Sponsor-to-Sponsor Deals May Breathe Life Into PE

As of early February, the private equity market remained dead. Lenders, still gun-shy, are only backing the strongest credits, while potential targets have little incentive to sell into the teeth of an historic downturn. A potential solution may be sponsor-to-sponsor sales in which the banks are enticed by improved terms to stay put following a change of control, while the sellers, anxious to clean out their portfolios, are open to any deals that might allow them to return capital to their LPs.

The sale of Global Tel*Link, for instance, caught the eye of M&A pros, who think it might serve as an archetype for future deals. Veritas Capital inked the transaction last September, after the credit markets collapsed, and completed the deal in January. Gores Group, the seller, had originally formed Global Tel*Link back in 2004 through a carveout of Schlumberger's correctional-facility telecom division. Calls to Veritas and Gores were not returned by press time.

For the lenders involved, Credit Suisse and Wells Fargo Foothill, the transaction effectively served as a debt exchange offer. The total leverage, according to market sources, climbed slightly to 4.4x Ebitda, thanks to the addition of a $95 million mezzanine facility, but the senior debt tranche was pared, while the terms and protections were sweetened. The first lien was syndicated with a coupon of Libor plus 600 bps, and a 3% Libor floor. This was up from Libor plus 350 bps and no floor under Gores.

The deal is encouraging to deal pros and lenders because it reflects an effort from all sides to reach a compromise.

"There is a lot less liquidity out there, to be sure, but it shows that deals can get done in this market," CapitalSource president and chief operating officer Dean Graham said. Generally speaking, both equity and debt holders are still working out pricing and structural changes that "reflect new market realities," he added.

Another factor that played a role in keeping the lenders aboard was an amendment to the change-of-control provision. According to Randy Schwimmer, senior managing director and head of capital markets at Churchill Financial, buyers can keep a syndicate in place by appealing to a majority of the debt holders, although pushing through such an amendment typically requires improved pricing and structure. "The advantage of working with the old money is that you only need to convince 50% of the constituency," he said, speaking generally on the topic. "With new money, you have to start from scratch."

Given the amount of LBO-driven activity in recent years, buyers will surely be targeting private equity portfolios as a source of deal flow. And private equity firms, recognizing that it could be years, if ever, before peak valuations return, may be motivated to unload a senescent investment if they can show even a slight profit. During 2005 and 2006, the U.S. private equity industry as a whole was averaging almost 50 deals a month, according to data from Thomson Reuters, which would seem to indicate that many portfolios are just now starting to show patches of gray.

In addition to age, private equity investors are also concerned about being able to demonstrate growth in their portfolio, especially in light of the economic picture. John Rogers, a principal at San Francisco-based LBO shop Gryphon Investors, notes that sponsor-driven combinations could be another option for firms not yet content to seek a full exit. "We're interested in talking to other sponsors about merging our companies as a way to get bigger," he describes.

A lynchpin, however, will be whether or not the sponsors can keep lenders interested in the credit after a change of control. According to Schwimmer, that will require a structure that "conforms to the realities of 2009" and a convincing argument on the part of the buyer that the sale won't have a negative impact on the company's operating performance. Similar to a debt exchange offer, additional equity can be quite persuasive in that regard.


New Blood

Graham, meanwhile, notes that it's often the case that lenders like to see new owners enter the picture. "New equity and new management usually breathe life into a company... it can be very influential in [a lender's] decision to stay in the credit."

One factor that buyers can't control, however, is the turmoil on Wall Street. Schwimmer said that if a pre-existing lending group contains a large amount of exposure to banks that have been tripped up by the turmoil, such as Lehman Brothers, then it becomes more difficult for a new buyer to reach the 51% threshold that would allow the change-of-control.

If that's the case, then it's back to square one as far as the debt is concerned, which makes life more difficult for all involved. -Ken MacFadyen, MAJ

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