LBOs enter the mainstream

The European LBO pipeline is building up, warn bankers. Although LBOs made up 10 per cent of total deal volume in the first quarter, the reluctance of institutionals to embrace this type of deal is limiting liquidity. Euroweek reports.

The European LBO market is primed with plenty of deals at the pre-mandate and pre-launch stages. BT's Yell is the subject of intense bid speculation. Eurozone speciality chemicals companies are prescribed for further restructuring. The UK's two biggest pub landlords, Punch Taverns and Nomura, are not alone in eyeing up further opportunities in a lively leisure sector. And there are over $10bn of funded LBO deals geared up for wider syndication.

Support for deals launched to sub-underwriting in the first four months of 2001 has been strong. A growing number of banks and institutions are ready to take on bigger LBO tickets. But the variety and spread of nascent deals, and choppy market conditions, have placed greater emphasis on how mandate winners time the launch of their deals to wider syndication.

Hospitality sets the standard

Of the $10bn or so of LBO loans funded in 2001 that are yet to be launched, six deals totaling $4bn are for the food and drinks and dining and lodging sectors, according to figures from Capital Data Loanware.

The biggest deal for these sectors, indeed the biggest LBO loan to date this year, is the Lehman Brothers-led £1.55bn facility for Fitband. Fitband is the acquisition vehicle set up by Morgan Grenfell Private Equity for its £1.625bn acquisition of Whitbread's pubs and bars division. The deal has catapulted Lehman Brothers to the top of the Euromarket LBO mandated arranger table.

The 10 year loan for Fitband, split between a £1.55bn term loan and a £40m revolver, is scheduled to be taken out by a securitisation later this year. The deal marks an increase in interim financing in the leveraged loan market. Some 25 bridge facilities priced at 150bp over Libor were signed in Europe in the year to end of March. Only 11 similarly priced bridges were signed between the second quarter of 1999 and the first quarter of 2000.

The high yield bond market, the channel favoured for taking out senior debt, has been unsettled of late. But figures show signs of a return to form. According to Capital Data Bondware, Euromarket high yield bond volumes are up, from $815m in the final quarter of last year to $2.4bn in the first quarter of 2001. However, the figure of $2.4bn for the first three months of this year is still $6bn lower than the figures for the first quarter of 2000.

A growing pipeline

Market conditions are not always the primary concern of a bank bidding for a sponsor driven mandate, as many LBO loans are put in place some months before being launched to sub- underwriters.

This delay between inception and conclusion has increased the build up of deals in the wings, a feature of the market. From announcement to launch the deals come under heavy scrutiny.

“Because of the balance sheet to go through, shareholder approval, accounting reports and separation issues, it takes time to settle out the practicalities,” said one leveraged specialist in London. “Naturally, sponsors do not like syndicating the deal too early in case it collapses.”

Institutional reticence

Given the strong pipeline, liquidity is a potential area for concern, though there is talk of more involvement from institutional investors. At the moment, institutional participation is hardly prolific. Just seven institutional investors have been signed into LBO loans so far in 2001.

Richard Revell, executive director responsible for European loan sales and distribution at Goldman Sachs, believes that educating investors about the merits of the loan product as an asset class is the key. He also admits that more issuance will help. “Once institutions are feeling more comfortable with the product, then we will see more participation from them. We are seeing CDOs and gradually more life funds get involved, and I am sure that not too far down the line we will see retail funds in the loan market.”

This year, familiar faces such as PPM, Axa and GMAC have been joined by the three loan funds that participated in the £37m facility for United Biscuits: Dutchess, Eurocredit and Harbourmaster. The 8-1/2 year add-on to last year's £490m loan was priced at 350bp over Libor.

LBO activity

While non-bank participation in the market is improving slowly, traditional players have shown good commitment to deals in the right sectors. 26 banks have committed to LBO deals as co-arrangers so far this year. This compares favourably with 121 co-arrangers for all Euromarket loans.

And contrary to some comments that the LBO market is propping up the Euroloan market, LBO related loan volume represents 10 per cent, or $12bn, of the $120bn worth of deals signed so far this year. Attracting over 20 per cent of all co-arrangers in the market underscores the healthy subscription enjoyed by deals such as Perkins Foods and Picard Surgelés.

The average LBO loan size has stepped up from $278.7m in the first quarter of 2000 to $363m in the first quarter of this year. Despite this rise, banks mandated to arrange LBO loans are less likely to give away arranger titles than banks leading non-LBO deals.

There are 17 banks with non-mandated arranger titles in the LBO market so far this year – in the rest of the market there are 204. The rich fees on offer to sub-underwriters of LBO loans evidently make better bait than an inflated title, though the LBO market has by no means been immune to the rampant title inflation in the loan market this year.

The percentage of sole mandated deals is higher in the LBO market than the rest of the Euroloan market. Of the 37 LBO driven deals signed so far this year, 27 were mandated to just one bank. This higher concentration of sole mandates in the LBO arena reflects the intensity of a sponsor driven buy-out. “There are quite a few sponsors who only want to deal with one bank versus corporate loans where there is very little arranging to do,” says one source.

Banking bravery

However, a bank must have confidence in the credit story if it is to take on a big sole mandate. “If a bank is brave enough to take a long term position on a single deal, then good luck to it,” says another leveraged financier.

Naturally, the bigger the deal size, the greater the propensity for more arrangers. The E865m credit backing the LBO of Lafarge Matériaux Specialités was initially linked with just Citibank, but three other banks also have mandated status on the deal: BNP Paribas, Crédit Agricole Indosuez and Royal Bank of Scotland. And the six tranche DM4.13bn in debt arranged for the LBO of Messer Griesheim is mandated to four banks, Goldman Sachs, HypoVereinsbank, JP Morgan and Royal Bank of Scotland.

As well as strong names at the top of the syndicate, increased pricing levels will help push deals through the crowded market. Average pricing has stepped up from 234bp over Libor in the first quarter of last year to 265bp over Libor in the first quarter of 2001.

However, contrary to bullish talk from some corners of the market, pricing has dropped since last quarter. According to Capital Data Loanware, the average margin on 'A' loans and revolvers has come down from 235bp over Libor in the last quarter of 2000 to 218bp in the first quarter of 2001.

One source pointed out that this drop may be due to the high number of French LBOs signed since the start of the year. “France is one of several countries where you can get aggressively priced deals away,” he says. “But increasingly structured features and overall leverage are more important than the margin.”