As turmoil continues around the fate of Europe’s peripheral economies, the outlook for high-yield issuance remains uncertain. Even if stronger-rated companies do manage to access the market, the chances are not so good for highly-levered and low-rated notes backing fresh LBOs.
Sponsors and arrangers are therefore turning their attention to the possibility of using mezzanine debt to fill out subordinated debt tranches to support buyouts, market sources say.
“A few months ago, mezz was the stalking horse [on Birds Eye Iglo or BSN Medical], but now if you consider the caps on a bridge-to-bond, I’m not sure high-yield would be that attractive,” says a fund manager.
LCD tracked just one mezzanine deal during May – a €110 million tranche from Alain Afflelou – bringing the year-to-date new-issue volume for the subordinated asset class to a paltry €300 million, based on three deals. Mezz financing represents a minuscule 1.9% of overall LBO debt financing, while senior loans make up 64.9%, and high-yield 33.2%.
However, the potential cost of using high-yield to support buyouts, with high caps demanded by arrangers, is now putting mezzanine back in the running. “Mezzanine is certainly becoming more attractive, especially if sponsors are pushing leverage and for those low-single-B/high-triple-C credits, too,” an arranger says. “Banks will be reluctant to write bridges to high-yield for companies with high leverage and low ratings, and even those that are willing will struggle to get approval at credit committee.”
Arrangers considering high-yield not only face the question of when the market will reopen, but also where pricing will be positioned once issuance does get started again. The secondary market has certainly traded off in recent weeks: the average bid of LCD’s flow names was 92.27 on May 31, down from 97.18 at the beginning of the month on May 3, taking the average yield to 10.35%, from 8.62%.
For reference, when the high-yield market reopened in the first quarter of 2012 after the 2011 shut-down, single-B deals had markedly higher pricing. The average primary yield was 9.79%, up from 9.06% in the third quarter of 2011, and well above the 8.45% seen in the first six months of 2011. In the three months to the end of April, the average single-B yield eased slightly, to 9.46%. For May, the average readings trimmed somewhat, to 8.8% for single-Bs, but issuance was weighted towards the beginning of the month.
In addition to the uncertainty around the cost of issuing in the high-yield market, sponsors bidding for new businesses must accommodate relatively high primary yield caps in documentation. These caps – set roughly 200-250 bps above where the issue is targeted to price – give protection to the arranging banks, but threaten to eat into the sponsor’s IRRs.
Talk around financing packages for some of the current auction situations points to subordinated debt that would carry low-single-B or even triple-hook ratings, depending on how aggressive the bidding gets (and there are indications bidding could get very aggressive), which could in turn mean very expensive bridges.
Pinning down the price
Average readings for mezzanine pricing are necessarily based on rather thin data. The average total spread in 2012 through end-May was E+1,083, but there are so few readings behind this figure that negotiations on price for new, large transactions will more or less start fresh, rather than be based on recent experience.
One arranger suggests that a coupon in the area of E+1,100-1,150 could work on either Birds Eye or BSN, although the sizes involved mean the sponsors may have to pay up further. “It compares well to the cap on a high-yield bridge,” he says.
The fact that mezzanine is usually now negotiated directly between the sponsor and the providers, rather than via an underwriting bank, could be an advantage for the sponsor in uncertain times, since it pins down the cost of one part of the capital structure.
Whether the sponsors favour this route will depend on the way the discussions pan out, and also on their view of the outlook for the high-yield market.
“It depends whether sponsors are happy with the terms of the bridge financing,” says an arranger. “As the volatility increases then the bridge caps will presumably widen, which makes mezzanine pricing more attractive. You could then argue that if pricing is similar, it makes more sense to remove the market risk of issuing a bond and taking the certainty of funds from mezz.”
In terms of size, one manager lists a handful of funds that can do really large tickets, plus a queue of others that take smaller tickets of €30-50 million, and says it would not be impossible to get to the €600 million-plus potentially required by the larger auctions.
As well as BSN Medical and Birds Eye Iglo, senior-and-mezzanine debt packages are also being considered for several of the mid-sized deals that make up the bulk of the auction pipeline. These include Kerneos and St Hubert in France, and Schenck in Germany. – Ruth McGavin