Termsheet

This summer London-headquartered private equity sponsor IK Investments recapitalised Solina, a French ingredients company it has owned for the past three years. Also included in the €166 million transaction was funding for the acquisition of Danish ingredients group SFK, the fourth business IK has bolted onto Solina since the original buyout.

French banks Credit Agricole (CA-CIB) and BNP Paribas co-ordinated a process whereby IK carried out a dividend recapitalisation in order to partially reimburse shareholder loans with senior debt. IK also cut the cash and payment-in-kind interest on its debt and put in place new acquisition facilities to fund the purchase of SFK and leave headroom for other add-ons also. The arranging banks did not respond to a request for comment.

Post-recapitalisation Solina has the same level of debt as the 2011 deal, with net debt to EBITDA estimated at around 5 times, according to one source. However, the sponsor has been able to change the profile of the debt after “strong performance” enabled the company to “deleverage significantly”, IK said in a statement.

Prior to the recap, net debt to EBITDA had come down to roughly 4.2 times, helped by annual turnover of more than €200 million. Key to raising the new debt including the provision of fresh acquisition capital were three alternative lenders that have been around for decades and are now adapting quickly to the new lending environment. In fact, it is conceivable that Solina’s new capital structure would not have happened without the trio’s involvement, all of which provided mezzanine financing to Solina in 2011 and have now provided mezz plus senior debt to Solina for the first time.

Alcentra, one of Europe’s largest and longest established credit managers, joined by LFPI, France’s largest independent alternative asset manager, and Cerea Partenaire, the French agribusiness specialist, all took part in the deal.

Together they provided a €60 million term C loan and a €22 mezzanine loan to Solina’s debt structure, which was also supported by a pool of eleven banks for the total amount of €166 million. The three credit funds were particularly active in making the deal happen. “It was a request from the funds to have a specific loan allocation,” Fabrice Vidal, managing director at Cerea Partenaire, tells Private Debt Investor.

“Everyone was involved. There was a large approach to support the company [which] had an interest in seeing banks and funds participating in the debt.” César Rodriguez-Montes, head of debt funds at LFPI, explains further: “Funds proactively underwrote the new term loan, then negotiations with banks culminated with a sharing of the new term loan and allocation was executed among all lenders.”

BORROWER’S MARKET

With bank lending activity constrained by capital requirement rules that have tightened over the last few years, particularly in the lower and mid-market sector, alternative loan funds have been steadily making ground. What’s considered risky territory by some is now considered prime real estate by others. The Solina transaction is a dividend recap, which enables shareholders to replace their own capital, usually equity or an equity-like instrument, with new debt. It is a practice that is experiencing a resurge as the appetite for corporate debt grows again post-crisis. It allows private equity sponsors to de-risk their original investment without the need for an exit.

The Solina deal also sees amortising debt replaced with non-amortising debt, with principal paid at maturity rather than throughout the life of the loan. The total debt service payable by Solina has been reduced with the partial repayment of a senior term A loan, an instrument which amortises or requires principal payment on a yearly basis. It’s the loan banks or institutional lenders have traditionally made, with repayment scheduled before other instruments such as term B or C loans. To refinance the recapitalisation, Solina used €9 million of cash as well as a new senior term C loan of €60 million, which is non-amortising and underwritten by the loan funds. A new committed acquisition line of €40 million was made available together with a non-committed acquisition facility of €20 million.

Said a source close to the deal: “This time around it made sense that the debt backing the deal was non-amortising. The deal only has debt that needs to be refinanced at the end of maturity as opposed to progressively over the life of the loan. That’s something only loan funds can do hence it made more sense for loan funds to be included in the senior financing. Their instruments are more flexible.”

The terms of a €22 million mezzanine loan were also amended with a maturity extension and a slight decrease in margin, which was also provided by Alcentra, LFPI and Cerea for a second time split evenly three ways. Alcentra and IK Investments declined to comment. Solina was not available to comment.

BANKS BECOMING LESS PROTECTIONIST

Improved terms are not that surprising in a persistently low interest rate environment. However, the inclusion of alternative lenders in the senior and mezzanine capital structure position, each using funds with different strategies, is quite unusual, according to one industry source.

LFPI, a mezz lender which has transitioned to senior since 2012 and also trades on the secondary market, contributed €5 million of senior debt, thus increasing its exposure to Solina from roughly €7.3 million to €12.3 million. “In my view, Solina’s refinancing shows how flexible private debt lenders can be. We are able to play at all levels of the debt structure,” Rodriguez-Montes says.

