Leveraged buyouts have a chequered history but JPMorgan – which acted in the mega-deals of Refinitiv and AkzoNobel Specialty Chemicals – argues that both were reasonably structured and the market is different from a decade ago. Edward Russell-Walling reports.

Team of month 0119

Natalie Day Netter, Todd Rothman, Daniel Schlumberger

Mega-deals have their own cycle, it seems, with the stars lining up for them every decade or so. Two-thousand and eighteen saw a reopening of the mega-deal window, ushering in, in turn, the two largest leveraged buyout (LBO) financings of the past 10 years. JPMorgan was lead left bookrunner on the junk bond element of both.

“There is a point in time when you can do mega-deals,” says Daniel Schlumberger, JPMorgan’s head of leveraged finance for European sponsors. “Whether you believe in cycles or not, there is a window every 10 years.”

The LBO bubble burst

The late 1980s spawned a string of LBOs, culminating in the mammoth Kohlberg Kravis Roberts (KKR) seizure of RJR Nabisco. The late 1990s and the tech bubble led to Vodafone-Mannesmann and AOL-Time Warner, the two biggest 'mergers' in history. The late 2000s ended in tears, but not before they witnessed deals such as the ill-fated acquisition of Texas power company TXU by KKR and Texas Pacific Group, the largest ever LBO.

The leveraged finance market in 2017 was powered mainly by companies taking advantage of low rates, looser covenants and lower borrowing costs to refinance their debt. “Roughly three-quarters of supply on both the loan and the bond side in 2017 was refinancing-driven,” says Todd Rothman, a managing director in JPMorgan’s Europe, the Middle East and Africa (EMEA) high-yield and leveraged loan capital markets team.

By 2018, Mr Rothman notes, it was more about mergers and acquisitions and LBOs. While the rate environment remained attractive, many companies had already pushed out maturities and the number of those needing to refinance was lower, he says. Private equity groups and credit investors, on the other hand, have been under pressure to put large amounts of capital to work.

A new cycle

Thomson Reuters, the media and information business, kicked off 2018 with the announcement that it had agreed to sell 55% of its financial and risk unit for $17.3bn. The buyer was Blackstone, the US private equity firm, helped by the Canadian Pension Plan Investment Board and GIC, the Singaporean state fund.

The unit, which was Thomson Reuters’ largest, comprises its trading and data activities and has since been renamed Refinitiv. The buyers put up $3bn in cash between them, with Blackstone stumping up the largest share, leaving $14.3bn to be raised in the debt markets. “Investors made room in their portfolios, because they knew that there was a lot of supply coming in September,” says Mr Rothman.

This would be the largest financing for a single B LBO since the financial crisis. JPMorgan was financial adviser to Blackstone, lead left bookrunner on the $4.3bn bond issue and joint lead arranger on Refinitiv’s $10bn credit facilities. The credit facilities consisted of a five-year $750m revolver, a seven-year US dollar term loan B of $6.5bn (with a coupon of Libor plus 375 basis points) and a seven-year $2.75bn equivalent euro term loan B (Euribor plus 400 basis points).

“The European debt was more expensive than the US dollar portion to the issuer, but euros made more sense for the business mix,” says Natalie Day Netter, an executive director in JPMorgan’s EMEA leveraged finance syndicate.

The bond issue was in four tranches. There were secured notes of $1.25bn (with a 6.25% coupon) plus $1bn euro equivalent (4.5%), with unsecured notes of $1.575bn (8.25%) and $425m euro equivalent (6.875%). All tranches were priced tight of or at the tight end of initial price talk.

A welcome sight

This was just what investors wanted to see, and the loans and bonds on offer were reported to be more than twice oversubscribed. “Certain market participants will only look at transactions with scale,” says Ms Day Netter. Coming from a global business, with dollar and euro components, makes a deal as compelling as it can get.

