EUROPE NEWS: The vultures are circling(2)

Private equity firms are buying into the debt structures of troubled operators that are rich in real estate, with Toys R Us and General Healthcare Group currently being evaluated. PERE Magazine July, August 2012 issue.

Private equity firms are bidding on loans against troubled companies that are rich in real estate in order to potentially gain control of the company and/or get at the underlying real estate. According to experts, current examples of UK restructuring talks in which private equity firms are interested include those of Toys R Us and General Healthcare Group.

Such examples follow the recent manoeuvring to control Four Seasons Health Care Group, in which Kohlberg Kravis Roberts & Co reportedly bought into the loans in February and Terra Firma later took over the company for up to £825 million (€1 billion; $1.3 billion). The company previously had been acquired by a Qatari investment fund, Three Delta, in 2006, but it was taken over by creditors including Royal Bank of Scotland when Three Delta found itself unable to pay its debts. In that case, some 445 nursing homes and 61 hospitals and other specialist care facilities were at stake.

“A lot of funds are buying into CMBS deals and real estate loans,” said one expert contacted by PERE. “They buy into these distressed structures with an eye towards having some influence on the outcome. If the situation can’t be resolved, they are happy to take an ownership interest in the underlying real estate. If they don’t get ownership, they are happy with the return because they bought at a massive discount and will get paid back at par.”

Situations such as Toys R Us and General Healthcare Group are perhaps best thought of as being different than ‘hard’ real estate deals, such as the one TPG Capital and Patron Capital recently negotiated regarding Dutch property company Uni-Invest. Instead, experts pointed out, these are cases in which there is a real estate-related operating business.

Take, for example, Toys R Us, which was taken over by KKR, Bain Capital and Vornado Realty Trust for $5.7 billion in July 2005. In the UK, the three owners entered into a sale-leaseback of the retailer’s stores, in which the operational side of the business agreed to pay the property side of the business fixed rental increases every five years for 30 years. The property company itself was financed by a CMBS transaction.

According to documents relating to the financing, Deutsche Bank as the servicer of the loans and Hatfield Philips as the special servicer are trying to restructure the debt. Interestingly for private equity firms, although many of the UK properties sold and leased back were pioneering out-of-town retail locations built over the past 20 years, most of the locations are now considered prime retail warehouse parks.

In the case of General Healthcare Group, the company was bought by a consortium comprising South African healthcare group Netcare, private equity firm Apax Partners, private property company London & Regional and London-based private equity real estate firm Brockton Capital, the latter being the smallest owner with around three percent. The buyout was financed in complicated fashion via another sale-leaseback structure. In order to take over General Healthcare Group, the consortium paid mostly into the property company, injecting £405 million of equity and £1.65 billion of debt, while simultaneously injecting £115 million of equity and £215 million of debt to buy the operating company. The prop co loan is serviced by lease income from 35 acute-care hospitals in the UK occupied by BMI Healthcare, a division of General Healthcare Group.

Providing an idea of how complicated things became, the prop co was financed by a £960 million senior loan, £300 million of which was sold to minority lenders and £660 million of which was securitised by two separate issuers, Theatre (Hospitals No 1) and Theatre (Hospitals No 2). In addition, there was £690 million of junior loans, comprised of a £515 million subordinated A loan and a deeply subordinated B loan of £175 million.

According to those that have studied the financing, the transaction also has massive long-dated swaps attached to it, which would trigger big fees if unwound. “People are trying to figure out whether to invest in the senior or junior portions of the debt,” said the expert.

One observer added: “There is a conflict because the op co will probably want to renegotiate the leases, but that is the last thing the prop co wants. Maybe they will allow the prop co to default.”

More imminently, however, all eyes will be on Deutsche Annington, the German apartment operator owned by Terra Firma, where the largest restructuring of debt ever was due to be put to bondholders at press time. The name of that finance transaction is ‘Grand’, in which a colossal €4.5 billion of debt reportedly needs to be reorganised.