Leveraged Finance: An Australasian blossoming
Australasia has seen a blossoming of LBO activity that has brought in a wave of innovation and a fundamental change in the way risk is perceived and managed. While these developments have not been to everyone’s liking, a new breed of mega-sized LBOs are changing the corporate landscape in the region, and the private equity firms say they are here to stay. Hugh Chow reports.
Australia and New Zealand have witnessed a flowering in demand for leveraged financing amid unprecedented levels of private equity activity that has sought to return some of the region's best-known listed companies back into private hands.
The proposed A$11.1bn sale to private equity firms of national carrier Qantas Airways has prompted heated debate in Australia. The next iconic Australian brand up for grabs is retailer Coles. Final plans are being formulated by Coles management for the sale of the group, either in its entirety, or with separate sales for the individual businesses.
Meanwhile, New Zealand's largest ever leveraged buyout, the NZ$2.2bn sale by Telecoms of its Yellow Pages directories business, has produced a winner in the form of a consortium comprising CCMP and Ontario Teachers Pension Plan.
ABN AMRO, Barclays Capital, Calyon and Deutsche Bank provided the financing which consisted of NZ$1.2bn in six-year senior debt and another NZ$300m six-and-a-half year subordinated tranche.
Leverage is expected to be more than 9x total net debt-to-Ebidta, which would make the deal the most highly geared LBO transaction seen in Australasia so far. It also set a new benchmark for Yellow Pages deals globally.
Although LBOs from the region have only recently taken off in terms of size, frequency and public awareness, these types of transactions first started appearing around a decade ago.
"The market has been active and growing since the late 1990s, although mostly in the small to mid-sized space with the exception of the occasional larger type deal once every 12 to 18 months," said David Chapman, director of corporate & structured finance at BOS International.
"However, most of these transactions up to the last 12 to 18 months occurred through the sale of public company "non-core" divisions or private sales," he said. Chapman defines small to mid-sized deals those with financings of up to A$750m.
What has changed has been the amount of cash controlled by global private equity funds, which have started to unearth assets in previously overlooked markets with which to maximise investment returns.
"Over the last few years the number of private equity/leveraged buyout deals in Australia has been steadily increasing, and with the weight of liquidity in the private equity space globally and high levels of activity in Europe and the US, it was inevitable that the trend would follow in Asia-Pacific," said Graham McNamara, global head of syndications & agency at nabCapital.
"Australian companies are by and large well managed, conservatively geared and often operate as part of duopolies or small oligopolies," said Aziz Dean, managing director, fixed-income capital markets at Citigroup. "Add to that the stable economy and legal and regulatory frameworks and it should come as no surprise that leading private equity firms are finding this a good market to invest in."
The arrival in Australasia of the likes of legendary buyout firm KKR has coincided with a sharp increase in the percentage of mergers and acquisitions attributable to private equity and their efforts to return public companies back into private ownership.
"M&A has not materially increased, but critically it is the percentage of M&A which is going to private equity which has increased substantially from around 5%-8% a few years ago to circa 23% for year-to-date 2007," said BOS International's Chapman.
Larger deal sizes have forced innovation as funding requirements begin to exceed the ability of the local industry to provide capital without help. Before retailer Coles rejected an A$18.2.bn offer from a consortium led by KKR last year (Coles management is preparing a new sale process in which KKR is expected to take part) much speculation had been focused around how lead arrangers would source funds from overseas – with troublesome foreign exchange issues – without making the whole process prohibitively expensive.
"The structure and terms of local financings are quickly catching up to European deals. This is due to the fact that global PE firms look to use similar structures that have been successful for them on transactions in other parts of the world," said nabCapital's McNamara.
Marla Heller, Deutsche Bank's head of leveraged finance (Australia and New Zealand) agreed that Europe would provide the template for future market development in Australasia. “Europe has grown in volume and structures have become more aggressive. For example, covenant-light structures were virtually non-existent pre-2006. Lenders are willing to take more risks for the same assets.”
The Qantas financing has set a precedent for a deal originated in the local markets in that it has brought the “covenant-light” concept, or looser to non-existent covenants, into the southern hemisphere.
Kevin Bush, head of leveraged and acquisition finance at UBS, identified other recent innovations as the beginning of significant buy-ins from institutional investors from Europe and elsewhere into Australasian financings. “Global funds will assign part of their funds to Australia which will deepen the market and make it easier to underwrite larger deals,” he said.
While Bush reckoned the most significant impact of this new involvement by institutional investors would eventually be in the shallower junior debt markets, recent deals that have seen offshore hedge fund and fixed-income fund manager participation, such as the financings behind the PBL Media and Seven Media transactions following changes in media ownership rules, have been restricted to the senior debt space.
“With the development of the market over the last 12 to 18 months and the increase in purchase price multiples, we have seen more aggressive financing packages based on current parameters in the European market, such as higher gearing, certain funds, no MAC clauses, equity cure rights, no scheduled loan amortisation and yank the bank clauses,” said BOS International’s Chapman. “I see the larger deals being structured more and more to be distributed to funds in Europe. Although less so in the mid- and little, if any, in the small part of the market,” said Chapman.
Payment-in-kind (PIK) notes have also seen a surge in popularity in Australasia as private equity sponsors see them as a means of super charging leverage while minimizing cash requirements to fund LBOs.
Tranches of PIK notes first appeared in the leveraged financing to back KKR’ acquisition of Brambles’ Cleanaways and Industrial Services businesses last year and also made part of the financing that enabled CVC Asia-Pacific to acquire a 50% stake in its joint venture with Publishing & Broadcasting (PBL Media).
They would also have featured in the MBO of travel agency Flight Centre had shareholders not poleaxed the deal. Meanwhile, the Qantas financing will likely feature PIK, if its own shareholder problems can be overcome.
“Without a doubt, there has been an increase in LBO activity in Australia and with the size of these transactions becoming significant, PIK note issues are being seen more often compared to the past when takeover sizes were comparatively more modest,” said Nicholas Chaplin, director of hybrid and structured securities at Westpac Institutional Bank.
While the blossoming of LBOs in Australasia, has been a blessing to many, its arrival has not been without controversy. The risks associated with highly leveraged acquisitions have been debated from the corridors of power in Canberra, to the pages of national newspapers as concerns from the sustainability of interest repayments in an economic downturn, to job security under new management come under major scrutiny.
While frequently portrayed as rapacious barbarians hammering at the gates intent on an orgy of pillaging and looting of well-loved national assets, private equity firms are keen to highlight their experience and professionalism.
“The private equity doomsdayers within the market are obviously entitled to their view. However, our perspective is that the larger recent buyouts have been consummated by world-class sponsors with significant experience in this business," said Avi Gilboa, principal at CCMP Capital Asia. "That experience doesn't insulate LBO practitioners from failure, and yes, there will undoubtedly be some underperforming deals that emerge from this vintage of investments. But the reality is that top quartile sponsors are zeroing in on undermanaged assets that offer strong operating improvement potential. Valuation and debt multiples need to be looked at within that context."
"It would be a bold call to suggest that Australian buyout activity will permanently outpace the rest of the region, so it's importance in relative terms will inevitably diminish," he said. "In absolute terms, though, it is difficult to imagine that the level of private equity momentum created in the last 12 months will simply come to a grinding halt. Private equity has well and truly arrived in this part of the world and is not planning on going home any time soon."