June 19, 2020 / 11:14 AM / a month ago

Lenders get creative on debt to tie up M&A

LONDON, June 19 (LPC) - Banks and borrowers are being forced to get creative on debt financings, putting in place sub-optimal structures in a bid to complete M&A transactions.

A £4bn unfunded credit facility to back the US$38bn merger of the British businesses of Liberty Global and Telefonica; and a US$1.3bn club loan backing KKR’s acquisition of a 60% stake in US-based cosmetics maker Coty’s hair and nail care business were both innovative financings, designed to overcome the challenges that come with bringing such large deals to market during the Covid-19 pandemic.

Under normal circumstance, both assets would have been acquired using a leveraged underwrite, to reduce the amount of equity in a deal and maximise debt and profits. The underwritten deals would have been syndicated to a wide group of institutional investors.

Yet this has not been possible given the current market constraints over capacity, as lenders take a more risk averse approach. Banks and borrowers have had to overcome this using unconventional financings, to ensure that the few deals that are out there are successfully completed.

“There is going to have to be a fair bit of creativity between now and the end of year to get certain transactions done due to market capacity. People are coming up with creative structures to bridge the gap,” a syndicate head said.

COSTLY BUSINESS

Creativity comes at a cost and while these financings are good enough to secure the acquisitions, they are unlikely to provide a long term financing solution.

“The right way to finance deals now isn’t necessarily the way deals will be done in the future. The financings give security of execution which is most valuable,” a second syndicate head said.

The Virgin-O2 merger was backed with a 2.25-year investment-grade term loan that will sit on the O2 business.

The loan will be used to initially de-risk the transaction and will save the company up to £800m in carry costs had they of put in a leveraged financing from the outset, sources said.

The i-grade term loan is then expected to be refinanced next year when the merger is complete and increased to in excess of £6bn through a combination of multi-currency leveraged loans and high-yield bonds, sitting across both balance sheets. Leverage at that point will stand at between four and five times.

Meanwhile, the US$1.3bn club loan for Coty’s unit, known as Wella, was secured via 10 banks and a handful of investors. The exposure will be held on balance sheet.

The covenant-loose financing comprises US$1bn of funded debt via a five-year term loan A and a six-year term loan B, as well as a US$300m revolving credit facility.

The TLB will price with a five handle and will be leveraged around 3.5 times the company’s approximate US$350m Ebitda.

In a similar move to Liberty/Telefonica, KKR will look to refinance Coty’s loan when it can, to optimise the structure.

KKR will seek to reduce pricing, remove a covenant, increase debt and increase leverage by a further two turns.

“If Wella was done in good market conditions, the funded debt in the transaction would be two times higher than now but the deal can be made to work on a lower debt quantum. Can the debt structure be optimised throughout the ownership? Yes.” a capital markets head said. (Editing by Christopher Mangham)

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