Acquisition Finance Products Expanded Debt Capacity Structuring The
Acquisition Finance Products Expanded Debt Capacity Structuring The Deal Joseph V. Rizzi Amsterdam Institute of Finance 10 -12 October, 2016 Login to our free WIFI Login: AIFGUEST Password: welcome@aif Share your AIF experience @AIFknowledge #AIF
PRODUCTS: EXPANDED DEBT CAPACITY (Affordability Products) Amsterdam Institute of Finance Joseph V. Rizzi October, 2016
Expanding Debt Capacity Rising purchase price multiples and ROE concerns drive acquirers to seek ways to expand their debt capacity. Some of the most common techniques are: Adjusted (Increased) EBITDA - Operating improvements - Normalization Asset Sales - Bridges to asset sales - Liquidity is key in case bridge cannot be taken out Innovative Securities - Defer interest - Push out amortization - Increase flexibility Amsterdam Institute of Finance October, 2016 3
Debt Options 1 L Term Amortization Covenant Call Seniority Secured Revolver 5– 7 Bullet FULL YES YES Term Loan A 5– 7 40% in first 5 years FULL YES YES Institutional Term Loans 7 -8 1% per annum / bullet FULL YES YES Covenant Lite 8 - 10 1% per annum / Bullet LIGHT YES YES Mezzanine 10 + Bullet LIGHT PREMIUM NO Depends High Yield 10 + Bullet LIGHT PREMIUM NO&YES NO Holding Company PIK 10 + Bullet LIGHT PREMIUM NO NO Bridge Term Loans 1 -3 Bullet FULL YES YES Second Lien 8 -9 Bullet FULL YES YES Bullet Yes Yes Unitranche Unsecured 1 -10 1% P. A. /Bullet Yes Yes No OPCO/PROPCO 10+ Bullet Yes Yes The above table shows the features of different debt options available to issuers The availability of the different options is subject to market conditions Amsterdam Institute of Finance October, 2016 4
Source of Funds Bank Debt High-Yield Subordinated Debt Tranches in the LBO Structure Key Terms Comments • Typically 30 – 50% of capital structure • Based on asset value as well as cash flow • LIBOR-based (i. e. , floating rate) term loan LIBOR floor; pricing grids • 5 -8 year maturity, with annual amortization often in excess of that which is required (average life 4 -5 years) • Up to 5 X LTM EBITDA (varies with industry, ratings and economic conditions) • Usually secured by assets and pledge of stock • Maintenance and incurrence covenants; cash sweeps • Bank debt will also include an unfunded revolving credit facility to fund working capital needs • Can be split into Term A (shorter term, higher amortization) and Term B (longer term, nominal amortization, bullet payment) • Generally, no minimum size requirement • Amortizes over the life of the loans • Generally, no prepayment penalty • 2 L • Cov-Lite Typically 20 -30% of capital structure Generally unsecured Fixed coupon; PIK-T May be classified as senior, senior subordinated or junior subordinated • Longer maturity than bank debt ( 7 10 years, with no amortization and a bullet payment) • Incurrence covenants • Holding company obligor • Public and 144 A high yield offerings are generally $150 mm or larger; for offerings below this size, assume mezzanine debt. In some cases, it may be appropriate to include warrants such that the expected IRR is 17 -19% to the bondholder • Senior and senior subordinated offerings are generally cash-pay; junior subordinated offerings (which would generally be issued in combination with senior subordinated offerings) may be zero coupon and issued at a holding company • Bullet payment (non amortizing) • • Amsterdam Institute of Finance October, 2016 5
Tranches in the LBO Structure Source of Funds Key Terms Comments • Can be preferred stock or debt • Convertible into equity • IRRs in the high teens to low twenties on 3 -5 year holding period • Occasionally used in place of high-yield debt • Generally a combination of cash pay and PIK; can be both, or change over time • Often includes warrants to enhance IRR to desired level above coupon rate Total Debt • Typically 3. 0 x-7. 0 x LTM EBITDA • Interest coverage at least 2. 0 x LTM EBITDA/first year interest • Total debt varies by sector, market conditions, and other factors Common Equity • Typically 20 -35% of capital structure • 20 -30% IRR on about a 5 -year holding period • Exit multiple = entry multiple • Management options of 5 -10% • Required IRR may be lower for larger or less risky transactions • Exit: IPO, Trade, STS, Recap Mezzanine Debt Amsterdam Institute of Finance October, 2016 6
