Refinance race: the vast wave of leveraged buyouts (LBOs) in the boom years of 2006 and 2007 saw private equity firms swallow companies worldwide with the cheap credit available. But will there be a scramble to refinance as these companies avoid defaulting? Lawrie Holmes investigates.
Certainly, there appears to be plenty of competition from leveraged companies worldwide. Consultancy Dealogic recently said that global loans of $2trn need to be rolled over globally by 2016. This figure covers all companies acquired by private equity firms using the assets of the acquired company as collateral for borrowing. The private equity firms took out the loan terms that they would have expected to pay off on maturity, or expected to be refinanced by banks offering similarly generous terms.
A further worry is that the eurozone meltdown threatens to choke off the $550m of refinancing required in Europe in the same period, according to London-based law firm Linklaters. The firm says that by the end of last year refinancings had slumped to 2009 levels as concerns about the eurozone debt crisis and weakening economic conditions took hold and investor confidence seeped away.
Linklaters says that part of the problem is that the wall of refinancings itself is moving. "There is evidence that European LBO loan refinancings between 2009 and 2011 typically had terms of between three and five years, effectively deferring those refinancings to 2012-16. These must be addressed, in addition to those originally due in 2012-16, as the outcome of the eurozone crisis remains unclear and the attendant lack of confidence, politically and economically, continues. While this affects European LBO loans generally, countries perceived to be the least strong are affected the most. This sits uneasily with the refinancing needs of LBO loans in those countries."
Banks are likely to be less able to participate in such refinancings, instead required to comply with regulatory requirements to deleverage their balance sheets and raise more capital, says the law firm: "Collateralised loan obligation (CLO) funds, another key investor group from the boom years, are also less likely to be able to participate as they did previously, as their constitutions limit the extent to which they may invest or reinvest. Those entities that are still involved may find themselves approaching such refinancings with a different mind set and objectives, given both the seismic market changes they are witnessing and increased governmental intervention in the restructuring process - directly or indirectly, through government shareholdings in banks or the introduction of regulatory or legislative changes."
Linklaters adds that the broader backdrop to this scene is of a difficult economic environment. If default rates for the S&P European Leveraged Loan Index increase they move the wall of debt, bringing forward the date on which a company's debt structure needs to be addressed. Dominic Slade, managing partner at private equity firm Alchemy Partners in London, says the issue applies much more to European companies than to those in the US, "where they have made much better progress with the 'refinancing wall'."
But a solution may have come in the US and Europe in the form of high-yield bonds as, somewhat counter-intuitively in times of crisis, investors have been seeking higher returning holdings, even if they may be riskier. In a report earlier this year from Ernst & Young and the Wharton School of the University of Pennsylvania, high yield was identified as the answer for private equity in Europe, as well as the US. Stephen M Sammut, a lecturer at Wharton and a partner at San Francisco-based private equity firm Burrill & Company, says: "Financial institutions and other buyers were searching for greater yields, and neither stocks nor bonds were promising. They basically made some room in their portfolios for high-yield bonds, and they didn't have to take much to make a difference to the private equity industry."
Bond funds are drawing capital from yield-hungry investors, says George Maddison, an investment banker at Credit Suisse who is engaged in a number of refinancings. "That works well for large-cap companies. Mid-caps are served by high yield that has become very liquid and a deeper market than before." He says that a real problem is for small-cap companies needing to deleverage, which rely on banks or access equity at a discount as they are unable to tap the bond market to the same degree.
Even given the number of companies that were acquired globally by private equity in the boom years of 2004-07, there are those who don't see a scramble to refinance developing, says Dr Ruediger Stucke, a research fellow in finance and economics at the Private Equity Institute, Said Business School, Oxford University. "In my opinion, there will be sufficient liquidity on the debt side to refinance the remaining term loans maturing in 2013 and 2014 for deals that have not been exited or partly refinanced already. And if bank lending is limited, bond markets should be in a good position to make up for the remainder."
Dr Stucke doubts that corporates will be left facing a capital shortfall by their private equity owners if they are intrinsically good companies. "It is very unlikely that private equity funds will let an investment default on its debt that does not face severe fundamental difficulties and is still attractive to maintain," he says. "If there is the requirement to inject additional equity, they will clearly do it." Dr Stucke says they may need to seek approval from investors or they could invite another equity co-sponsor to join in.
