Friday, 20 July 2018

Leveraged Finance: Potential amid the obstacles

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Although the buyout market in central and Eastern Europe can match Western Europe in terms of structure and pricing, volumes remain small. And while the market offers considerable potential, there are still difficulties in transacting deals, meaning convergence with the rest of Europe could still be some years off. David Cox reports.

The market in Central and Eastern Europe reached a milestone earlier this year with the completion of the debt supporting the Falcon Consortium's buyout of two telecom assets in the Czech Republic. Backed by a debt package of €770m, the loan closed well oversubscribed resulting in a structural and pricing flex. This success showed that sponsors can achieve similar terms in central Europe to what they can achieve in the more mature western European markets.

"It is hard to generalise given the diversity of the countries within the central and Eastern European region," said Paul McKenna, managing director and head of leverage finance at ING. "However, for EU accession borrowers the extent of structural aggression in terms of purchase price and debt multiples is now fairly close to Western Europe."

The Falcon Consortium's success was quickly followed by Permira's buyout of Hungarian chemical group, BorsodChem. Backed by a €1.15bn loan package, the deal set a regional LBO debt record and both structure and pricing were flexed down.

Despite these successes, however, volumes remain small, with just US$1.79bn worth of deals completed in 2006, according to Thomson Financial. In addition, though from a private equity perspective there are higher returns available in countries like Bulgaria, Romania and Ukraine, large buyout funds remain focused in the first wave of EU accession countries.

Since their accession to the EU, the countries of central and eastern European have all performed economically extremely well. For buyout funds this means the region offers superior growth prospects, but this is leading to higher purchase prices and higher debt multiples.

And while the loan markets has shown maturity in terms of back-ended structures and reverse flex, the universe of lenders - specifically institutional investors - is limited. This has put the loan market at something of a disadvantage to the bond market where investors have been willing to accept higher leverage multiples. For example, BITE, a Baltic mobile group, recently completed a €300m FRN bond sale supporting its Mid Europa-led buyout with leverage mooted to be close to 10x.

The relative sophistication of the bond market means the loan market is not automatically a sponsors' first port of call so the outcome of the auction of the Bulgarian

telecommunications BTC is set to be closely watched. A 65% stake in the group is up for sale and, not withstanding trade interest from groups such as Turkcell, a private equity solution is a good possibility. So far several sponsors are rumoured to be looking at the group including Mid Europa, Texas Pacific Group and Warburg Pincus and bankers said that if private equity was victorious, then the deal could come with a debt package of at least a €1bn - a big ticket for any Bulgarian borrower, let alone a buyout.

Although, BTC could be another milestone in the region, deal flow remains light. And while €1bn-plus deals may grab the headlines, the market is still bereft of smaller deals that are the bread and butter of the western markets. This is in part because difficulties remain. Bankers said that performing due diligence was not as easy in the region and that there was not the same confidence in the legal system.

Moreover, as a general point, lenders said that financial reporting was not as reliable in the region as it could be, which could partly explain sponsors' preference for established businesses in predictable highly cash generative sectors such as telecoms.

As ING's McKenna explained: "As for convergence with Western Europe, with regard to the earlier EU entrants - Poland, Hungary and Czech Republic - convergence has already very nearly happened; whilst for the newer entrants - Romania and Bulgaria - you are probably looking at a three to five-year time horizon. In terms of deal structure, there is little difference with features like aggressive leverage, tight pricing, back ended debt profiles and reverse flex now common in the bigger deals in the region. But the deal flow is still relatively light and focused in key sectors like telecoms and cable (eg Ceske Radiokommunikacja), with industrials only making a recent entrance - eg Borsodchem. The question remains whether the Central and Eastern European market will ever be as big as the region's GDP suggests it should be."

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