US High-Yield Bond: Neiman Marcus’s US$600m PIK toggle bond
Back on the map
Luxury retailer Neiman Marcus came full circle in October 2013 when its new owners, Ares Management and Canadian Pension Plan Investment Fund, issued a US$600m PIK toggle to part-finance their US$6bn buyout of the iconic US luxury retailer – the largest leveraged buyout in the retail sector since 2007 that required a PIK to get leverage to more than seven times earnings.
There may have been a string of holdco PIK toggles before this – mainly to finance dividends – but this was the first opco structure used to finance an LBO since before the onset of the financial crisis.
The same banks that deemed it too risky to underwrite, are now trying to figure out how the financing can be replicated.
“Every sponsor has read the documents,” said Marc Warm, head of US high-yield capital markets at Credit Suisse, lead-left on the debt financing. He warned, however, that such structures were unlikely to become widespread because of their riskier nature.
The debt financing also included a US$960m cash pay bond and US$3.75bn senior secured credit facility, while the buyers put in a US$1.6bn equity cheque.
Both tranches are rated Caa2/CCC+ and mature in 2021, but the cash pay bond offers a coupon of 8%, compared to 8.75% on the PIK for a cash payment and 9.5% on the PIK – a differential that created balanced demand across the tranches. The PIK also did well in secondary, rising by two points.
Neiman pioneered PIKs as a buyout tool in 2005 when Warburg Pincus and TPG bought it. When the company stopped making cash payments as the credit crisis took hold and sales took a nosedive, that PIK plummeted to single digits.
Although it eventually recovered – producing very good returns for some investors along the way – others PIKs that followed in its footsteps ended up in bankruptcy.
It’s understandable, therefore, that eyebrows were raised when the financing – underwritten by Credit Suisse, Deutsche Bank and RBC – was first talked about in September.
“Investors were concerned that we were going back to a place in the market that they just didn’t want to see again,” said Warm. “But the structure of this deal went a long way to reassure them.”
For a start, the company’s free cashflow is strong enough to service its debt, unlike a lot of the PIK toggles underwritten in pre-crisis times, said Warm.
And while it was standard in PIK toggles issued back then to allow cash interest to be skipped for several years, Neiman’s new owners must pay cash interest for the first year.
As Warm says: “From an investor perspective, you are getting extra yield for the company having the option to toggle even though it cannot do so for the first year … It’s disaster insurance.”
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