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Europe: Aurelius creates division to invest in German SME LBOs

aurelius_logo01_klAurelius Group has created a new investment division, Aurelius Mittelstandskapital, through which it will invest in profitable companies with strong management and growth potential, according to a company release.

Aurelius Mittelstandskapital will take majority interests in German SMEs with annual revenue of up to €50 million, in the form of leveraged buyouts. Investment criteria include the ability to demonstrate a double-digit EBITDA margin, a good cash flow profile, an established market position, and a good customer base, together with the potential to expand revenue and earnings via organic growth and add-on acquisitions.

Four M&A professionals will join the division directly from Aurelius Group, and the newly formed investment team will focus on the large number of potential takeover targets in the German-speaking area, which includes family enterprises and mid-sized firms.

Aurelius Group is a listed, mid-market pan-European investor, with a focus on the Industrials, Chemicals, Business Services, TMT, and Consumer sectors. It targets pan-European private and public companies with revenue of £30-750 million. – Staff reports

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Bursting The ‘Bubble’ Talk: Today’s Leveraged Loan Market, By The Numbers

From stories in the popular press to dire analytical reports to pronouncements from Federal Reserve Chair Janet Yellen to statements from the OCC, a growing chorus is warning of a bubble in the leveraged loan market. Driven in part by the liquidity that (ironically) has resulted from the Fed’s zero-interest-rate/QE policy, banks and other lenders are said to be seeding the loan market with increasingly aggressive transactions and could end up reaping a bitter harvest of high defaults and stinging credit losses.

Our analysis of how far the pendulum has swung is based on hard data and is informed by conversations with loan market participants. One point on which everyone agrees: structure and terms are looser than they were earlier in the cycle, when liquidity was scarce and the economy was fragile.

Where views diverge, however, is on the question of whether we are witnessing the excesses normally associated with late-cycle booms such as those of the late 1980s (hyper leverage on thin-margin retail businesses), 1999-2000 (blueprint telecom deals), or 2006-2007 (highly leveraged, jumbo take-private LBO trades). Many market participants argue that the answer is no – or at least not yet.

To illustrate this point, the state of play in the leveraged loan market can be viewed along three broad lines:

  • Credit: Today’s loan issuers sport higher-than-average leverage multiples, but levels are well inside the peak readings of the past. However, this theme is mitigated in two ways. First, today’s low borrowing costs offset higher leverage by bolstering coverage ratios. Second, few 2014-model deals carry either the heroic leverage associated with the large-scale LBOs of 2007 or the negative out-of-the-blocks cash flow.
  • Risk/return: Though loan yields are low on an absolute basis, spreads relative to the base rate are still in the middle of the historical fairway.
  • Terms and conditions: Loan T&Cs have evolved in the post-crisis period in a way that offers issuers unprecedented optionality, most notably in the widespread use of incurrence tests and incremental tranches.

We’ll take each of these in turn.

New-issue credit profile
Large LBO deals provide a consistent gauge by which to measure the credit hygiene of the loan market. And, indeed, the average leverage ratio at which these deals have been struck has crept higher in recent quarters from the more conservative levels of 2010-2011.

At the same time, PE firms are reeling in equity contributions:

Still, what is missing from the recent mix is the large tail of highly leveraged, thin-coverage deals that were rampant in 2006/2007. This chart, for instance, shows the share of LBO deals structured at 7x-plus leverage:

In the past, such loans produced an outsized share of defaults when the cycle ultimately turned.

As well, rising leverage levels are being ameliorated by low borrowing costs, which bolster coverage ratios, as this chart illustrates:

More to the point, the super-thin-coverage deals of the 2006/2007 period are not in play. So far this year, just 2% of LBO loans had an initial ratio of EBITDA less capex to cash interest of less than 2.0x, versus 64% in 2007.

Here again, narrower coverage produced the expected spike in defaults.

Of course, some of this cushion could evaporate if interest rates spike. After all, just 14% of the average debt stack for first-half LBOs is in the form of fixed-rate bonds, and provisions that once required borrowers to hedge half of their floating-rate exposure are a relic of a bygone era, participants say. Thus, if LIBOR climbs past the average floor of 1%, issuers could be in for higher interest costs, and loans will reset higher. That said, forward three-month LIBOR doesn’t cross the 1% barrier until January 2016, according to Bloomberg, with expectations for 2% in January 2017 and 3% in April 2019. As these figures imply, the market believes it is unlikely that rising rates will crimp coverage any time soon.

