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Introduction to Acquisition Finance

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Title: Introduction to Acquisition Finance


1
Introduction to Acquisition Finance
  • Workshop for Fiscaal Economisch Instituut

June,2012, Erasmus University, Rotterdam
2
Profile
  • Bjorn Stibbe
  • 1982 - 1988 RU Groningen Business Administration
  • 1988 - 1992 F. van Lanschot Bankiers, Banker
  • 1993 - 1996 Citibank Amsterdam, Senior Banker
    Global Corporate Banking
  • 1996 - 1998 Citibank Moscow, Member Policy
    Committee
  • 1999 - 2001 Citibank Frankfurt, Senior Banker,
    Member Management Team
  • 2001 - 2006 Citigroup London, Director Leveraged
    Finance
  • 2006 Rabobank London, Director Leveraged
    Finance
  • 2007 Rabobank Utrecht, Senior Vice
    President Leveraged Finance
  • 2008 Author of Financial thriller De
    Zwendelaar

3
What do you expect of this workshop?
4
I
  • Introduction to Rabobank Acquisition Finance
  • II
  • Some (jargon-busting) definitions
  • III
  • How do Financials Sponsors create returns for
    their investors?
  • IV
  • Structuring LBO deals
  • V
  • What is currently happening in the Leveraged
    Finance market
  • VI
  • Q A

5
Introduction to Rabobank Acquisition Finance
  • Section I

6
Rabobank International Acquisition Finance
  • Our approach
  • Our business
  • A focused team of over 50 professionals in 9
    locations globally
  • Origination and portfolio management integrated
    in product line
  • Our approach
  • We arrange and syndicate senior subordinated
    term debt
  • We undertake club deals and participate in
    syndicated loans
  • Our clients
  • Financial sponsors and leveraged corporates
  • Our focus
  • In our home market we cover all industries with a
    preference for Food and Agribusiness (FA)
  • Globally our primary focus is on FA
  • Full range of products and advice to support
    lending
  • Corporate Advisory, MA
  • Food Agri (FA) Research
  • Risk management / Global Financial Markets
  • Securitisation / High Yield bond solutions
  • Close cooperation with corporate banks
  • At heart, Rabobank is a relationship driven bank
    with lending as our core activity
  • Source Rabobank International

7
Rabobanks sweet spot
  • Boxes to tick for new transactions
  • Strong preference for FA or company active in
    Dutch market
  • Focus on reputable sponsor relationship is key
  • Track record of acceptable sponsor behaviour in
    restructurings
  • Mid market transaction (debt packages between EUR
    100 mln and EUR 1,000 mln)
  • Strong and realistic business case, showing
    reliable and sustainable cash flows (no hockey
    sticks)
  • Strong negotiation power in the value chain
    strong position in sustainable market
  • Limited exposure to economic cycle, e.g. staple
    goods, non-discretionary items
  • Sufficient cross sell vital for success of new
    transactions (MA/DCM etc)

More is better. However, not all boxes need to be
ticked
  • Source Rabobank International

8
LBO landscape and outlook
  • Tick....
  • Key issues in structuring/arranging new deals
  • Relationship
  • Sector
  • Credit
  • Liquidity
  • Valuation
  • Underwritten sponsor deals are back with a
    vengeance
  • Competitive fees and margins
  • Underwritten transactions are back on the table
  • Banks
  • More nationalistic
  • Herd mentality persists
  • Preference for either multi-arranging deals or
    club deals
  • Risk of lowest common denominator
  • ..........all the boxes
  • Source Rabobank International

9
Comprehensive product range
Transactions Parallel roles Size Sect
ors Products/Cross-Sell
  • Leveraged buy-out
  • Public-to-private
  • Recapitalisation/refinancing
  • Corporate acquisition
  • Lead Arranger and underwriter
  • Joint Underwriter and/or Participant in
    syndicated loans
  • Debt packages between EUR 100m and EUR 1,000m
  • All sectors with particular strength in Food
    Agribusiness
  • Senior, second lien, mezzanine term debt and PIK
  • Bridging facilities
  • Total return swaps
  • Securitisation
  • Asset based financing
  • Hedging
  • Leasing
  • Real Estate Financing (the Netherlands)
  • Source Rabobank International

