Wednesday, October 17, 2012

You Can't Always Get What You Want

Acquisition finance choices depend heavily upon potentially volatile market conditions. The tricky part is when the conditions change after the deal is structured, but before it closes and is funded. This can leave the acquirer-issuer in the uncomfortable position of marketing an out-of-season transaction to investors or pulling the deal.

The match between issuer preferences and market availability looks easy. Issuers seek low pricing, flexibility (i.e. minimal covenant constraints), large levels of debt availability, and high leverage with small equity contributions. The match is easy during bull markets like those we enjoyed prior to 2008.

Investors can pick from the bull market menu to support higher purchase prices, which includes the following:
  •  Tight pricing
  •  Higher leverage-greater than 5X funded debt (FD) to EBITDA
  •  Equity contribution below 35%
  •  Larger, $1B+, deals
  •  Fewer covenants
  •  Plentiful high yield bonds supply
  •  Debt capacity enhancing instruments like payment-in kind (PIK), second lien and covenant lite (cov lite)
The markets essentially shut down during the crisis years of 2008/2009 resulting in busted deals and minimal transaction volume.  This produces a bear market menu.  Bear market menus are less flexible and include 
  •  Higher pricing like today’s LIBOR+ (400-500) bps
  •  Less leverage-less than 4X FD/EBITDA
  •  Higher equity requirements-50%+
  •  Less high yield bonds and more mezzanine debt
  •  Fewer and smaller deals
  •  More covenants
Current conditions have recovered in the U.S. Investors are hungry for yield. Leverage levels are increasing, equity contributions have fallen below 35%, high yield bond issuance is rising, and PIKs, second lien and cov lite are returning. The continuing Euro crisis, however, has dampened deal flow and structures on the continent. A recent example is Stork Technical Services. Stork was launched and then withdrawn in July due to lack of demand. It was restructured and re launched in September with the following changes:
  •  Increased equity
  •  Reduced cash paying debt and increased holding company PIK
  •  Reduced leverage
  •  Higher pricing
The art of structuring is in reading markets to match issuer preferences under different market conditions. In so doing-just as the Rolling Stones once said, you may not get what you want, but if you try real hard you may just get what you need.


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