Credit profile of the S&P/LSTA Index universe
By most measures, the credit profile of the loan market remains robust, despite the fact that leverage levels across the S&P/LSTA Index have climbed steady – if slowly – in recent quarters as a result of (1) record recap activity and (2) as noted above, more highly geared new-issue transactions.

Loan issuers’ ability to service debt, for instance, has improved dramatically in recent years as a result of two salutatory trends: (1) muscular EBITDA growth since the recession ended in June 2009 and (2) shrinking financing costs.

The result: fatter cash-flow-coverage multiples across the universe of S&P/LSTA Index issuers that file publicly.

While wider coverage doesn’t rule out defaults, it obviously affords issuers greater wherewithal in the event of a downturn.

Looking at rating dispersion shows a similar pattern. The share of performing S&P/LSTA Index loans outstanding that Standard & Poor’s rates CCC+ or lower climbed to a two-year high of 5.98% by June, from a five-year low of 4.19% in January. In the interim, S&P downgraded a few borrowers’ loans to triple-hook territory, including Caesars EntertainmentGymboreeEducation Management, and Auxilium. Despite the recent run-up, however, the share of CCC paper in the Index remains well inside the historical highs of 10-13%, from 2009.

Yield versus risk
Lining up the loan market’s current risk/return proposition with those of the past is a difficult exercise, given today’s historically low interest rates. In terms of absolute yields, today’s loans clearly offer a low prospective return.

In part, this situation is a product of razor-thin underlying base rates. Loan spreads, by contrast, are more generous. This chart shows the same trend but uses the discounted spread over LIBOR.

Putting this trend in context, BB Index loans offered a discounted spread of L+361, on average, as of July 11, which is 23 bps wide of the historical median level (we use median here because the heights of the dislocation skew the averages). Single-B loans, meanwhile, were at L+473, or one basis point wide.

It gets more interesting when we exclude the benefit of LIBOR floors, which many players see as a way to compensate lenders for a particularly steep yield curve, with three-month LIBOR lingering in the 0.20-0.25% range and 10-year Treasuries recently in a 2.5-2.6% band. Excluding LIBOR floors, the current BB discounted spread is L+296, 15 bps inside the long-term median, with single-Bs at L+391, or 20 bps lower.

Taken together, these metrics show that the market remains in the historical fairway between boom and bust.

Looking at the data another way, the average discounted spread of the S&P/LSTA Index was L+441 as of July 11, which implies an imputed default rate of 2.83%, outside both June’s reading of 1.08% (excluding Energy Future Holdings) and managers’ average June 2015 forecast of 1.76%.

As this chart makes plain, the margin of safety has tightened significantly in recent years in the face of robust market liquidity and consistent economic growth. That said, loans are not priced today as if there will never be another default, as was the case in late 2006/early 2007.

Documentation
Where the factors discussed above suggest a Goldilocks scenario in the loan market, the erosion in documentation protections is the poster-boy trend of the bubble brigade. Covenant-lite is the most visible example. So far this year, 62% of new institutional loans cleared with only incurrence tests, topping 2013’s prior high of 57%. As a result, a record 56% of S&P/LSTA Index loans are now covenant-lite, up from 46% at year-end 2013.

There is no doubt that managers see the proliferation of covenant-lite technology as an unfortunate outcome of today’s market liquidity. But the reason is not that covenant-lite loans are inherently more risky. In fact, the historical record shows that maintenance tests did not produce either (1) lower default rates or, more to the point, (2) lower losses given default. As reported, Energy Future Holdings’ $19.5 billion loan default, from April, pushed the 2008-to-date default experience of covenant-heavy S&P/LSTA Index loans to 19.0%, from 16.6%. By comparison, the corresponding figure for covenant-lite loans is 10.3%. Drilling down to loans that S&P initially rated single-B, the stats are similar, at 19.8% for loans with maintenance tests and 11.0% for those with incurrence tests. As for recovery rates, the average price at which defaulted incurrence-test-only loans exited bankruptcy was 70.0 cents on the dollar, versus 65.6 for loans with traditional tests.

That’s not to say that toggling from maintenance to incurrence tests is without consequence to lenders. Clearly, traditional financial covenants provide an effective repricing option for lenders when an issuer’s financial performance slides. Take the default spike 2008-2010. During that three-year period, issuers loosened tests on roughly 21% of covenanted loans that were outstanding at year-end 2007. On average, these waivers cost the borrowers in question a fee of 57 bps and 201 bps of incremental spread. Taking this calculation a step further, 86% of Index loans had maintenance tests when 2007 ended. Thus, from 2008-2010, lenders were able to increase the average spread of their legacy portfolio by 36 bps.

