Leveraged finance: New faces, slower processes

It took Pacific Equity Partners (PEP) five months to secure the acquisition of Spotless, eventually securing the asset with a A$720 million ($753 million) bid last April. The deal valued the Australian cleaning and catering contractor at A$1.1 billion and it was underpinned by a financing package worth A$865 million, including leveraged senior debt, bonded contracts and revolving credit facilities for working capital.

A consortium of 19 domestic and international banks provided the funding. Taiwan lenders featured prominently, accounting for nearly one quarter of the overall package and easing the burden on underwriters tasked with syndicating the deal.

"In the good days you wouldn't get anything like that amount from Taiwan," a banker involved in the deal tells AVCJ. "Without that money there would have been underwriting banks over their high holds and unable to handle their sell-downs."

The emergence of Southeast Asian lenders in Australian acquisition finance reflects how the industry has rebalanced in the years following the global financial crisis.

The big four domestic lenders - Westpac, Australia & New Zealand Banking Corporation (ANZ), National Australia Bank (NAB) and Commonwealth Bank of Australia (CBA) - have become more prominent and there continues to be interest from Japan and the US. But replacements were required for the likes of BOS International, Natixis and Credit Agricole that have scaled back or shut their Asian operations.

"There was concern, 6-8 months ago, when you saw a number of the European banks pulling out and reduced liquidity, which put a cap on what could be raised," says Craig Boyce, managing director at Bain Capital. "However, I think there are some Asian institutions that are starting to fill that void."

Widening the field

According industry sources, Australia's acquisition finance market taps out not far beyond A$1.5 billion, unless a transaction is heavily backed by an investment bank - usually because the agreement includes other fee-generating mandates, such as an IPO - or can raise debt offshore. To support a hypothetical A$1 billion deal, the private equity sponsor would need to get the big four domestic banks to contribute A$75-100 million apiece and corral half a dozen foreign banks for A$50-75 million tickets. Asian lenders are then approached to make up the difference.

As the Spotless deal suggests, the region's banks are willing to participate. The bullish mood is backed by a compelling economic argument. These banks are able to raise capital off US and European base rates of 0.5-1% and then lend it out at the 3% Australian base rate plus up to 450 basis points on top.

"Given the current margins, it's an extremely interesting proposition for Southeast Asian banks," says Tim Sims, co-founder and managing director at PEP.

This hunt for yield is creating ripples beyond Taiwan, Hong Kong and Singapore. Babson Capital and ICG, best known as mezzanine specialists, are now active in the senior debt space, as is listed investment manager Challenger, which last year won a A$300 million mandate from Government of Singapore Investment Corporation (GIC) to invest in senior and mezzanine debt.

It is logical for the likes of Babson and ICG to target senior debt given that Australia's mezzanine market has always been shallow and pricing has come under pressure in the last couple of years due to falling base rates. But they aren't the only new entrants. 

HarbourVest Partners and Partners Group are now raising senior debt-focused funds as part of their increasingly diversified product offerings and Australian superannuation funds are also getting involved. Industry Funds Management (IFM), which is owned by a group of super funds, has been providing infrastructure debt for a number of years and has gradually widened its remit, while sources say that Victorian Funds Management is also active in the space. They are attracted by the prospect of an immediate return on capital at attractive interest rates.

Bryan Paisley, a partner in Baker & McKenzie's Sydney-based banking and finance team, notes that he has been doing leveraged lending work for Siemens Financial Services.

For private equity investors that require deal financing - and the banks that act as arrangers - the issue isn't so much who provides the debt as how big a check they are able to write. Many of these newcomers, from Asian banks to Australian superannuation funds, are still only dipping a toe in the water, so they might only be good for $10-20 million.

The debt-equity split in deals has fallen from 75-25 circa 2007 to 50-50 in 2009-2010, before recovering to present levels of 60-40. However, financing packages provided by a much reduced bank loan market are restricting equity check sizes, resulting in fewer investment opportunities meeting investment return thresholds for private equity firms.

"Pre-financial crisis, there was far greater deal flow, resulting in more data points and therefore greater transparency and easily identifiable negotiation benchmarks," says Lyndon Hsu, head of leveraged and acquisition finance for Asia Pacific at HSBC. "It was a very liquid market with up to 40-50 institutions participating in the largest transactions, but the number of participants has fallen to 15-20. Predicting syndication outcomes has become challenging."

The long game

Financing is available - Australia's syndicated and club loans market was worth $80.1 billion in 2012, down from $107.2 billion in 2011, but still higher than any other year since 2007, according to Thomson Reuters - but the process takes longer. "The funding is okay; the hard bit is getting the syndicate together because no one wants to take the lead position," attests Rupert Harrington, managing director of Advent Private Capital.

Standard practice, certainly among the larger domestic and international PE firms, is to compile a proposed term sheet and banks then bid for the financing mandate based on the sponsor's requirements and their own capacity. The two sides typically work together and refine the terms as more information becomes available. If the sponsor and the banks are unable to agree on an underwrite structure it switches to a club format, with 12-14 different lenders negotiating with the sponsor. It often results in requests for more capital up front and tighter conditions on covenants, structures and draw-downs.

