Termsheet: The right blend

A capex intensive and over-leveraged business like Selecta was bound to come under pressure during a sustained downturn.

The rise of branded coffee chains like Starbucks and Pret A Manger also left the Switzerland-headquartered company – Europe’s largest coffee and snack vending machine business – exposed to increasing competition.

But it was the imposition of £690 million of debt as part of its acquisition in 2007 by private equity firm Allianz Capital Partners that set its real troubles in motion. Relative to the purchase price of £773 million, the proportion of debt seems eye watering by today’s standards. Even at the height of the buyout boom, an 11 percent equity component was certainly aggressive. It equated to a debt-to-EBITDA multiple of 7.6 times, according to Debtwire. 

In 2012, Selecta was put up for sale by Allianz Capital Partners, but failed to reach bids which exceeded its net debt. KKR was a bidder, a source says. 

“There was junior as well as senior debt traded in the secondary market, sometimes at quite a significant discount. We kept up a frequent dialogue with all of our debt providers and [stayed] in compliance with our covenant tests,” Jörg Spanier, managing director at ACP, tells PDI.

By June 2013, Selecta’s mezzanine was trading in single figures (i.e. 0-10 percent of par), and it was close to breaching its covenant test, with leverage of 6.0x versus a test level of 6.1x. It avoided maintenance covenant breaches throughout the year by implementing operational efficiencies, Spanier explains. 

Along with debt maturity looming in 2015, the situation meant ACP had to act in order to avoid a restructuring.

After conversations with its lenders, which originally comprised seven banks, ACP made the decision to launch a high yield bond, driven by a “very strong bond market,” Spanier says. But first it needed some kind of fresh equity.

Selecta launched a structured process led by Goldman Sachs to find a lender willing to provide junior debt with which to refinance €820 million of senior and mezzanine facilities. 

In May, KKR Asset Management offered the firm a €220 million payment-in-kind (PIK) seven-year loan with sizeable warrants attached using capital from its $3.8 billion special situations platform. The interest rate on the loan is about 12 percent. The warrants guarantee KKR an equity stake of between 35 and 40 percent upon refinancing or sale of the firm. 

ACP’s choice of KKR as a partner was largely due to its private equity mentality and partnership approach, according to Mark Brown, director of special situations at KKRAM, which gave the firm an edge over hedge fund investors who generally operate on a shorter timeline.

“ACP sees us as a long term partner and not a short term hedge fund. We bring a private equity mentality and operational resources to support management in the execution of the business plan. ACP remains in control of the asset but as you would expect KKR has certain contractual minority protection rights,” he says.

AN EASY BLEND

Selecta fits snugly into KKR’s existing portfolio. Its investment in Selecta follows a €100 million PIK investment in Italian coffee vending machine company Gruppo Argenta in January this year. 

Brown, who also sits on the Gruppo Argenta board, tells PDI: “We were pretty familiar with the sector and have a strong institutional relationship with ACP. We spent some time talking to them about the pending maturity on Selecta. The fact that we had already made an investment in the sector, could provide the entire junior financing and had a private equity mentality was important to both management and ACP.

“For several years Selecta has been known by the market to have a levered capital structure,” he says. It’s cash generative, but some of that cash has to be invested in the vending machines themselves, which was becoming increasingly difficult due to the interest burden on the debt. Indeed, ACP had already started to cut capex to meet its covenant tests in early 2013.

The junior capital provided by KKRAM, quasi-equity in nature, was a vital factor in Selecta being able to approach the bond market. “I would agree it was helpful to secure the junior financing before the launch of the bond process,” Spanier says.

“Initially we spoke to 20 parties which created various options. In the end, KKR’s offer was the most competitive,” Spanier adds.
Contrary to market commentary, Spanier doesn’t see the loan as rescue financing, however: “I would not call it a rescue loan. KKR invested €220 million of fresh capital in exchange for accretion as well as significant equity participation realisable upon an exit event.”

BULKING UP WITH A BOND

Shortly after the loan was agreed ACP began to pre-market the bond. The rapid and public deterioration of its rival, UK-based Autobar, raised concerns in the market however. On 12 June, its private equity owner CVC Capital Partners had to walk away from restructuring talks empty handed following a takeover by hedge fund creditors. The Selecta bond took longer to come to market than expected as a result, according to portfolio management company ECM.