Cerea too has invested in the senior piece, an area this traditional mezzanine house has just started to explore this year, closing four deals so far. Alcentra has provided an undisclosed amount of senior debt in the deal for the first time also. “In terms of where to invest, it depends on the strategy of each debt fund, whether they are able to go into the senior position, and whether they are able to adapt. We could be at all levels as long as the debt is liquid,” Rodriguez-Montes says.

It wasn’t always the case that funds would take a senior slice over banks. In a deal LFPI co-arranged in 2010 called Unipex, Rodriguez-Montes says: “Some of the banks wanted to disenfranchise the right of the mezz lenders. Back then banks had a much more dogmatic position. ”

According to one industry source, the main concern of pure senior lenders is typically to protect their subordinated piece, particularly when the sub holder is also exposed to the senior position. But Rodriguez-Montes observes that banks have changed their mind-set, “from a ‘we don’t want you in the senior’ to a much more flexible position, as many of these deals trade in the secondary market and can open access to subordinated lenders anyway.”

Some things remain the same. “Banks have not changed their position [insofar] as it is their business model to arrange and syndicate,” he adds.

The business model seems somewhat under threat despite concessions, at least in the mid-market.

One large fund manager tells Private Debt Investor: “There is no syndication process anymore. The owner decides which lender they want to go with. There is no bank involved as such. We arrange directly without the help of banks.”

This chimes with what other large debt fund managers are saying and is also reflected Rodriguez-Montes: investing wherever the debt is liquid by current statistics demonstrating the decline of mezz syndication.

IS MEZZ DEAD?

Mezzanine financing was one of the hardest hit sectors post-Lehman. It was and remains a market used by private equity sponsors in particular to leverage portfolio businesses, and one which banks had a firm grip on in Europe in particular. At one time mezz provided a buffer between senior debt and equity. But high yield bonds and unitranche are proving more popular now, according to one large fund manager. In the absence of mezz syndication and under pressure to make returns, mezz managers have had to get creative about where else to go for deals and naturally they have gravitated towards senior debt.

And while they’ve been known to invest in second lien senior previously, in this business cycle there has been a clear change in terms of how they are approaching senior. Solina is a case in point. Cerea’s Vidal says his firm was comfortable to play an unusual role in the transaction because it was familiar with the asset:

“We know the company, the management team and the shareholders very well and it was a natural extension of our historical mezzanine investment to also be involved in the senior debt, through a different investment [account].”

He continues: “Mezz funds will always have to adapt and they can clearly adapt up and down the capital structure. It depends on their own strategy and their investors' expectations. Mezz can take some minority equity stakes, or you see them doing unitranche sometimes. Mezz funds are firstly asset managers and they have expanded their product offering so they can adapt to the cycle and cater to what investors want and also what corporates want. They need to remain flexible, one strategy being to have different funds to invest in different strategies and asset classes.”

Make no mistake though: senior returns are significantly less than what mezzanine has traditionally sought to earn. According to sources, senior can currently charge around 4 percent, significantly below mezz returns pre-crisis when the latter reached the low to mid-teens. One of the keys to increasing cash returns is direct lending without the banks, one manager says. In this scenario returns of around 7 to 8 percent are achievable, he explains.

“Mezz is dead,” he declares, so direct lending without the banks up and down the capital structure is the future now. In fact, this source continues, banks are often not needed at all, and some corporate treasurers are increasingly aware of it: “They’re left scratching their head wondering, ‘what do we need these guys for’.”

A borrower will look and ask why it should deal with a syndicate of banks anymore when one lender can stump up all the capital, he explains. And with many banks finding it ever more difficult to hold loans that exceed €20 million in size on their balance sheets, their ability to underwrite is becoming severely impaired, thus raising further questions about respective roles in syndication. That is why mezzanine shops and alternative credit funds perceive of their deal flow as widening.

The refinancing of Solina with its simultaneous bolt-on financing is a prime example of a mid-market business unable to fund itself with traditional senior debt alone, thus looking elsewhere and ending up doing business with a group of mezzanine providers who in turn have ventured beyond their traditional hunting grounds and further down the risk curve. Solina also reflects a trend of alternative lenders increasingly making loans to support M&A activity in the mid-market.

And finally, Solina demonstrates how banks are responding to increased competition from alternative lenders by being more flexible and willing to lend side by side. Moreover, it is said that some European banks are becoming that much more accommodating as to provide and underwrite non-amortising structures that are similar to those provided by alternative lenders.

From a borrowers’ perspective, the upshot of all this ongoing flexing of lenders’ traditional business models appears to be this: yes the decline of traditional bank lending has made it harder to source credit. But new sources of funding have opened up and are proliferating, and private equitybacked companies in particular are getting increasingly good at using them.