Apply those same statistics to today’s Index universe (44% of which is are subject to maintenance covenants), and the spread lift – based on the same pace of waivers for covenanted loans and average spread increase – would be just 19 bps.

Where covenant-lite is viewed more as a damper on future returns than a spur for higher credit losses when the cycle turns, managers do worry about the credit implications of free-and-clear incremental tranches. These provisions, which allow issuers to tap the market for additional loans unfettered by the restrictions of incurrence tests, have become a pervasive feature of newly minted covenant-lite loans over the past 18 months. Some parameters:

An anecdotal scan of recent deals shows that the vast majority of covenant-lite loans have an incremental carve-out under incurrence tests that allow issuers to add another turn, give or take, of fresh loans outside the scope of the covenant. In LCD’s review of the data, 2014 covenant-lite loans allowed free-and-clear tranches equal to 0.96x pro forma EBITDA.

The lenders have some protection, in that with rare exception – Gates Global being a notable recent example – loans are fortified with most-favored-nation provisions that do not sunset and therefore provide pricing protection for the life of the loan. So far this year, the average MFN is 50 bps. Moreover, managers have scored small victories by pushing back against excessively large incremental amounts. Recent examples include Vantiv, which scaled back its free-and-clear limit to $650 million, from $800 million; Phillips Medisize (to $80 million, from $100 million); and Nextgen (to $65 million, from $80 million).

Still, credit vigilantes worry that in an extreme case an issuer could raise an incremental tranche at some high rate to pay a dividend, thereby allowing a PE firm to get some (or all) of its bait back while lenders are left with a less creditworthy debtor vulnerable to default. Another potential downside risk: struggling issuers might use incremental tranches to effect a distressed exchange that converts subordinated debt into a lower-face-value amount of secured loans, but, in the process, dilutes first-lien collateral coverage. Those are just two obvious ways in which free-and-clear tranches could work to the detriment of secured lenders, managers say. Because free-and-clear technology is a recent innovation, however, there may be other pitfalls as yet unseen.

More issuer-friendly documentation in the form of incremental tranches, incurrence tests, and equity cures may well be a direct response to the rising liquidity in the loan asset class, which allows managers to enter and exit positions more easily and therefore may obviate the need for the buttoned-up terms that were necessary when the lender was married to a loan until maturity or repayment. Of course, this is cold comfort to managers who studied credit at the old school and are concerned that today’s less-restrictive terms may result in less-favorable recovery outcomes down the road.

Risk assessment
Innings of a baseball game is useful shorthand to describe where the market stands relative to the overall cycle. Some managers, however, prefer to describe the current cycle as a three-game series, with the first game over and the second now underway. To wit:

  • Game One (recovery/QE): That part of the cycle, which produced outsized returns for loans and virtually every other risk asset, concluded in 2013 as the Fed began tapering bond purchases and 10-year Treasury yields climbed from a decades-long low of 1.43% in July 2012 to the recent level of 2.5-2.6%.
  • Game Two (rate/event risks): The large early-cycle gains of Game One are now in the rearview mirror, but there appears to be little risk of a default spike over the next 12-24 months. Instead, managers say the paramount risks of this part of the cycle are a sudden change in the interest-rate curve or a disruptive outside shock, either of which could send liquidity to the sidelines and cause loan prices to fall.
  • Game Three (default/loss spike): This game will be played eventually, as it always is. The timing, however, will likely be several years into the future based on most economic prognostication, which views the chance of a near-term recession as remote – unless, of course, the U.S. economy is rocked by a catastrophic outside shock.

Given this framework, managers say the market is likely to be in the middle game of the cycle for a while longer. For the time being, the biggest risks for investors will be:

  • Event risk, in the form of an outside shock that sends investors to the sidelines and causes outflows from loan mutual funds to accelerate, while the CLO window slams shut.
  • Rate risk, such as either (1) an unexpected decline in rates or (2) a steeper rate curve that, in either case, could drive money from short-duration products like loans to longer-duration products like bonds, thereby crimping loan demand.

– Steve Miller

Follow Steve on Twitter for an early look at LCD analysis, plus market commentary.

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Despite rise in LBO activity, public-to-private deals remain scarce

Take-private buyouts were virtually absent in the first half even as other forms of LBO activity picked up. The reason, participants say, is that public-to-private deals face powerful headwinds from:

  • sky-high public share prices,
  • record profit margins,
  • aggressive competition for properties from strategic buyers, and
  • regulatory pressure to keep leverage levels in check.