Buyout Financing Scenarios Expected Best Case Future Cash Flows Base Case Downside Bank Debt R/C + T/LA 5 – 7 yrs Amsterdam Institute of Finance October, 2016 T/LB HYB Other Worst Case --------- Biblical Bad 8 yrs 10 yrs 7
Sponsor Based Debt Financing Allocations and Capital Providers of Capital Institutional Investors Banks, Commercial Banks, Securities Firms Hedge, Mutual, Pension Funds CLOs 1 L Capital Structure Facilities Revolving Credit Facility Term A Loan (Tla) Leveraged Loans – Pro Rata Tranche --------------Leveraged Loans – Pro Loans Rata Tranche Asset Backed ------------------------- Insurance Companies 2 L Special Purpose Facilities (e. g. , Acquisition Line Term B Loan (TLb) Others (e. g. , Financing Companies) (BDO) Second Lien Private Debt Funds Equity Other Debt High Yield Bonds (incl) PIK Mezzanine Unitranche Private Equity Funds and Co-Investors Warrants Preferred Equity Common Equity Leveraged Loans. Institutional Tranche Senior (Including Cov – Lite) Junior Debt Equity Based on amended HBS case exhibit Amsterdam Institute of Finance October, 2016 8
Complex Corporate Structure Equity #1 Equity #2 European Holding Company #1 European Holding Company #2 Preferred Stock NEWCO High Yield/Sub Notes Bank Deal with Upstream Guarantee Collapsed After Closing Local Target Guarantee Due to the structural nature of Subordination in Europe, bank Debt would be placed at the Operating subsidiary level. Domestic Operating Subsidiary Foreign Operating Subsidiary* * Tax limitations surrounding guarantees from foreign subs. Amsterdam Institute of Finance October, 2016 9
Innovative Securities and Relative Value Considerations Innovative securities allow for the expansion of debt capacity by one or more of the following mechanisms: Reduce Annual Debt Service - Reducing cash interest expense - Lengthen duration (Reduce/Delay amortization) Increasing Flexibility - Covenants - Cash flow control - Bridging - Public Disclosure - Call Premium - Partial/fully Unsecured Tranching (sequential ordering of payment or priorities) – A/S - Holding Company instruments - Restricted Subsidiaries - Second lien/bifurcated collateral-crossing liens - Senior/Subordinated Cost – Second Lien vs Mez Amsterdam Institute of Finance October, 2016 10
LBO Transaction Structures Bank Debt Unsecured Debt Sr. Unsec’d Debt Public/144 a High Yield Bridge Loan Mezzanine Hold. Co Debt/Seller Note Preferred Equity Common Equity Rollover Equity Other 2007 2010 2012 2015 1 H 16 53. 3% 41. 6% 48. 8% 52. 1% 48. 9% 5. 1% 5. 8% 6. 9% 2. 4% 1. 7% 3. 5% 0. 3% 1. 8% 0. 3% 0. 1% 1. 3% 0. 7% 0. 3% 5. 1% 0. 5% 0. 9% 0. 6% 0. 4% 0. 0% 2. 9% 0. 3% 0. 0% 0. 3% 0. 6% 0. 0% 0. 2% 0. 8% 0. 0% 1. 0% 0. 9% 30. 4% 30. 0% 37. 4% 40. 3% 42. 1% 1. 3% 1. 4% 0. 6% 1. 3% 0. 6% 2. 0% 2. 4% 1. 6% 1. 9% 2. 9% Total Senior Debt 60. 1% 48. 7% 56. 3% 55. 4% 52. 2% Total Equity 32. 9% 43. 8% 39. 7% 42. 4% 45. 9% SD/EBIITDA 5. 4 x 3. 9 x 4. 1 x 5 x 4. 68 Total Sub Debt FD/EBITDA PPX 5. 7% 6. 1 x 7 6. 1% 4. 2 x 9 x 3. 3% 4. 5 x 9 x 0. 9% 5 x 9 x 1. 0% 4. 68 10 x Source: S&P Capital IQ Amsterdam Institute of Finance October, 2016 11
Country Financing Styles Average Sources of Proceeds of Buyouts – By Country LTM 6/16 Bank Debt 2 nd-Lien Debt Secured HY Sr Unsec HY Mezzanine Bridge Loan/Public High Yield Vendor Note Total Debt Europe Western Europe U. K. France Germany 46% 47% 48% 46% 1% 1% 0% 2% 2% 0% 0% 2% 54% 3% 2% 0% 0% 2% 55% 2% 3% 0% 0% 0% 52% 2% 1% 0% 0% 0% 53% 4% 2% 0% 0% 0% 55% Source: S&P Global Amsterdam Institute of Finance October, 2016 12
Non Investment Grade Loan Market Bank Oriented Revolver T/LA Institutional Investor T/LB 2 L Regulatory Leverage “Test”: <6 X EBITDA Amsterdam Institute of Finance October, 2016 13
Second Lien Loans – 1 H 16 Senior Secured, but with Junior or Second Lien-Lower recovery Competing with EURO Mezzanine ◦ Investors – hedge funds and CLO Spread differential between Second Lien and First Lien currently around 325 BP Volume: U. S. EUR 1 H 16 (Depressed) $5. 4 B $1. 9 B Issues: - Inter-creditor - Standstill Agreement - Obligations - New Investors Behavior in a Workout bought at discount - CLO Rating Impact % limit on 2 L paper Amsterdam Institute of Finance October, 2016 14
Unitranche Hybrid Senior/Mezzanine/2 L Combination Separate Revolver: Usually Banks with an Inter-Creditor Agreement Unitranche Term Position: Alternative Nonbank Providers Middle Market Oriented Bank Risk Appetite Supplement Size: Usually <€ 150 mln First Appeared in 2005. Increased Popularity Following Crisis When 2 L and CLO Stalled Blended Rate: Target Returns Around 7% PIK Portion Amsterdam Institute of Finance October, 2016 15
