Termsheet: One scoop or two?

When UK-listed private debt group ICG financed the acquisition of Italian gelato manufacturer Mec3 by private equity group The Riverside Company last month, it underlined both the increasing popularity of non-bank-derived debt, and the qualities that make unitranche in particular such an attractive product.

ICG provided a €90 million financing package to underpin the deal. That comprised a unitranche debt facility of €80 million and a minority equity co-investment of €10 million. ICG acted as sole arranger and agent of the unitranche debt facility.

Although both Riverside and ICG declined to reveal the overall size of the deal, reports in the Italian media suggested it was valued at about €140 million, which would equate to an approximate 60:40 debt to equity split.

So why did Riverside go down the unitranche route? It’s worth looking back to when Riverside first began stalking the company.

Riverside first approached Mec3 three years before its eventual buyout of the company, its interest piqued by the gelato maker’s strong brand name and global growth potential. What followed was a long gestation period before the owner was ready to talk about a transaction.

“Sometimes the first time around is not the time you get to the deal. In this case it came back in a different shape after three years and we were able to conclude,” says Karsten Langer, a partner at Riverside who worked on the deal.

After reaching agreement with the company in the summer of 2013 to progress the buyout, Riverside approached a number of lenders, including ICG. The firm had discussions with “different types of lenders – both local traditional lenders, fund based and newer types of financing sources,” Langer explains. “Mec3 is a very stable, growing business with a strong cash flow, which can sustain more leverage than was available with senior only. Therefore we looked at unitranche and combinations of senior and mezz,” Langer explains.

Ultimately, Riverside chose unitranche because it “allowed the company a lot of additional room for growth,” says Langer.

Luigi Bartone, ICG’s Italian head, explains: “It was very important [that] we were able to give significant leverage on this financing. The Mec3 unitranche is bullet meaning the principal and capitalised interests (PIK) are repaid at maturity. There is also a cash coupon component,” Bartone explains. “As a result, there is much more cash on the books which will allow it to grow faster. It’s one of the characteristics the sponsor liked,” he adds.

The financing package equated to a leverage multiple of more than 4x the company’s EBITDA. The term of the debt is eight years.

Langer adds: “The structure leaves us comfortable knowing that if we need quite a bit of cash flow for growth, that is there, whether it’s for add-ons or capital expenses. We have a standard five year investment period [at Riverside] in which we know what we want to do. It’s nice to have a little leeway in the back end if you need it. [There is] no pressure to exit and the bullet loan gives the company [the] freedom to spend cash on growth.”

Speed of execution was also a key factor. It’s an area where nimble private debt funds, typically with a relatively small headcount, have an advantage over banks, where approvals have to be granted by credit committees and other hoops jumped through.

“ICG provided Riverside with a flexible capital solution quickly, meeting the demands of the business,” Bartone says.

Langer agreed. “[ICG’s] speed demonstrated the strength of interest that comes from moving fast,” he says.

Banks typically also have more rigid lending criteria when it comes to amortisation, covenants, structure, pricing and size. From ICG’s perspective, the deal was an attractive one – the firm praised Mec3’s niche position and strong potential for further growth domestically and internationally in a statement at the time of the deal – evidenced by its willingness to co-invest €10 million of equity in the deal as well as provide the unitranche financing package. Despite the equity component, ICG will remain a silent partner in terms of the day-to-day running of the business.

“[It gives] some added comfort to the sponsor that the interests are more aligned between the debt and equity,” Bartone says. Langer comments that the “Equity co-investment provides a return boost to ICG and aligns interests. We are very pleased that they made this extra investment.”

Lastly, unitranche providers tend to hold the debt for longer, and in greater quantity, than banks. DLA’s report suggested up to £150 million was a typical hold for unitranche, significantly more than the £25 to £30 million average holds offered by conventional mid-market lenders. Banks also typically require 30 to 40 percent of the term debt to be repaid in semi-annual instalments, and are less keen on PIK or bullet structures.

Alongside the unitranche package, GE Capital Interbanca provided a working capital revolver. Equity co-investment was also provided by Lexington Partners and a large family office investor.

A recent report by law firm DLA Piper supports the thesis that sponsors are increasingly warming to unitranche as a product. Its survey found 28 percent of respondents believed it would be the most common non-bank acquisition finance debt structure in 2014, garnering the most votes of any instrument and followed by mezzanine and high yield secured notes at 25 and 21 percent respectively.

It also helped to underpin the assertion that unitranche structures help to increase leverage. Respondents expected the average leverage ratio in 2014 to be 4.9x for deals using unitranche structures, 4.7x for senior plus mezzanine structures and 3.4x for senior only structures, the report said.

It’s not all positive however. There are some concerns in the sponsor community about the product. “Most importantly, there is some uncertainty amongst the sponsor community over how private debt funds will approach a deal in default, especially given the larger share of the capital structure they hold,” DLA said.

The ease and speed of execution unitranche provides also carries with it a pricing premium, although this can be overstated.  Whilst declining to comment on the exact details of pricing, Langer said that when comparing senior plus mezz packages with unitranche, “it washes out about the same.” 

“[Its] a competitive market for lenders and comparable debt packages are priced similarly,” he adds.

In this case then, a private debt fund was able to outmanoeuvre traditional lenders by offering speed of execution, additional leverage, and an equity co-investment. Not all private debt funds are able to offer the latter, but the Mec3 deals speaks to an underlying trend towards the increasing institutionalisation of the European lending market, at least where midmarket buyouts are concerned. The recent news that Riverside had chosen Fifth Street to finance its latest buyout also demonstrates that for one sponsor at least, private debt is an ever more attractive financing option.