M&A Looks Different on its Return
February 11, 2010
M&A activity is in the midst of a comeback, but like a patient recovering from a long illness, it doesn’t look quite like its old self. The leveraged loan and high yield bond markets are seeing more deals motivated by mergers and acquisitions, but those deals are more likely to be made by strategic investors and require a greater share of equity.
M&A activity did not really start to pick up until the fourth quarter of last year, though market sentiment began to change during the summer, according to John Huwiler, head of M&A with Jefferies. “August of 2009 is when we very clearly saw a turn in sentiment with respect to M&A,” he said. “Prior to that we had a pretty extended time out from both strategics and sponsors. …Through the course of the fall that dialogue accelerated and was largely led by corporate [buyers].”
Distressed companies are among the first targets in the newly active M&A market, including those that avoided official restructurings and those that have been restructured and are now owned by “unnatural” or “involuntary” equity holders, said Saul Burian, a managing director with Houlihan Lokey who specializes in financial restructuring and distressed M&A. “We are finding financing for decent companies that are reasonably capitalized,” he said. “Generally speaking, there is an upswing in distressed M&A activity as markets begin to improve. … Some of the first people to start looking aggressively at exits are companies that are otherwise surviving at the pleasure of their lenders.”
Recent leveraged loan and high yield bond deals illustrate the resurgence of corporate buyers on the M&A market. JPMorgan has prepared an $800 million term loan B to help facilitate the merger between Quad/Graphics and Worldcolor Press (see related story, page one). JPMorgan also arranged a $400 million revolver. The proceeds from the facility will specifically go to help repay existing debt prior to the merger. As of Sept. 30, 2009, the two companies had a combined debt balance of roughly $1.7 billion.
On the bond market, Dallas-based oil and gas company Denbury Resources issued $1 billion in 8.25% senior subordinated notes due 2020 on Feb. 3 to finance its acquisition of Encore Acquisition. Upon closing, $400 million will be used to finance the acquisition, including purchasing three series of Encore senior notes, and the remaining $600 will be used to fund other debt repurchases related to the merger. JPMorgan, Bank of America Merrill Lynch, RBC, UBS and Wells Fargo were the joint bookrunners.
According to market observers, corporate deals, which are leading the M&A resurgence, will continue to dominate it, partly because private equity firms are being more cautious. “There’s an emphasis on operational opportunities, synergies and tangible elements in growing cash flow to service debt,” said Anders Maxwell, a managing director with P.J. Solomon Co. “Private equity guys are looking at these things with a bit more discrimination, not to say they’re not taking advantage of liberalized terms in the debt markets. But there’s still more thought going into these deals.”
Part of the reason that corporate buyers will continue to have a greater share of the M&A space is that deals now require a much larger equity portion. “The leveraged loan market will still be an important source of funds for M&A activity,” said Richard Grice, an M&A focused attorney with Alston & Bird. “However, the level of equity required by leveraged financing sources is higher than in the pre-crash era of 2007 and before. This gives strategic acquirers that have an equity medium (e.g. their stock) an advantage over financial buyers and sponsors that must use greater amounts of investor cash to meet the required minimum levels of equity.”
While deals in the 2005 to 2007 era managed to close with equity contributions of less than 20%, such deals couldn’t get financing today. Huwiler estimates that the average equity contribution to an M&A deal today is in the 40% to 50% range, and some deals have equity portions above 50%. In a few instances, larger private equity firms that have competed to buy firms smaller than their normal target range have offered to acquire a company with a 100% equity purchase, he notes, though this is a rarely-used competitive tool not likely to become a trend.
In 2009, said Mike Simonton, an analyst with Fitch Ratings, “the overall value of transactions (at around $700 million) exceeded the recent low points in 2002 and 2003. … Acquisition multiples are not likely to reach 2006 or 2007 levels [this year].”
It Takes a Market of Billions…
Still, private equity firms are not absent from the leveraged loan and high yield bond markets. “Private equity is certainly making a comeback,” said Steven Rutkovsky, a partner with the law firm of Ropes & Gray who focuses on M&A. “After a real lull in new deals last year, we’re seeing a lot more activity from private equity sponsors.”
Case in point, Goldman Sachs recently launched a $2 billion term loan for IMS Health, a Norwalk, Conn.-based pharmaceutical data provider. IMS plans to use the proceeds from the loan to help fund its acquisition by TPG Capital, the Canada Pension Plan Investment Board and Leonard Green & Partners, which have put up $2.8 billion in equity and cash. Bank of America Merrill Lynch, RBC Capital Markets, Barclays Capital and HSBC are also involved in the deal. The facility also includes a $275 million revolver (LFN, Feb. 3, 2010).
In January, a bank consortium began shopping a term loan for Cedar Fair, the Sandusky, Ohio-based amusement park that was purchased by Apollo Management in a $2.4 billion deal. The banks—Bank of America Merrill Lynch, JPMorgan, Barclays, UBS and KeyBanc Capital Markets—shifted $200 million from the company’s senior unsecured notes offering to make the term loan $1.2 billion. The term loan has a coupon of Libor plus 375 bps and a 1.5% Libor floor.
And Madison Capital and Dymas Capital are in the market with an $80 million credit facility for Pretium Packaging, a Chesterfield, Mo.-based manufacturer of custom-designed plastic containers. The facility will be used to finance the company’s acquisition by private equity firm Castle Harlan (LFN, Feb. 4, 2010). It consists of a $50 million term loan and a $30 million revolver. Price talk on the term loan is at Libor plus 600 bps, with a OID yet to be announced and a 2% Libor floor, according to S&P.
Despite the recent activity on the loan market, financing for mergers and acquisitions will be more high yield bond dominated than in the past, sources say. “The dependence on the high yield market is probably greater than ever,” said Rutkovsky. “The loan market has been following that success in the high yield market, but high yield is still a critical component of leveraged acquisitions. Watch the high yield market closely if you want to get a glimpse of M&A activity for the rest of the year.”
Of course, economic uncertainly will continue to play a role. The slow recovery will keep the M&A activity slower and where the economy goes, so will M&A. “We’re not hearing consistency across many industry groups about what they expect in 2010 2011,” said Huwiler. “The underpinning comment would be a lot of uncertainty.”
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