With all of these factors working against public-to-private deal-making, it’s no wonder that of the $89 billion in LBO deal flow that LCD tracked during the first half, a mere $3.1 billion, or 3.5%, funded public-to-private transactions. That is the smallest share for P2P deals on record (the period with the lowest dollar total remains 2009, at a mere $1.06 billion).

LCD subscribers, please click here for full story, analysis, and chart:

  • LBO volume
  • Average purchase-price and enterprise multiples

Steve Miller

Follow Steve on Twitter for an early look at LCD analysis, plus market commentary.

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Ortho-Clinical sets price talk as LBO loan launches

A Barclays-led arranger group this afternoon outlined price talk of L+350, with a 1% LIBOR floor and a 99-99.5 offer price on the B term loan backing The Carlyle Group’s $4.15 billion purchase of Johnson & Johnson’s Ortho-Clinical Diagnostics business, sources said.

Lenders to the institutional loan are offered six months of 101 soft call protection. At the proposed guidance, the loan would yield about 4.67-4.76% to maturity.

As noted earlier, the senior secured financing is split between a $2.175 billion, seven-year B term loan and a $350 million, five-year revolving credit.

Barclays, Goldman Sachs, Credit Suisse, UBS, and Nomura are arranging the loan. Commitments are due on Wednesday, May 7.

Lenders are offered a ticking fee of half of the drawn spread that kicks in 45 days after the allocation date, and steps up to the full spread after 75 days. The ticking fee is payable until Aug. 12.

Agencies assigned B/B2 corporate and B/B1 facility ratings to the deal, with a 3 recovery rating from S&P.

Goldman Sachs will be left lead on the adjoining bond execution. As reported, underwriters in February syndicated a $1.15 billion high-yield bridge loan. Pro forma for the transaction, net leverage runs 3.2x through the secured debt and 5.1x on a total basis, sources said.

The Ortho-Clinical Diagnostics unit is a global provider of solutions for screening, diagnosing, monitoring and confirming diseases. Headquartered in Raritan, N.J., with manufacturing operations in Rochester, N.Y., Pompano Beach, Fla. and Pencoed, Wales, the business operates in 130 countries. – Staff reports

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YouTube video: April 2014 European leveraged loan market analysis

LCD’s video analysis detailing the European leveraged loan market during March and 2014′s first quarter is now on YouTube.

Of note is the imbalance created by thin supply and vigorous demand, which is causing conditions in the market to become increasingly issuer-friendly. The loan market definitely felt livelier in terms of new issuance, with a mix of new buyouts and opportunistic refinancing and repricing activity coming over the horizon. The elephant in the waiting room is Numericable, which has lined up a huge covenant-lite M&A financing to back its bid for SFR.

This month LCD looks at:

  • Annual senior loan volume
  • Annual arbitrage CLO volume
  • Average TLB primary spread and yield to maturity
  • Annual pro forma debt/EBITDA ratios of LBOs
  • Quarterly Index returns (excluding currency)
  • Forward pipeline volume as of April 4, 2014


The video is available here.

Click here to download PDF slides of the video on Slideshare.

While you’re on YouTube please subscribe to LCD’s YouTube Channel. That way you’ll be certain not to miss any LCD videos. You can also subscribe by clicking on the link to the right of any LCD News email, or here:

http://www.youtube.com/user/LCDcomps

If you’d like to embed any LCD video on a web page or in other digital media, it’s simple via the “embed” button on the YouTube page for the video. You can also embed the slides via Slideshare.

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Credit Suisse to provide financing for Thoma Bravo’s TravelClick buy

travelclick logoCredit Suisse is providing financing for Thoma Bravo’s $930 million purchase of TravelClick from middle-market private equity firm Genstar Capital Management, sources said.

The sale is expected to close in the second quarter. Evercore served as financial advisor to Genstar and TravelClick.

TravelClick, based in New York City, provides reservations technology systems and marketing services for hotels.

Genstar and Bain Capital Ventures acquired TravelClick in 2007. Since the acquisition, TravelClick’s revenue and EBITDA have more than doubled, according to a joint press release from Genstar and Bain.

In March 2011, BMO Capital Markets arranged a $160 million term loan (L+500, 1.5% LIBOR floor) and a $20 million revolver to refinance junior and senior debt at TravelClick.

Last year, BMO arranged a $90 million second-lien term loan due 2018 for TravelClick to pay a dividend. At the same time, $192 million of TravelClick’s first-lien debt was repriced to L+450, with a 1.25% LIBOR floor.

