By Stephen Fitzmaurice, Capital Data Loanware
In what appears to be a natural extension of the Euromarket sponsor-driven buyout fest, the presence of mezzanine in LBO debt structures is becoming more and more common.
Indeed the Merrill Lynch-arranged financing behind the acquisition of Le Meridien Hotels by a group of sponsors led by Nomura's Principal Finance Group, comprises not one but two tranches of mezzanine. The deal is the latest in a line of jumbo Euromarket leveraged-buyouts.
According to figures from Capital Data Loanware, 35 mezzanine loans for a total volume of almost $2bn have been either signed or launched in Europe since the start of the year. During the same period last year 21 mezzanine credits were put in place. Figures for this year and last dwarf the 29 and 27 mezzanine loans signed in the whole of 1999 and 1998 respectively.
Furthermore the number of LBOs comprising a mezzanine tranche has all but doubled. For the past four years the number of LBO deals incorporating mezzanine portions has averaged around 30 per cent. Over half of this year's LBO deals, 33 out of a total of 62, include mezzanine.
Commitments are increasing
According to Barrie Moore, Managing Director of ABN Amro Mezzanine, the capacity of the mezzanine market has increased considerably recently, to the degree that in today's market mezzanine tranches can be anything from E3m all the way up to E300m. 'Mezzanine commitments are definitely increasing', notes Moore. 'There were insufficient providers of finance to do the deals five years ago.'
Such high-profile deals as the Barclays, Merill Lynch and Goldman Sachs-led credit for Kappa Holdings and the JP Morgan and Royal Bank Scotland-arranged loan for Doncasters plc incorporate mezzanine tranches of Skr1.05bn (E115m) and £65m respectively. In both these deals, there are subtle differences between the banks leading the senior debt and the banks that are arranging the mezzanine. Barclays is sole-arranger of the mezzanine for Kappa and Bank of Nova Scotia has joined RBS to arrange the mezzanine piece for Doncasters.
Adding impetus to the mezzanine market is the proliferation of mezzanine funds. These are pools of investment raised specifically to invest in mezzanine, leveraged loans and high-yield bonds. Dutchess, Harbourmaster, AIG MezzVest and GS Capital Partners are a few of the funds raised this year. All four have been active in the loan market. Both AIG Mezzvest and GS Capital Partners joined the £37.8m mezzanine tranche of the E200m credit arranged by Lehman Brothers, which backs the Cinven and UBS Capital-sponsored Convenience Foods Stores' acquisition of meat processor Wolfking AS.
The definition of mezzanine widens as the deals themselves are increasingly structured. Essentially it is the financing instrument used to plug the gap in an LBO transaction, when the combined total of bank debt and sponsor equity falls short of the price tag on the buyout. While subordinate to the senior debt provided by the banks, mezzanine ranks above the equity put into the deal by the sponsors. There are inter-creditor agreements between the mezzanine and senior debt providers, and holders of mezzanine often have the right to be present alongside the banks at the workout sessions with the borrower in the event of default.
These added negotiation rights have been given added significance in the light of some recent headline-making problems in the European buyout market, namely the financial difficulties experienced by Autodistribution and Steiner Industries. Steiner went into the equivalent of receivership at the beginning of May. Two-thirds of the shares in the Austrian plastics company were bought out by Duke Street Capital in the spring of 1999. The E195m debt package in support of the deal was led by Merill Lynch, and incorporates a E55m mezzanine tranche.
Are prices too high?
Some believe that the predicted return to the kind of default levels seen in the late 1980s will lead to a needed correction in Euromarket pricing. 'We could do with a default in Europe so that pricing begins to reflect a realistic return on leveraged loans, provided it's not a deal that we're involved in' said one institutional investor.
When problems do occur on this side of the Atlantic, they get the full treatment from the press. The Magnet deal, an oft-rattled skeleton in the Euroloan market cupboard, is a case in point from the late 1980s.
The hugely overpriced £649m management buyout of Magnet was the high water mark of late eighties excess. The deal was backed by a £532m syndicated loan signed on March 29 1989. The Bankers Trust-led deal comprised a £300m term loan and a £172.5m bridge, both priced at 175bp over Libor. There were also two tranches of mezzanine, a £160m eight-year tranche at 350bp over Libor and £30m of junior subordinated debt. Within six months of the deal being signed Magnet was unable to service its debts. It was ultimately acquired in 1994 for the knockdown price of £56m.
When problems began to emerge for Magnet a few months after the deal was completed at the top tier, the loan was withdrawn from the market. The comment from the banks at the time was that 'syndication will recommence once more normal conditions are installed in the market for facilities of this type'. In 1989 the European LBO loan market was worth $26.4bn. In 1990 only $6.8bn of LBO-related loans were signed.
It has taken ten years for Euromarket LBO levels to surpass those seen in the late eighties. And as the European economy turns full circle, the LBO loan market has produced $50bn of issuance already in 2001. The mezzanine market will be a key part of the continued growth of LBOs, which for the time being at least remains a very fashionable sector of the market.
By Stephen Fitzmaurice, Capital Data Loanware