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Investment bankers who string together complex corporate takeovers have a new item on their checklists: avoid deal terms that force acquirers to refinance debt.
Keeping old borrowings on the books rather than rolling into new bonds and loans has become a priority for private equity groups and corporate buyers as interest rates rise and lending markets constrict. Because debt held over generally costs less, it has propped up valuations and made some megadeals possible in the toughest environment since the 2008 financial crisis.
“Buyers in this market are seeking to keep the existing debt in place whenever possible,” said a senior adviser involved in one of the largest such deals of last year.
Arrangements to preserve lower-cost debt were a hallmark of several big transactions announced in late 2022, including Kroger’s proposed $24.6bn takeover of rival grocer Albertsons; Brookfield’s $7.9bn sale of Westinghouse; and private equity firm BDT Capital’s near-$4bn purchase of grill maker Weber.
Among the approaches are so-called “portable capital structures”, which allow sales of large stakes in companies, or even complete takeovers, to be executed with just enough cash to pay for a business’s equity. Buyers can avoid having to raise extra money to pay off the debts of their targets, as is typically the case.
In the Albertsons deal, which is being reviewed by US regulators, most of the $7bn in lower-cost debt on the target’s books will be transferable. Kroger’s strong debt rating means it will not need to repay the earlier debts, as legal covenants would have required if the buyer had a weaker financial profile.
“Most capital structures that were executed prior to last year’s [market] sell-off offer significant value to a buyer, given in today’s market a financing would be materially . . . more expensive,” said Jeff Greenip, global head of financial sponsors at Jefferies, the investment bank.
Many deals have also been structured to avoid triggering “change of control” provisions that force buyers to repay all outstanding debts and put new financing in place.
In its sale of Westinghouse, a unit of Canada’s Brookfield Asset Management sold a 49 per cent stake in the nuclear services company to uranium miner Cameco. However, since another unit of Brookfield that manages renewable energy investments purchased the remaining 51 per cent controlling stake, the transaction did not lead to a change of corporate control.
The structure allowed Cameco to simply purchase its minority stake for $2.2bn in cash, just less than half of Westinghouse’s $4.5bn equity valuation. Westinghouse’s $3.4bn in debt stayed in place, allowing one of the biggest transactions of the fourth quarter to sidestep frozen credit markets.
“Advisers are modelling out transactions, and there is a certain breakpoint above which refinancing at current rates make it not a good opportunity for them to pursue,” said one person involved in the deal.
So-called secondary transactions are another type of arrangement, in which new investors are brought in to take minority stakes that do not trigger a change in control.
Recent secondary transactions include Bain Capital’s sale of a large minority stake in warehouse operator Imperial Dade to Advent International at a near $6bn valuation, and Partners Group’s sale of a 50 per cent stake in pipeline services company USIC to Kohlberg & Co for $4.1bn. Neither involved new debt, according to people briefed on the deals.
Since the target companies were able to maintain the low-cost financing they raised when interest rates were low, sellers received valuations that were not as affected by higher financing costs that have swept through the market.
The yield on the average single-B rated US corporate bond — a credit rating that often includes many risky leveraged buyouts — has risen to 8.28 per cent, from 4.74 per cent at the start of last year, data from Ice Data Services showed. And that probably understates the true cost, given that financing markets are mostly shut to big private equity takeovers. The cost to borrow from direct lenders in private markets in some cases has surpassed 12 per cent or 13 per cent, according to investors.
“Selling a business with debt remaining in place is a real asset,” said an executive involved in one of these transactions.
However, portable structures are viewed with scepticism by funds that invest in corporate credit. Fund managers are wary of acquisitions that might result in them holding debt that becomes riskier than when they first agreed to buy it.
“What you are nervous about is that someone will buy the company and make the capital structure substantially [more leveraged]” as a target company’s debt shifts on to the acquirer’s books, said John Yovanovic, the head of high-yield portfolio management at PineBridge Investments.
Creditors of Latin American telecoms group Millicom International Cellular saw the value of their bonds slip last week after the Financial Times reported that private equity giant Apollo was in talks to buy the business. Apollo, known for running its portfolio companies with relatively high levels of debt, plans to leave Millicom’s existing debts in place.
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