To finance the 2007 buyout, San Francisco-based Genstar lined up a $105 million senior secured loan via Jefferies and $40 million of mezzanine debt via Blackstone Group. – Abby Latour

Follow Abby on Twitter @abbynyhk for middle-market deals, leveraged M&A, distressed debt, private equity, and more

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MultiPlan preps $2.275B leveraged loan backing LBO

Barclays and J.P. Morgan have scheduled a lender meeting on Monday, March 10, at 2:30 p.m. EDT to launch their $2.275 billion senior secured financing backing Starr Investment Holdings and Partners Group purchase of MultiPlan, sources said.

The transaction will include a $2.2 billion, seven-year term loan and a $75 million, five-year revolver, sources said.

Starr Investment and Partners Group are acquiring the U.S. healthcare-cost-management company from BC Partners and Silver Lake Partners, which acquired a controlling stake in business in 2010 for $3.1 billion.

MultiPlan last tapped the loan market in July for a $100 million fungible add-on to its then $1.03 billion term loan due 2017, proceeds of which helped support a shareholder dividend. The add-on, arranged by Barclays, was issued at par and is priced at L+300, with a 1% LIBOR floor. – Chris Donnelly/Kerry Kantin

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IMG Worldwide sets Feb. 26 launch of $2.45B buyout loan

J.P. Morgan has scheduled a bank meeting on Wednesday Feb. 26 at 2:30 p.m. EST to launch the $2.45 billion LBO financing for IMG Worldwide. As noted earlier, SilverLake and William Morris Endeavour Entertainment are buying the talent management business from Fortsmann Little.

The covenant-lite financing will include a $1.9 billion first-lien term loan and a $450 million second-lien term loan, sources said. Additional leads are expected to be named shortly.

IMG is one of the world’s premier sports, entertainment, and media companies with 3,500 employees in more than 30 countries around the world, involved in an average of 11 sports and entertainment events every day.

IMG Worldwide last tapped the loan market in 2011 with a $300 million TLB that was used to refinance debt. The five-year loan is L+425, with a 1.25% LIBOR floor. – Chris Donnelly

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Bain sweetens pricing on loan backing Bob’s Discount Furniture LBO

bobs discount funitureRBC Capital Markets and UBS have finalized pricing on the LBO financing for Bob’s Discount Furniture after increasing the spread on the first-lien term loan and cutting the offer price on the second-lien, according to sources.

The spread for the $180 million, seven-year first-lien term loan was increased to L+425, from original talk of L+400, while the 1% LIBOR floor and 99 offer price remain unchanged, according to sources. At the revised level, the yield-to-maturity increases to 5.54%, from 5.28%. The loan includes 101 soft call protection for 6 months.

Pricing for the $80 million, eight-year second-lien term loan is unchanged, at L+800, with a 1% LIBOR floor, but the OID was cut to 98, from 99. With that, the yield-to-maturity is 9.7%, versus 9.5% as initially outlined. The second-lien will be callable at 102 and 101 in years one and two.

The financing will also include a $40 million asset-based revolver.

Corporate ratings are B/B3. The first-lien is rated B/B2, with a 3 recovery rating. The second-lien is rated CCC+/Caa1, with a 6 recovery rating.

The financing supports the buyout of Bob’s by Bain Capital, which was announced in December. Bain is taking a majority stake in the retailer from Apax Partners, KarpReilly and other shareholders. Company management will continue to own a significant stake.

Bob’s Discount Furniture, based in Manchester, Conn., operates as a furniture retailer, with 47 stores located throughout the Northeast and Mid-Atlantic regions. – Jon Hemingway

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Apollo readies $725M leveraged loan backing Chuck E. Cheese LBO

chuck e cheeseDeutsche Bank, Credit Suisse, Morgan Stanley, and UBS have scheduled a bank meeting for 2:00 p.m. EST on Tuesday, Feb. 4 to launch a $725 million, seven-year covenant-lite term loan backing Apollo Global Management’s $1.3 billion acquisition of CEC Entertainment, according to sources.

Price talk is not yet available. Financing for the LBO also includes a $150 million, five-year revolving credit facility and $305 million of unsecured notes. Credit Suisse will be left lead on the adjoining bond deal.

CEC, which operates pizza and family entertainment chain Chuck E. Cheese’s, announced earlier this month that Apollo agreed to purchase the company, for $54 per share, or $1.3 billion, including the assumption of debt.

The sale was the result of a strategic review aimed at boosting revenue and profit. Revenue dipped slightly in the fiscal third quarter ended Sept. 29, 2013, to $195.9 million, from $196.6 million in the comparable 2012 quarter, while operating income fell to $13.2 million from $14.5 million. – Kerry Kantin/Abby Latour