“A large-scale deal matches investors’ desire for secondary market liquidity,” says Mr Rothman. “They want to know that a deal they are invested in will trade in all market environments. It’s hard for them to put their capital to work in size, and deals like these don’t come around every day.”

However, the issuer took full advantage of investor appetite, and covenants appeared to give new meaning to the phrase ‘covenant-lite’. One clause allows the owners to pay themselves dividends even if the business is in default, and one credit analyst told reporters these were “probably the worst” high-yield covenants he had ever seen.

Critics also pointed to ‘add-backs’ that lowered leverage multiples by inflating pro forma earnings. While Refinitiv estimated total leverage at 5.3 times earnings before interest, tax, depreciation and amortisation (Ebitda), the latter included cost savings not expected to be realised for another three years.

Enter AkzoNobel

Hot on the heels of the Refinitiv financing came AkzoNobel Specialty Chemicals, the largest ever LBO in the chemicals sector. The unit was auctioned off by Dutch paintmaker AkzoNobel as part of its defence against a hostile bid by rival PPG Industries. US private equity group Carlyle won the bidding for the carve-out. Its victory was announced in March, along with a price of $10.1bn including debt. Here again, Singapore’s GIC was part of the winning team.

That left plenty of time for investors to do their homework on the financing. “AkzoNobel and Refinitiv are not [comparables], but the success of one helped the other in a symbiotic way,” says Ms Day Netter. “It supported the view that large deals do better.”

AkzoNobel could have been seen as a cyclical oil- and gas-dependent business, and so not a good candidate for more leverage at this stage in the cycle. “In fact, it is a very diversified business, with five divisions and 21 product lines,” says Mr Rothman. “We were able to present investors with historical data through the crisis, showing a balance across the portfolio through thick and thin.”

Oil and gas prices had less of an impact than might be supposed and electricity costs, the biggest input, were substantially hedged, according to Mr Rothman. Moreover, Carlyle’s experienced team had successfully handled several previous carve-outs, especially in the chemicals sector.

Carlyle put up €3.38bn of equity, and the financing would raise a further €7.25bn. As in the Refinitiv transaction, the level of demand allowed the (cheaper) term loan element to be increased at the expense of the bonds. A seven-year €1.79bn term loan B was priced at Euribor plus 375bps, and a seven-year $4.34bn loan at Libor plus 325bps. The package included a €750m revolving credit facility.

The loans were supplemented by eight-year non-call three unsecured note issues in both US dollars and euros – €485m with a 6.5% coupon and $605m paying 8%. JPMorgan was sole bookrunner on the US dollar term loan B tranche and joint bookrunner on all other tranches. 

The loans were rated B1/B+/BB- and the bonds Caa1/B-/B-. “In the US there has been a large migration to investment grade in chemicals, so this was a rare opportunity to add paper for high-yield accounts,” says Mr Rothman.

AkzoNobel calculated its total leverage to be 5.7 times Ebitda, though the Moody’s estimate of pro forma leverage was 6.5 times. The junk bond covenants were also at the flexible end of the spectrum.

Healthy demand

Previous mega-deal windows have slammed shut in a fog of excessive and unsustainable debt. Are these transactions a sign that history is repeating itself?

“Both deals are reasonably structured and not overleveraged,” says Mr Rothman, who adds that while the market in September was strong and aggressive, it was not behaving in the same way as it did 10 years ago, he adds. “History will be the judge, but in 2006/07 there was a higher percentage of deals where sponsors took every ounce of leverage available to them,” he says.

Mr Schlumberger believes there is still a good technical environment for issuance and for leveraged finance. “Our investors have cash, but they worry that this is the end of a long period of growth and that recession is coming,” he says.

Yet he reckons the nature of demand is healthier than it was in 2005 to 2007. “There are more long-only and more diverse investors and they are less leveraged themselves,” he says. “The cycle always turns, but what’s coming should be a correction, and not what we saw in 2008.”

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