In late June, Selecta priced €550 million of dual tranche six year senior secured notes (rated B+/B2 by S&P and Moody’s) at 6.5 percent, the tighter end of guidance. A Swiss tranche provided the company with a natural hedge as that market is a very important profit contributor, Spanier says.

“It went better than expected. Despite the challenging industry backdrop, ACP and the company have been able to implement a number of strategic initiatives which resulted in a convincing credit story for both senior and junior capital investors,” he said.

It was oversubscribed multiple times thanks to fortuitous timing, just before a jittery high yield market manifested itself in the third quarter following a bull run of several years.

FINER DETAILS

As a result of the refinancing, Selecta hasn’t deleveraged its capital structure but instead reduced the overall cash pay amount by placing senior debt solely with the opco, while the PIK loan sits with the holdco, separate from the business. Its total debt-to-EBITDA leverage multiple now stands at 5.9x, marginally lower than the 6.08x pre-refinancing. Excluding the PIK loan it is 4.49x, according to Debtwire.

Brown says: “Lenders were refinanced at par. The key differences are that the company has less cash pay interest, no financial covenants, the ability to invest in the business and management can go back to managing operations and not the balance sheet. The bond structure with incurrence covenants means the only default that can occur is payment default as there are no other financial covenants.

“Covenants can be a big distraction to management when financial performance starts to deteriorate. Management can easily find itself spending most of their time managing lenders and the balance sheet which can be a distraction. Their focus should be on running the business. The attention should be 90 percent on the operation and 10 percent on the balance sheet,” he adds. 

“Selecta is well positioned to benefit from a medium term market recovery,” Spanier says. A portability feature providing flexibility and options for exit has also been included in the deal’s conditions. “The new capital structure should allow the company to pursue several strategic opportunities,” Brown says.

Selecta has also secured some breathing room before its 2.5 year non-call bonds are due in 2020. “From a lender point of view, the company has stable cash flows and therefore provides good risk reward,” Brown says.

A SELECT FEW

There are few firms in the non-bank lending space that could lend to a company in Selecta’s position on this scale. Blackstone’s GSO Capital Partners and Oaktree Capital Partners have been active in the distressed lending space for some time and now it seems KKRAM is set on forging a similar path.

Credit investments account for $30 billion of KKR’s $100 billion in total assets, compared to almost $70 billion at GSO. At Oaktree, distressed debt alone represents around $22 billion out of roughly $93 billion in total AUM.

Brown, who worked for several years at GSO, explains: “There are not many examples of one counterparty funding a junior deal north of $200 million into a stressed balance sheet.” 

However, KKR has made several large plays in recent times, providing €350 million to Europe’s largest mattress maker Hilding Anders last September and €320 million to Spanish building materials company Uralita in April 2013. The firm is looking at providing another large scale PIK loan to struggling Spanish pizza delivery business Telepizza, sources say.

To mitigate the risk of lending in such situations, KKR seeks sizeable equity stakes, which it aims to crystallise when the businesses are on a better footing. Pricing is influenced by the returns the firm seeks for its special situations fund, which has a target IRR in the mid to high teens.

In a second quarter earnings call last month, Scott Nuttall, KKR’s head of global capital and asset management, said the firm was almost fully invested in its $2 billion special situations fund I. This is quite a feat considering it was only 30 percent invested by the time of its final close in January. As a result, the firm is likely to begin raising a second fund shortly. While it’s too early to say whether deals like Selecta will be a success, KKRAM’s team are certainly pursuing the strategy with vigour.

SELECTA TIMELINE

May 2007 – ACP acquires Selecta from UK catering group Compass for £772.5m, including £690m of debt.

Sept 2012 – Annual results show that Selecta’s revenues have started to decline in 2011, but profitability is maintained through costs cuts.

Sept 2013 – EBITDA falls year-on-year, after further revenue declines.

July 2013 – Selecta attracts a number of bids after being put up for sale for a reported €700m. The sale is pulled after bids fail to exceed the company’s net debt.

March 2014 – Selecta launches structured process to find a junior capital provider led by Goldman Sachs. 2Q13/14 results show revenues have fallen again but at a slower pace.

May 2014 – Junior financing is agreed with KKRAM before a senior secured bond is
pre-marketed in late May.

June 2014 – Goldman Sachs and original lender BNP Paribas are joint bookrunners on the €550m bond syndication. KKR is the co-manager.