Termsheet: A box office bond issue

Sometimes a deal comes along that changes perceptions of just what’s possible in the market. The debt financing package arranged to back French cable company Numericable’s takeover of Vivendi subsidiary SFR was one such deal.

The $21.9 billion debt package comprised bonds and loans in both dollar and euro tranches. The real eye-opener, however, was that investor appetite equated to more than $100 billion of orders. That made it, according to S&P Capital IQ LCD, the biggest ever subscription in the history of debt capital markets worldwide.

That appetite even forced Numericable and its advisors to alter the composition of the debt package, reducing the loan component from 50 percent to 30 percent. Appetite from US investors also saw the dollar-denominated tranches increased at the expense of the euro ones.

James Slessenger, European managing director and senior European covenant analyst at Xtract Europe, believes the deal illustrated the depths of investors’ hunger for yield.

“There is huge appetite for sub-investment grade debt, and the high yield markets in the US and Europe can evidently absorb a big deal like this. That was so even though the Numericable issues followed hot on the heels of the recent €3.75 billion Wind issue,” he added.

Numericable staggered the maturities of the various bonds (2019, 2022, and 2024), which would have broadened the pool of investors and mitigated against refinancing risk, Slessenger said.

A WATERSHED FOR EUROPEAN HIGH YIELD

The US high yield market has long been highly liquid and as such, an attractive way to raise capital for sponsors and corporates. But its European counterpart is developing at pace, and the Numericable deal can be viewed as a watershed.

Europe has long relied on bank-derived debt, far more so than the more balanced US market where institutional capital plays a broadly equal role to traditional lending. So the development of the European high yield market suggests the fundamental change which many have talked about in the wake of the financial crisis is finally coming to fruition.

THE DEAL’S STRUCTURE

For a detailed breakdown of the various elements of the financing, see the attached graphic. All tranches of the bonds were given long-term corporate credit ratings and issue ratings of B+ by S&P, with a recovery rating of 3. Moody’s rated the bond at Ba3, three notches into junk territory.

Debtwire affiliate XTract Europe scrutinised the deal and concluded it had “a very weak covenant package overall”.

Concerns raised by XTract include the lack of protection for noteholders in the event of a change of control, due to the portability covenants, which are normally found in bond issues by sponsor-backed businesses but are less common for corporate bond issues. The portability provisions also bear much in common with an investment grade bond – for instance, a put option on the senior secured notes would only be triggered in the event that, for as long as Vivendi owns 20 percent of Numericable, at least one ratings agency downgrades the bond’s rating. XTract notes that leverage-based portability tests are becoming more common in European high yield bond deals, but are far from market standard.

There is also a ‘drag along provision’, which again is a feature more typically found on investment-grade bonds. The drag along provision means that if holders of not less than 90 percent of the notes outstanding put their notes, all remaining outstanding notes can be called at 101 percent of principal.

CAUSE FOR CONCERN?

A deal of this size, and particularly the apparent size of the order book for it, does raise questions about investors’ judgement. Lombard Odier Asset Management’s head of credit, Kevin Corrigan, was quoted in media reports as saying: “It’s not just a dash for trash, it’s a dash for anything,” which neatly summed up much of the commentary surrounding the deal. That didn’t stop some blue chip investors, including Henderson and Hermes, buying into the issue however.

What are the implications of this deal for private debt funds? The high yield market is certainly a source of competition for some. It’s been more commonly used in refinancing scenarios over the past year, but this deal suggests that increasingly it will come to be used for large acquisition financings too. If a shift from loans to bonds is occurring in both scenarios, that’s potentially a concern for loan-focused private debt funds.

But high yield is only really a financing option for companies of a certain size. Although the market has seen a smattering of smaller bond issues, the generally accepted minimum in Europe is around €200 million. Most private debt funds generally tend to target deals below that threshold, so there is an element of deconfliction. For the larger funds which chase bigger deals, high yield is a threat to some extent, but ultimately a borrower will have to weigh up a variety of considerations.

A high-yield bond has many attractions when compared to a traditional loan: less onerous incurrence covenants; a longer term; bullet maturity and potentially more flexibility. There are downsides too of course: they generally feature a non-call period of anything up to five years (or beyond in exceptional circumstances); amendments require consent solicitation; documentation requires more time (and therefore expense) to complete; reporting is public rather than private (this can be an advantage too, in preparing a management team for the rigours of going public), and there is potentially liability incurred as a result of the prospectus.

The bond market appears to have won the day, at least as far as Numericable is concerned, but leveraged loans will continue to be an important financing tool for corporates and sponsor-backed businesses alike. It’s highly unlikely too that even the largest private debt funds would have participated in a financing of this size (had it been a predominantly loan, rather than bond, focused package), at least prior to syndication.

For private debt funds then, the deal illustrates just how much appetite there is for yield, and how far up the risk spectrum investors are prepared to go to find it. This has implications for managers who operate funds with a higher risk / return model, of course, notwithstanding the illiquid nature of closed ended loan funds when set against more readily traded junk bonds.

The deal is also of course very encouraging from a European market perspective, suggesting that there is ample liquidity to support megadeals. That in turn is good news for CLOs, for example, which rely on strong issuance of new debt to populate their new funds.

A watershed financing then, and one which will take some beating from a size perspective.