A London-based private equity firm, which declined to be named, says concerns around the refinancing wall may have been overstated. "Firms usually try to anticipate capital structure issues and fix them as early as possible. Certainly, in our case we have addressed the vast majority of the capital structure issues in our portfolio over the past few years with success. In doing so, we have also significantly pushed back maturities and renegotiated covenants, so that it is not an issue today. In addition, the financing markets have improved significantly, particularly in the US, and you can refinance businesses today if you have to.
Private equity firms have proved to be expert in refinancing, says a spokeswoman for the European Venture Capital Association (EVCA). "Despite being described in apocalyptic terms the firms have fared relatively well because many have been able to tap the high-yield bond market, where there's been plenty of appetite from investors. It hasn't suddenly happened and we don't see it as a wall that is not manageable because there is plenty of appetite to tackle it."
Karsten Langer, a partner of global private equity firm The Riverside Company, and last year's chairman of the EVCA, says that for new lending institutions filling gaps will also help. "Although a large number of banks have retreated in Europe, plenty of others are picking up the slack."
One area that might remain tricky is when a company tries to refinance debt provided by a large syndicate of lenders. Mick McDonagh, a director of advisory firm Liberty Corporate Finance, says: "When debt is heavily syndicated it makes it very difficult for anything to happen. There are lots of situations where some members of the syndicate aren't keen to extend terms. Quite often, the solution might be that the private equity houses have to put more capital into the company in question."
Investor concerns that refinancing issues may hinder private equity's ability to compete with corporate rivals seeking to buy companies is overplayed, says Oxford University's Dr Stucke. "Private equity deal flow has been back to its 2005 level in 2010 and 2011 in terms of' capital invested," he says. "2012 looks a bit weaker, perhaps reaching only 2004 levels by the end of the year. But I suspect this is less due to limited investment opportunities or competition by corporates, rather than difficulties in raising new private equity funds since the financial crisis. The relatively high level of investment activity in 2010 and 2011 has probably been the result of lots of unspent capital from 2006 and 2007 funds, whose investment periods were expiring towards 2012."
Dr Stucke says that private equity firms will face limited competition from corporate acquirers. "First, there is only a partial overlap in target companies that financial and corporate sponsors are interested in. Second, there has been no increase in M&A activity in 2012. US M&A activity in 2012 will have been lower than in 2011 and will be approximately at the 2010 level. European M&A activity by the end of the year will have been below the previous two years'. Third, there is still a high level of concern about the US and European economic outlook; at the same time, with lots of capital flowing into the market by central banks at lowest rates, equity markets have reached quite high levels again, with deal multiples not much below pre-crisis levels."
RELATED ARTICLE: Public v private
Peter Williams has 20 years' experience of being a finance director and chief executive of both public and private companies in the retail sector. In the early 1990s, he joined department store group Selfridges and became finance director and then CEO when it formed part of the listed Sears Group.
He continued to lead the company when it was demerged and listed as a public company in 2003, and when it was acquired in a public-to-private deal by the Canadian Weston family the following year. He has been at the helm of numerous public companies, including chief executive of Alpha Airports and chairman of Blacks Leisure. He is now senior independent director of online fashion group ASOS.com and anon-executive director at cinema group Cineworld, which was taken public during his time there.
Despite the general perception that public companies are tougher to run because of the amount of public scrutiny by investors, analysts and the media, Williams says he found that in some respects the public company environment is more straightforward. "The board and CEO set the strategy and get to execute it, and then you go and tell shareholders how you got on," he says. "The strategy is clear - it's run by people managing the business, as long as it's to shareholders' satisfaction. When there is a problem shareholders are reasonably passive. They'll grill you but actually that's as far as they go. If you're completely cocking it up, of course, they might make a management change."
But in a company run by a private equity firm or other form of private owner, Williams says that the level of interference in strategy can be even greater. "In a private equity house they feel they know as much about strategy as executives," he says. "The participation of the owner in the strategy and development is much greater. When a family acquire a company, rather like a private equity firm, they usually have a view on how it should be run.
"For a finance director that can be a positive experience, but some find it quite difficult because the private owners try and get involved in every area of the business. It doesn't suit everyone. Like many big retailers, Selfridges always felt like a very public company, even when we were taken private, because of the level of interest in such an iconic company. For example, we issued the equivalent of an intermediate management statement (IMS) at Christmas, the key trading period."
Lawrie Holmes is the editor of Financial Management
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|Publication:||Financial Management (UK)|
|Date:||Nov 1, 2012|
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