M&A leads the way
The M&A revival means 2006 looks likely to be one of the most profitable years for European loan banks in a long time. After three years of a refinancing-dominated market, drawn event-linked transactions are now offering banks decent yields. Victoria Pennington reports.
M&A is back. Bankers are cheering the return of premium paying acquisition-related transactions and are salivating at the mass of ancillary business attached to these takeover deals.
“Few deals, almost none, were the traditional five to seven-year undrawn backstop deals priced at 12.5bp to 17.5bp, which was a feature of 2004 and continued into 2005,” said David Bassett, managing director and global head of loan markets at RBS. “It is hard to beat that pricing this year, so there have been fewer refinancings and these have been replaced with more high-grade M&A transactions that are generally better priced than relationship-driven deals.”
The scale of the revival can be seen most clearly from the yearly statistics. There have been 188 acquisition-related financings worth US$305bn in the 12 months to August 2006, according to data from Thomson Financial. This is a great leap from the 128 deals worth US$126bn syndicated in the same period last year.
As a consequence of the return of M&A and dearth of the refinancings that characterised most of 2005, the number of refinancings has declined by more than a third.
These figures make great reading for banks and understandably they are welcoming the return of acquisition-related deals. The number of M&A deals has not, however, increased in line with volumes due to the marked increase in the number of jumbo financings. The end of 2005 marked the return of sizeable acquisition transactions with the £18.5bn record sterling loan for Telefonica backing its acquisition of O2. And the record €30bn loan from France Telecom in 2000 was smashed in March by German utility E.On, which launched a €32bn loan to back its acquisition of Italian firm Edessa.
There has been some concern that even though substantial M&A deals have been done, any premium that used to be prevalent for these types of financings has been largely eroded. With margins of 22.5bp to 27.5bp with a participation fee of between 12.5bp and 17.5bp, E.ON paid a slight M&A premium, mainly because of the deal's size and the increased liquidity from the market. Another large deal was Linde’s US$8.9bn and €2b loan financing its takeover of BOC. Linde paid between 50-55bp, a clear premium over its 2005 €1.8bn revolver, which paid just 16.5bp.
But corporate M&A transactions seem to have fallen into two camps. “There are the very strong rated companies who can fund very cheaply, where the premium for banks is minimal in context of how much liquidity is being taken from the market; and there are other corporates, which are not so highly rated or do not have strong banking relationships, which have to pay a premium for event-driven transactions,” said Rachel Watson, managing director, head of western European origination at HSBC. Hostile and non-recommended bids, such as Mittal Steel and Xstrata for example, can command a much higher premium.
This year has also seen a marked shortening of maturities for large transactions and a continuation of last year’s trend of banks arranging bridge loans for large deals to facilitate takeout financing either in the capital markets or elsewhere, such as disposals as in the Bayer and RAG deals.
Borrowers have also been keen to keep bank groups small for these jumbo transactions with large underwriting commitments from fewer banks. HSBC underwrote €11.2bn of E.On’s €32bn loan – the largest even underwriting ticket for a European loan – with the intention of selling down the paper in the capital markets.
“These structures suit both borrowers and MLAs as it is a way of adding capacity without depending on raising large sums of money from the market,” said Julian Taylor, managing director, syndicated finance, at HSBC. “Also general syndication generally does not attract the preferential mix of investors looking to invest in one-year facilities.”
Linde’s deal also had a clear refinancing strategy in place with a large part of the loan to be taken out by a €1.4bn–€1.6bn capital increase, a €1.2bn–€1.6bn hybrid capital sale and longer-term bonds and bank loans.
The inclusion of a sukuk in Dubai Ports' US$6.5bn five-year loan backing its takeover of P&O demonstrates the much broader range of capital markets issuance even compared to five years ago when the last round of M&A activity emerged.
Larger M&A transactions have also required innovation in distribution: “You cannot increase your final take so you need to develop a more sophisticated distribution strategy by the increased use of the secondary market to manage high-grade paper – previously a tactic reserved largely for leveraged transactions,” said Damien Lamoril, managing director and deputy head of European loan syndication at SG.
As a result of this move away from general corporate purpose refinancings to acquisition financings, bank investors are balancing enhanced fee income opportunities in relation to the capital ‘ask’.
“Banks are spending more time evaluating the merits of acquisition-related transactions, particularly pertaining to the post-closing credit profile as any potential rating action may lag the distribution period and acquisition closing,” said Steven Victorin, head of global loans for Europe and North America at Citigroup. “During the prior period, general corporate purpose refinancing activity did not require the same level credit scrutiny as these financings generally reflected a steady-state credit profile. Regardless of any credit profile change, given the robust competitive environment, the ‘ask’ is not only met, but these financings are heavily oversubscribed.”
This new environment is expected to continue going forward and bankers expect there to be some tightening of leverage in corporate acquisitions and more risk analysis of M&A deals. “Banks are becoming more selective, with a lower hold level. That said, borrowers are still firmly in the driving seat and can command tight pricing. Last year there was a low point with a spate of seven-year refinancings at cheap prices, we seem to be through that now and are being pulled out of the trough by the return of acquisition-related deals,” said HSBC's Taylor.
One market-driven trend in 2006 has been the growth of infrastructure deals and the move of investment-grade deals into the crossover space. UK news directories group Yell is a good example of the latter.
Yell launched its £4.6bn crossover loan backing its acquisition of a stake in Spanish rival TPI in March, through bookrunners Citigroup, Deutsche Bank, Goldman Sachs and HSBC. This was the first time a high-grade crossover credit has included a B tranche aimed specifically at attracting hedge funds and institutional investors, which usually lend only to pure leveraged names.
Crossover credits generally pay between 110bp and 160bp over Euribor/Libor. Yell’s A loan and revolver paid out-of-the-box margins of 175bp over Libor, while the B loan paid 225bp over Libor, pricing aimed squarely at institutional investors.
“Yell is particularly hard to classify as it is a FTSE 100 company but leans towards the leveraged end of the spectrum due to its stable and highly cash generative operating model, providing a good yield in relation to its equity rating. The pricing of the institutional piece is strongly influenced by the credit rating, which facilitates the necessary liquidity when accessing this investor base,” said HSBC’s Watson.
Asset-starved institutional investors are also being tempted into the burgeoning infrastructure space as bankers begin to structure more hedge fund friendly structures for financing regulated assets.
Infrastructure deals are a hybrid of corporate finance, project finance and leverage acquisition finance, characterised by longer maturities and regulated assets. Ferrovial’s loan backing its takeover of UK listed airports operator BAA is the largest example, but last year three French toll roads were on the block for €20bn and Macquarie’s Indiana toll road (which is being syndicated in Europe and the US) have also been in the market. More recently the £2.37bn loan backing the purchase of Associated British Ports has launched, which includes a junior tranche to help appeal to a different type of investor. That deal is priced at 100bp over Libor across all tranches but the amortising junior piece will be the target for most funds.
Infrastructure deals pay attractive yields and are often oversubscribed as investors – most notably pension funds – like the stable cash flows of these long-term assets.
“Investors prefer assets where there is a good degree of regulatory oversight – airports for example. But for assets where there is less regulatory control, deals can struggle,” said HSBC's Taylor.
Bankers are also keen to lead these deals as they have a natural progression to securitisation. BAA's debt will almost certainly be securitized, probably after 12-18 months and banks are viewing such deals almost as bridges to securitisations.
The infrastructure pipeline is still filling with some airports on the block, most significantly London City Airport, while more port deals are also expected to come to market. With more deals to come, structures are expected to continue to develop as the infrastructure, and indeed the crossover, space expands.