Covenant Lite Covenant Issues ◦ Creditor – preserve deal; recovery value ◦ Debtor – flexibility Covenant Lite – liquidity vs. structure ◦ Similar to Investment Grade ◦ One or No Financial Covenants Rating Agency impact on CLO Volume ◦ US – Now dominant form >90% ◦ Europe – 30% (€ 8 B) Almost no incremental yield over first lien loans with financial covenants Amsterdam Institute of Finance October, 2016 16
‘Op. Co Prop. Co’ Financing (1) By structuring the financing of a pool of assets with a credit quality stronger than the corporate credit as a whole, ‘Op. Co’ ‘Prop. Co’ financing can provide a cost effective source of (acquisition) financing. Example: ◦ Target company de-merged into ‘Prop. Co’, which owns the real estate assets, and ‘Op. Co’, the operating company. ◦ Banks finance ‘Prop. Co’ acquisition of properties at agreed Loan to Value ratio. ◦ ‘Prop. Co’ leases the real estate assets to ‘Op. Co’. ◦ ‘Prop. Co’ debt refinanced by traditional Property Lenders or via Commercial Mortgage Backed Securities (CMBS) market. ◦ ‘Op. Co’ required to service the acquisition debt not assumed by ‘Prop. Co’. REIT Amsterdam Institute of Finance October, 2016 17
‘Op. Co Prop. Co’ Financing (2) Bid. Co Financing Approx. 100% Notes Approx. 100% Op. Co Prop. Co Rental Payments Amsterdam Institute of Finance October, 2016 18
High Yield Bonds • Longer Term Bonds q 7 -10 years and longer q 4/5 NC • Public or Private q q Usually issued in private form with exchange rights Pricing would step up if bonds not public within short period (say 180 days of close) • HYB New Issue (€ B) – YTD End of August 2016 v 2015 Issuance Market Size Amsterdam Institute of Finance October, 2016 2015 € 55 B 480 B 2016 € 30 B 470 B 19
Key High Yield Terms • Registration rights • Issuer • Status • Degree of subordination • Limitations on liens • Limitations on indebtedness • Restricted payments • Asset sales • Change in control • Minimal financial maintenance covenants Amsterdam Institute of Finance October, 2016 20
European Mezzanine Terms (Currently dead due to HYB, 2 L and Unitranche loan competition) Covenants * * Extensive (bank type) Maintenance basis (tested quarterly) Security * Second secured Call Provisions * Generally callable immediately (103, 102, 101) Maturity * Ten year Pricing * * * LIBOR + Warrants for total return TBD Liquidity * Low Disclosure * Limited Marketing * No research coverage, no roadshow Rating Requirements * None Amsterdam Institute of Finance October, 2016 21
PIK • Pay if you can toggle • Ratings – NR or CCC • Eats up equity • Holding Company Issuer • Characteristics Spread 825/900 Toggle 900 -1000 Term 7. 5 -10 Call 5 x. NC Leverage 6. 5 x+ • End of August 2016: 500 mln (all toggle) 2 deals Amsterdam Institute of Finance October, 2016 22
Stapled Financing Staple financing term sheet to deal book Be prepared to fund Establishes ceiling Conflicts of interest Amsterdam Institute of Finance October, 2016 23
ACCORDIAN LOAN Incremental Loan Facilities • • Option allowing increase in principal under existing terms subject to certain conditions Existing lenders can participate or new lenders can be sought Dilution of Lender Interest • • Uncommitted – access requires lenders willing to provide Suffer dilution if you elect not to participate and facility approved Amsterdam Institute of Finance October, 2016 24
Bridge Loans Equity ◦ Bank provides equity Find other equity investors later or keep Reduce PE equity Lowers need for club or larger deals ◦ Rationale – pay to play ◦ Bonds Amsterdam Institute of Finance October, 2016 25
Changing Nature of Leveraged Finance Capital Structures Increasing layers of debt Directed at different investors Intercreditors conflicts Pre-Crisis • Common equity < 35% • Hybrid preferred (0. 5 x) Post Crisis • Common equity > 35% • Unsecured/mezzanine (1 x) • Senior secured bank loan (4 x) - Amortizing T/LA – 40% - B tranches – 60% FDX – 5 x + PPX – 9 x + Amsterdam Institute of Finance October, 2016 • PIK notes (0. 5 x) • Unsecured/mezzanine (1 x) • Carve-out collateral (1 x) - OPCO/PROPCO • Second lien loans (1 x) • Senior secured bank loan (4 x) - Amortizing T/LA – 20% - B tranches – 80% FDX – 6 x + PPX – 9 + 26
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