DEAL MECHANIC

The securitisation of UK motorway services group Welcome Break in its buyout from Granada by Investcorp in 1997 was hailed as another example of how this technique was empowering sponsors. Today's acrimonious war of nerves between the company's equity sponsor, bondholders and in particular a hedge fund suggests that not all securitisation works though. The Deal Mechanic investigates why

Whole business securitisation as a method of financing is certainly a powerful tool, particularly in the world of acquisition finance. But in the European private equity landscape, it is gaining something of a patchy track record.

The example on everyone's lips at the moment, of course, is Welcome Break, the UK chain of what are euphemistically referred to as “motorway service areas” or, to a more jaundiced everyday travelling public, oligopolistic peddlers of overpriced, poor quality food and petrol.

For the moment it appears that the various parties involved in this securitisation have agreed to disagree. Investcorp, the Bahrainheadquartered private equity group, led the buyout of the company from Granada in March 1997 for £476 million (€712.4 million; $865.7 million). The deal was the first collateralised structured financing to leverage an acquisition at investment grade. Since then though the business has failed to achieve the growth targets forecast and despite a recent injection of equity by Investcorp is struggling. Investcorp has tabled a restructuring plan in an effort to ensure that the group can survive – for now. However, the bigger picture of how to fix the capital structure more permanently has yet to be resolved and may yet result in insolvency.

LEVERAGING BOTH TIME AND MONEY
Let's take a step back. What exactly is whole business securitisation, and how did it come to be that seemingly rational investors were persuaded knowingly to provide debt funding of around 9.5x EBITDA for an average spread of rather less than their leveraged finance brethren would have been willing to contemplate?

Regular investors in leveraged loans, perhaps without knowing it, will be rather more familiar with the fundamentals of the approach than they realise. Under it, leveraged financiers are essentially able to provide elevated levels of debt financing to support a buyout by employing two particular techniques. The first is to examine the future cash-generative ability of a company in great detail, and thus maximise the amount of debt that can be repaid by that company over a finite period.

The second, and slightly subtler, technique is to utilise subordination. This concept creates a ranking of debts, and of the risks inherent in them, permitting more precise structuring of each “layer”. In this way, leverage can be further increased by raising debt from investors with an appetite for higher priced, and – crucially – longer term instruments which, and this aspect is key, do not add to the cash flow amortisation pressures of the company during the period described above. In other words, senior debt, with a comparatively short average life, can be combined with subordinated bonds or other forms of more junior capital with a longer life in an attempt to hit the financing “sweet spot”: the provision of a flexible, yet aggressive, financing structure.

Securitisation, in essence, does precisely the same thing. There are, however, some crucial differences. The first is the number of layers created in a typical structure. In more complex transactions, it is not uncommon to see four or five distinct layers of debt, or asset-backed bonds. The second difference, which has considerable knock-on effects, is that most of these layers will carry public ratings, the majority of them investment grade. The bonds issued by Welcome Break in late 1997 were all in this category, with the lowest class being rated BBB.

The third important difference is that securitisation maturities are typically long-term, particularly when compared to those provided in typical leveraged finance situations. In the case of Welcome Break, for example, the four classes of notes issued carried maturities of 10, 13_, 18 and 20 years respectively. This implicitly increases the level of debt that can be provided as, in terms of simple logic, it provides a longer period of time over which that debt can be repaid.

Finally, and this is perhaps the most important aspect of all, due to a combination of each of the above factors a structure rich in assetbacked bonds is, pound for pound, significantly cheaper than any leveraged finance equivalent. Welcome Break's class A2 notes, with a 13_ year maturity (admittedly A-rated at issue) and an amortisation profile stretching from year 10 to maturity, were priced at LIBOR+0.85 per cent.

One might reasonably ask how this is possible. Quite simply, it can only be that credit risk, and the pricing of that risk, is very different in the eyes of a holder of assetbacked bonds than it is anywhere else in the debt markets. It is a view that many seeking to raise capital appear to have come to, as these types of bond have been amongst the most rapidly expanding asset classes in recent years.

DEAL DATA

Target: Welcome Break
Country: UK
Industry: Consumer/hotels & restaurants
Sponsor: Investcorp International
Acquisition date: March 1997
Acquisition price: £476 million [$803 million]
Acquisition financing: • £72 million equity
• £72 million class Ai secured floating-rate notes
due 2007 rated BB;
• £110 million class A2 secured floating-rate notes
due 2011 rated BB;
• £127 million class A3 secured notes due 2015
rated BB;
• £5.5 million revolving facility rated BB;
• £67 million class B secured floating-rate notes
due 2017 rated CC.
Debt arrangers: Bankers Trust, BZW and Chase

BREAK OR BROKE?
Naturally, a proportion of all LBOs go wrong. Many are subsequently fixed and the business survives, though a small number do not. However, where leverage is stretched to extremes, and the providers of finance from the public markets consist of several different classes, each with their own vote, actually engaging enough of the relevant parties in a restructuring process is extremely difficult. Where a sizeable minority of the financing subsequently comes under the control of a party or parties actively disagreeing with others in the transaction, as has clearly happened at Welcome Break, then stalemate is almost inevitable.

In this case, Investcorp has tried, or at least is threatening, to collapse bondholders' individual class rights so that they are simply treated as one single group of creditors – obtaining a majority in votes of this nature becomes much more straightforward, especially if a majority is offered par to exit. The firm has proposed paying off A class bond holders at par and at 55 per cent for all B class holders. Investcorp has not yet acted on its threats, and probably for good reason – its legal advice is clearly at odds with others'. Put simply, if the transaction structure was put together “properly” in the first place, then Investcorp should have no such ability at all – hence the strong refutations issued by the rating agencies recently.

It is most likely that Investcorp is simply seeking to exert pressure and to improve its negotiating position. This is a common tactic used by all sides when an LBO goes wrong and, if anything, would probably simply delay any final resolution of the issues.

This is not as illogical as it first may seem – atleast from Investcorp's perspective. Investcorp seems to have taken the view that its rival, in the shape of SISU Capital, is simply a vulture fund investor trying to achieve a turn on its investment. SISU has a blocking vote over 25 per cent of the B class notes. (It's worth noting that SISU made waves last year by buying an eight per cent stake in UK health club company Holmes Place just as Permira and Bridgepoint Capital looked to take it private in an MBO.)

If Investcorp's perception is accurate, then SISU cares about two things: the price at which it bought in, relative to what is on the table; and the timing of its exit. Just like mainstream private equity investors, both are critical in achieving one's target return. In other words, the longer the process takes, the shakier Sisu's investment case will likely look.

Underneath all of this, of course, one shouldn't forget that there is a business, with managers and employees, struggling to survive. While the fighting goes on, it is likely to remain that way. Let's just hope that the fighting doesn't stretch out the refinancing process too long, as there will finally come a point beyond which a business that once might have been saved cannot.