency of second lien loans from high net worth investors • Senior loan pricing varies greatly according to type of lender (Bank, Finance Company, BDC)

Trends:

Capital Options for Companies with More than $10 Million of EBITDA


Source: SC Credit Advisors, LLC

14

• Borrower size and credit quality greatly influence terms • Lighter loan covenants • Equity cures for financial covenant defaults • Flexibility on cash flow sweeps • Dividends / distributions allowed subject to loan compliance

• More EBITDA addbacks (e.g. for restructuring costs) for covenant calculations • ABL revolver plus cash flow term loans are a popular combination • BDC’s very active and aggressive across all loan segments • Unitranche lenders active, but under pricing pressure

Trends:

Pricing Leverage

• Generally no restrictions on leverage

-75%-95% of Accounts Receivable - • Loan amounts:

- 75% - 95% of Accounts Receivable (<5% dilution)

- 50% - 70% of Inventory (blended for RM, WIP, FG)

Private Equity • N/A • 35-50% equity contribution

Unitranche • 10%+ • Total Leverage of 3.5 - 5.0x

Subordinated /

Mezzanine Debt

• 10% - 12% current interest

• Up to 2% PIK

• Equity warrants less prevalent

• Total Leverage of 3.5 - 5.0x

Second Lien

Loans

• L + 800 and up • Total Leverage of 3.5 - 5.0x

Senior Cash

Flow Loans• L + 400 and up

• 3.0 - 4.0x (Senior leverage)

• 4.5 - 5.0x (Total leverage)

• Strong borrowers with higher EBITDA - up to 6.0x

Asset Based

Loans• L + 150 and up

About SC Credit Advisors

• SC Credit Advisors, LLC (SCCA) assists private middle market companies with structuring and raising capital through securities registered individuals. We also provide credit-related advisory services to companies, lenders, financial sponsors and high-net-worth investors.

• We develop and implement creative and practical financing solutions for our clients, allowing them to focus on running their businesses.

15

Typical Client Profile for Capital Raising

Ownership Private

Revenue $10 million to $300 million

Capital Needs $5 million to $50 million

Existing Capital Structure

Moderately to highly leveraged

Industries All industries, except development stage companies


Terms of Use


• The information contained in this publication was developed from market data compiled by SC Credit Advisors, LLC (SCCA). Any projections, estimates or forward looking statements contained in this publication involve numerous and important subjective assumptions and are subject to risks, contingencies and uncertainties beyond SCCA’s control and may cause results to differ materially.

• In no way does this publication purport to provide investment advice and nothing in this publication is intended to be a recommendation of a specific security or company. Nothing in this publication constitutes an offer to buy or sell, or the solicitation of an offer to buy or sell, a security.

• Neither SCCA nor Stillpoint Capital, LLC nor any of their respective officers, directors, employees, affiliates, agents or representatives make any representation or warranty as to the accuracy or completeness of any information contained herein and no legal liability is assumed or is to be implied against any of the aforementioned with respect thereto.

Contact Information

Headquarters

101 South Hanley Road

Suite 800

St. Louis, MO 63105

GREG PORTO Office: 314.889.1197 Mobile: 312.339.2857 Email: [email protected]

GREG TOBBEN Office: 314.889.1196 Mobile: 314.458.8186 Email: [email protected]

A Stone Carlie Company

Securities transactions conducted through StillPoint Capital, LLC Member FINRA/SIPC


sc credit advisors middle market capital edge 2013 q1

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