French distress

When LBO France handed over the keys to French building materials group Terreal this week to the company’s lenders, there were eerie echoes of another French deal – PAI Partners’ loss of Monier back in 2009.

Few sectors are as intimately tied to macroeconomic fortunes as the construction industry, and as the French economy staggered during the credit crisis, so too did its building industry. Monier and Terreal were both boom era deals, with leverage multiples to match. Such were the seeds of their downfall.

With Monier, PAI had to face off against a trio of seasoned distressed debt specialists: Apollo Management, TowerBrook Capital Partners, and York Capital. The three firms ultimately wrestled control of the business from PAI following a restructuring that saw PAI lose more than €250 million.

That same year, LBO France attempted to restructure Terreal. It had bought the company in 2005 from The Carlyle Group and French peer Eurazeo, for a reported €860 million. Sources with knowledge of the situation suggested the debt-to-equity ratio was very much ‘of its time’. A subsequent dividend recapitalization in 2008 allowed the French buyout group to recoup 40 percent of its equity, but laid the foundations for what was to come. In 2009, with the recession in full swing, LBO France took the view that a restructuring was necessary. But it made the fatal error, even as Monier was failing to meet covenant tests, of basing its new capital structure on the hypothesis that the French construction industry would recover.

When the second dip of the recession struck last year, LBO France resigned itself to a second restructuring, and a battle with lenders. Just as Apollo, TowerBrook and York had built positions in Monier, so Park Square did with Terreal.

Park Square took great pains this week to stress that the restructuring agreed was entirely consensual, and that the plan put in place for the business was sustainable and designed to support it over the long term.

A source close to LBO France indicated that the French private equity house and its investors had long foreseen this outcome and as such it came as no surprise. It certainly hasn’t dented the firm’s White Knight VI vehicle’s performance too severely – it’s understood to be delivering an IRR in the region of 60 percent. The source also stressed that the business was profitable – but that the debt burden had become unsustainable.

So what conclusions can be drawn from this pair of French restructurings? It’s accepted that boom era deals were over-geared. But it’s interesting to note that a number of recent restructurings are actually the second or even third such attempts to reconfigure a company’s capital structure, implying that sponsors’ and lenders’ appetite for radical surgery is often limited. Take another French building materials group (will they never learn?), Consolis, which restructured in 2011 and again earlier this year.

 Larger write-downs might seem unpalatable, but far better to take the hit and then aid a company’s return to profitability than see it limp onwards and collapse at a later date. And sponsors would do well not to antagonize banks – several banking sources have expressed concerns about ‘lender fatigue’ when it comes to credits that keep reappearing for renegotiation.

For distressed debt specialists, it’s probably too soon to say the floodgates are opening. A lot of capital has been raised, particularly for Europe, by distressed funds. Only a select few have maintained a healthy run-rate since doing so and even then, high quality opportunities are few and far between.

That could change. It must change. There are too many companies with unwieldy, or downright constrictive, capital structures which are hampering their growth. Arguably the most dangerous time for struggling companies will come when Europe’s economies start to claw their way out of recession. Interest rates will start to creep up, potentially soon, once the quantitative easing programmes wind down too.

For canny distressed investors then, life could be about to get interesting. But even as they look to turn a profit, they can also play an important role in the recovery.