Toiling with Terreal

If you had to come up with a perfect candidate for a restructuring, a European business in a highly cyclical sector, acquired by private equity at the height of the buyout boom, would probably tick most boxes. So it proved this year with French tile-manufacturer Terreal.

French private equity group LBO France acquired the company in 2005 for €860 million, underpinning the transaction with a sizeable debt package typical of boom-era buyouts. It had already been through one  iteration of private equity ownership, having been sold to LBO France by The Carlyle Group and Eurazeo, who had earlier bought it out of construction group Saint Gobain for €400 million in 2003.  

Construction is a notoriously cyclical sector, and with the economic crisis in full swing just a couple of years after the buyout, Terreal’s sizeable debt burden began to cause problems. 

In 2007, LBO France took around 40 percent of its equity off the table through a dividend recapitalisation, but as the economic crisis worsened through 2008 and into 2009, it became apparent that a restructuring would be necessary, according to sources close to the business. 

No new money was required, the sources said, but the plan put in place was based on the hypothesis that the economy would recover. Despite an uptick in late 2009 and 2010, by mid 2011 the double-dip recession in France had taken hold and it became apparent that the company’s capital structure was no longer sustainable.

Enter Park Square Capital, better known as a mezzanine and senior loan provider but with a growing presence in distressed debt. The firm had an ‘in’ – one of its partners, Joanna Hislop, knew Terreal well from a previous role at a group that had provided mezzanine finance to Terreal, and other Park Square employees were familiar with the business. 

The firm began building a position, buying up heavily discounted debt in the secondary market. “At that time [2009/10] the lender base was more fragmented, and mainly comprised banks and CLOs. Some of those lenders wanted to sell out so we built a position that way,” Hislop tells Private Debt Investor

“What differentiated us from traditional distressed lenders was that we had a relationship with the management team who supported our involvement,” Hislop adds. “They realised we were a lender who could provide some stability.”

“When we looked at its capital structure though following its previous restructuring, it appeared to us the covenants were based on very optimistic projections. We believed it was very likely the company would require another restructuring in due course as it was clear to us the business was over-leveraged.

“In our view there was a misalignment  of interests between the governance and economic ownership of the business.  Governance still lay with the company’s  sponsors, LBO France, but the lenders  effectively owned all the economic upside in the business. This was not a sustainable situation,” Hislop adds. 

LBO France’s initial preference was to sell the company, and it launched a process to that effect. Unfortunately, the bids received weren’t deemed satisfactory to the lenders. “As a group, we determined that it would make more sense to take ownership ourselves, and LBO France decided to do what was best for the company which was the restructuring,” Hislop says. 

Park Square by now had become Terreal’s largest institutional lender, and its second largest lender after ING.  

“Generally the other lenders were supportive of what we were doing. We are a large primary lender ourselves so they all knew of Park Square and many had worked with us before, so we had a pretty good relationship with them. They knew were weren’t a typical, aggressive distressed debt investor operating to their own agenda.”

As part of the restructuring agreement, Terreal’s lenders agreed to convert a significant portion of debt into equity and become significant shareholders in the business. ING, Goldman Sachs’ special situations group and Park Square together owned 52 percent of the business. The company’s management team remained shareholders through a restructured incentive plan.

Gross debt was reduced from €486  million to €300 million (or €230 million net of cash). ORAs (junior PIK notes redeemable in shares) were reduced from €550 million to €157.5 million, and the maturity of remaining debt was extended by three years. As a result of the restructuring, interest expenses were projected to fall by €7 million per annum.

The whole process was a protracted one, thanks largely to France’s onerous legal regime. “It was a very long process,” Hislop admits. “It took more than a year. The slow pace was down to the number of different constituent stakeholders, and of course in France you need unanimous consent.”

LBO France’s equity position was wiped out as a result of the restructuring. Fortunately, the firm had kept investors well appraised of the situation and so it came as no shock. 

LBO France had made its investment in the business from its sixth European mid-market buyout fund, White Knight VI. Despite the loss on Terreal, White Knight VI is understood to have delivered a return in the region of 2-2.5x to date with an IRR of about 60 percent, a source said, suggesting the Terreal situation has failed to seriously dent its strong performance. 

There were three key objectives for the restructuring, according to a statement from the parties involved at the time of the deal. The first was to achieve financial stability through reduced leverage and interest costs, thereby proving to customers it had a sustainable capital structure. The second was to achieve operational flexibility through long-dated debt maturity, no debt amortisation, and a covenant holiday, allowing the company time to return to a growth trajectory and profitability based on a cyclical recovery in the building industry. 

Lastly, the company’s governance structure was improved, with independent directors brought in to provide industrial, financial and commercial expertise.

Park Square
founder and managing  partner Robin Doumar commented at the time: “Lender-led transactions are rare in France, due to the unanimous agreement required from lenders, sponsors and management; however, Park Square’s long-standing knowledge of Terreal and its management facilitated this consensual approach. We see lender-led restructurings as being efficient and beneficial for all parties, and we intend to increase our focus on this type of transaction in the years to come, in order to replicate the positive outcome with other special situations.”

Where many distressed situations can turn into laborious, acrimonious tugs-of-war between stakeholders, Terreal appears to have been a largely consensual process, which in the end proved decisive in a jurisdiction which has historically proved notoriously hostile to restructurings. Perhaps the deal will serve as a blueprint for other restructurings.