Termsheet: Are Europeans risking a debt overdose?

When Bain Capital and Cinven finally agreed the €4.1 billion takeover of Stada in August – completing the largest leveraged buyout of a European listed company in the last four years – those involved in the deal may have needed to ask the German drugmaker for some calming medication.

The bid had dragged on for months, but while it reminded the market of some of the difficulties associated with German public-to-privates, the deal gave no indication of any loss of appetite in the financing markets. According to reports, the high-yield bond element of the financing was subscribed multiple times over.

At a leveraged finance seminar organised recently by UBS – one of eight co-leads on the debt financing of Strada – David Slade, the bank’s global co-head of leveraged finance and leveraged capital markets, said: “If investors find an asset that they feel they have to be part of, they will pile in.”

CONTROVERSIALBuoyed by the presence on the deal of two blue-chip private equity names, investors did not hold back – even in spite of a highly controversial high-yield bond covenant which allowed debt to be incurred at the parent level and used for any purpose (including a dividend payment to the sponsors) without being constrained by the restricted payments covenant.

“There is little doubt that the covenant package [in Stada] pushed the edge of what has in recent months become a very flexible envelope,” said leveraged finance data specialist Debt Explained in a recent examination of the deal. However, the same analysis also said that, while the package was “aggressive” it was also “not unprecedented”.

While it is not unusual for private equity firms to pay themselves a dividend by raising holding company debt, it is less common for the company itself to guarantee the debt – as is the case with the Stada deal.

According to Debt Explained data, 29 percent of deals in the European high-yield bond market in 2017 have contained a restricted payment carve-out that allows principal and/or interest payments to be made on debt incurred at the parent level. The percentage has steadily increased year after year, having stood at less than 15 percent in 2013.

However, the carve-out is subject to a number of different formulations – the most investor-friendly of which is seen in around 80 percent of cases and involves debt being guaranteed by the restricted group and proceeds injected into the restricted group.

However, this is not the type of formulation seen in Stada, which involves the debt being guaranteed by, but proceeds not being injected into, the restricted group. This is less investor-friendly and is seen in far fewer cases.

One question posed at the seminar, in light of the pricing and structuring of Stada, was whether European investors are perhaps becoming too excited at the prospect of deploying a material amount of capital when a mega-deal comes along – and are, in the process, losing their discipline. One covenant may not provide a whole answer to that question, but perhaps it should not be overlooked either.