Filling the Void

With Europe's high-yield bond market showing few signs of life, mezzanine finance has become key to leveraged buyouts.
Ian RowleyJuly 1, 2003

Who says lightning never strikes twice?

When Bertelsmann, the 18 billion euros German media giant, accepted a 1.05 billion euros bid for BertelsmannSpringer from Candover and Cinven in May, it was the second time in four month the two private equity houses had joined forces to acquire a publishing business. The first deal came in January, when Candover and Cinven agreed to pay Amsterdam-based Wolters Kluwer 600 million euros for Kluwer Academic Publishing.

Subject to regulatory approval, the pair of leveraged buyouts (LBOs) will make the buyout specialists the world’s second largest publishers of scientific material. However, the deals provide far more than just an insight into the purchasing habits of private equity firms. In particular, the two transactions also highlight the growing role of mezzanine loan finance in European LBOs.

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Indeed, at a time when the high-yield bond market in Europe has nearly ground to a halt, mezzanine loans are filling the void. In LBOs, mezzanine occupies a similar position to high-yield bond debt-sitting between secured debt and private equity investment in a capital structure. But mezzanine doesn’t have a public listing; it’s also not traded.

High Yield’s Low

“Historically, high-yield debt provided the meat in the sandwich between the secured bank debt and the equity,” says Dominic Crawley, an analyst at Standard & Poor’s. “But that market has been in a dreadful state for a couple of years.”

For most LBOs, he adds, private equity and secured bank debt lenders account for around 60 percent to 70 percent of the deal — with the remainder increasingly covered by mezzanine. “If it wasn’t for the availability of mezzanine, a lot of these buyouts wouldn’t have been concluded.”

Corporate finance experts note that the buoyancy of mezzanine funding-volume in Europe will jump from 1.7 billion euros in 2000 to an estimated 3.7 billion euros this year-has had a stabilising effect on the LBO market. According to Standard & Poor’s, the value of LBOs in Europe between January and May this year was 17.2 billion euros, roughly the same level as in the first five months of 2002 despite the general economic downturn and the woes of the junk market.

It now looks as if fresh mezzanine funding could provide the buyout market with a bigger boost in the second half of the year. First, Goldman Sachs launched a new $1.5 billion (1.2 billion euros) global mezzanine fund in April. Second, Intermediate Capital Group, a European mezzanine specialist, is understood to be in the process of raising 1 billion euros.

Against this backdrop, more and more deals with high proportions of mezzanine finance are getting off the ground. “In the last few months, we’ve seen deals that include 300 million euros of mezzanine finance — that’s something which even two years ago was unthinkable,” says Kirk Harrison, director of mezzanine finance at Barclays Capital, which arranged the mezzanine tranche of the BertelsmannSpringer deal.

The Gala Group, a 613 million euros U.K. gambling company, is a case in point. When Gala completed a 1.24 billion pounds LBO in March, it raised 190 million pounds from mezzanine investors to plug the gap after raising 615 million pounds of senior debt and an equity investment of 274 million pounds each by Cinven and Candover.

Blair Sinton, Gala’s finance chief, says completing the sale to Cinven and Candover would have been much trickier if it hadn’t been for the mezzanine investors. When the deal was put together in February the prospect of war in Iraq had closed the high-yield bond market for many companies. “It could have been difficult to get a high-yield bond away in that atmosphere,” he says. “In the end it just made more sense to tap the mezzanine market.”

He adds that going for mezzanine finance instead of a high-yield bond gives Gala more flexibility. Namely, the early repayment of a high-yield bond typically requires the agreement of bondholders and, in most cases, a significant charge to the issuer. By contrast, there’s usually no penalty for early repayment of mezzanine debt.

Credit Ceiling

Another attraction is that the profile of mezzanine investors is closer to senior debt investors-in fact, in some cases, such as the Gala deal, they’re same-so it’s easier for companies to find a consensus among their investor base.

Nonetheless, even proponents of mezzanine admit that there’s still a limit to the amount of mezzanine debt that can be raised for a single deal. “To raise 500 million euros would require a large proportion of the pool of mezzanine investors in Europe to all back a single deal,” says Harrison of Barclays Capital. “The chances of that happening are slim.”

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