"We believe the market is moving towards closer to finding underwrite solutions that work for both parties. In large clubs you have 12-14 banks around the table and then only 4-5 banks doing much talking," says Russell Sinclair, head of acquisition finance director of leveraged and acquisition finance at Westpac.

"In the absence of being able to agree an underwrite, sponsors might be better off appointing a structuring group and get a small number of people to put together a deal. That way you get away from the lowest common denominator approach. This benefits the sponsor."

These tighter conditions are also driven by stringent internal oversight within the banks themselves and, in this context, the prominent role played by the big four local lenders is instructive. These banks are an essential part of successful underwriting solutions by virtue of their lower cost of funding in local currency, larger physical presence and relationships with domestic corporates. However, HSBC's Hsu claims that their influence results in financing solutions leaning towards the conservative side on pricing and terms.

The situation is far removed from the years prior to the global financial crisis when sponsors could rely on foreign investment banks to deliver quick credit approvals and large amounts of risk capital. But then it could be argued that this period represented the exception rather than the rule - pre-2006, the big four were dominant forces in the market as they are now.

PEP's Sims adds that these conditions shouldn't deter private equity firms able to deliver returns through operational improvement as opposed to financial leverage and pay-down. "The leading listed Australian businesses today (excluding mining and finance) have EBTIDA multiples in the mid-sevens," he says. "That is sensible stuff in an economy growing at a nominal rate of 6%, driven by population growth, inflation and the mining boom."

 

SIDEBAR: How far will the liquidity go?

In the space of a few weeks, the global M&A market has gone into overdrive. Michael Dell teamed up with Silver Lake and Microsoft to engineer a $24.4 billion buyout of the PC maker he founded; Virgin Media accepted a $23 billion offer from John Malone's Liberty Group; and Warren Buffett's Berkshire Hathaway joined forces with 3G Capital for a $28 billion takeover of Heinz.

Unsurprisingly, Dealogic says the average size of transactions is at its highest level since before the global financial crisis. 

The reason for this spike in activity is strong liquidity in the leveraged financing market, which is allowing private equity firms to think bigger and bolder than they have for years. These large-scale transactions are likely to be underpinned by high-yield bonds and non-investment grade loans, and much of the debt will be covenant-lite, limiting creditors' rights in the event that borrowers struggle to make repayments.

"The US credit markets are very hot and this is manifesting itself in things like the Dell and Heinz deals," says Bryan Paisley, a partner in Baker & McKenzie's Sydney-based banking and finance team. "The headlines are more like 2006."

Will the exuberance in Europe and the US - admittedly more muted than before the financial crisis and with lower levels of leverage - filter through to Australia?

Hopes were raised by the financing package put together for Nine Entertainment, which underwent a A$3.3 billion ($3.5 billion) restructuring at the end of 2012 as creditors forced through a debt-for-equity swap that wiped out almost all of CVC Capital Partners' interest in the business. After reaching an agreement with Nine's mezzanine lenders, hedge funds Apollo Global Management and Oaktree Capital introduced a new capital structure that included $700 million in Term Loan B financing raised by UBS out of New York.

Apollo and Oaktree's brand recognition and banking relationships in the US clearly facilitated the process, but industry participants note that a few other transactions have also managed to secure offshore financing.

"My sense is that domestic banks have increasing concern that they are being bypassed and folks are finding it more interesting to raise financing in the US where you can get seven-year tenor, bullet amortization, covenant-lite terms and post-foreign exchange hedged interest-rates that are competitive to that in the Australian market," says Craig Boyce, a managing director at Bain Capital.

Although it is still early days, an opening up of Australia's acquisition financing market would be well-received by private equity investors targeting larger deals. The US market is institution-led - as opposed to a bank-led structure in Australia - and therefore seen as slightly more aggressive. It offers higher levels of leverage on better terms and greater capacity in areas such as subordinated debt financing where Australia has traditionally been weak.

There are two potential hurdles. First, the US high-yield market is only likely to be open to international sponsors engaged in large deals where the target companies have some relevance to US investors (for example, overseas cash flow). Second, there is a currency mismatch, which places a hedging burden on lenders with US dollar-denominated balance sheets supporting Australian dollar deals.

"Whilst we have seen a couple of instances recently, a 5-7 year cross-currency interest rate swap between Australia and the US is difficult to swap back at competitive low interest rates. This is especially so after recent changes to the regulatory capital environment," says Russell Sinclair, head of acquisition finance director of leveraged and acquisition finance at Westpac. "It eats up a lot of credit capital and once that is factored in it might be better to raise the money in Australia."

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• Topics
• Financing
• Australasia
• Buyouts
• Australia
• buyout
• Leveraged finance
• Pacific Equity Partners
• HarbourVest Partners
• Apollo Global Management
• Oaktree Capital
• Bain Capital Asia