10
Alternative financings
  • Mezzanine senior
  • Expensive/dilutive
  • Inflexible
  • Liquidity
  • Best efforts / Book-building
  • Stage-by-stage
  • No Certain Funds
  • Disposals
  • Back-to-back
  • Debt-bridging
  • Asset backed loans
  • Receivables
  • Inventory
  • Other
  • High-yield bond (cooperation with Jefferies)
  • Liquidity
  • Underwriting requirement / horizon
  • Can be longer-term
  • Bullet repayment
  • Incurrence covenants
  • Ongoing flexibility?
  • Onerous reporting
  • Prepayment premium
  • All-equity deal
  • Certain Funds (if required)
  • Visibility of subsequent take-out
  • Equity guarantee
  • A drawing on the fund?
  • Enables top-slice soft underwriting
  • Subsequent book-building
  • Source Rabobank International

11
Rabo Acquisition Finance has weathered the storm
well
  • Achievements in 2011
  • Having successfully weathered what seems to have
    been the worst of the economic crisis, Rabobank
    AF is proud of what is has achieved in
    challenging times completing both new
    transactions as well as executing several
    restructurings
  • Lead underwrites
  • Innovation
  • Transforming client relationships
  • Collaboration with other departments
  • Examples of 2011 Acquisition Finance Utrecht deals
  • Hunkemöller
  • (The Netherlands)
  • Leveraged buy-out by PAI Partners
  • Bookrunner and Mandated Lead Arranger
  • 2011

Scotch Soda (The Netherlands) Leveraged
buy-out by Sun Capital Mandated Lead
Arranger 2011
  • Raet
  • (The Netherlands)
  • Leveraged buy-out by CVC
  • EUR 300,000,000
  • Senior debt facilities
  • Underwriter, Bookrunner
  • and MLA
  • 2011

12
Some (jargon-busting) definitions
  • Section II

13
Some (jargon-busting) definitions
  • Hoeveel flex zit erin? We gaan 4 of 5 trees
    opzetten
  • Vandaag wordt de SPA getekend Back to Back
    gecovered
  • Covenant Lite Hebben we dit geflagd? Pre
    crunch?
  • Super Senior Wij zijn MLA We clubben
    met 2 others
  • Key Sponsor Bankers meeting Bankview team We
    hebben buy side due dill
  • We wachten nog op vendor due dil Welke multiple
    doet ie? Ik vind m vrij chuncky
  • In the DC krijgt hij de double whammy Zitten er
    nog p2ps in de pipeline?
  • De comps doen 6x Misschien kunnen we er een PIK
    note ingooien? Hoe draait de DSCR?

14
Most people have a view on Private Equity
Netherlands 60 of Dutch company chairmen
positive about venture capitalists
Private equity firms are worse than mafia, says
union chief
UK - Trustees of the UKs biggest pension fund,
extol the benefits of private equity
The Observer (March 4, 2007) They are a risk
to the economy as a whole
Private Equity
Tony Blair I think the private equity market
brings a lot of benefits to our economy.
The Guardian (May 11, 2007) Barbarians at the
gate of Boots
PWC - As a result of .. private equity.
activity in the European food sector is rising
with the value of deals completed already well
ahead on this time last year
The Independent (June 9, 2007) IMF chief
attacks complacency of private equity industry
  • Source Rabobank International

15
Definition of Leveraged Finance
Leveraged finance is the provision of debt to
fund acquisitions (often by Financial Sponsors)
of companies or parts of companies with more debt
than would be considered normal for that company
or industry Although different banks mean
different things when they talk about leveraged
finance, it generally includes two main products
- leveraged loans and high-yield bonds A large
part of the role of leveraged financiers is to
calculate how much of what type of debt finance
should be raised
16
What is Private Equity?
  • Overview Private Equity

Investors
  • Private Equity firms (Financial Sponsors) are
    investment schemes, using funds raised from
    investors to acquire substantial stakes in
    companies and holding on to these interests for a
    period of time - usually 3 to 5 years - and then
    disposing them
  • Private Equity funds (some as large as EUR
    10-18b), usually have a maximum life of around 10
    years
  • Private Equity transactions are referred to as
    Leveraged Buy-Outs, as they are often financed
    with significant amounts of debt (leverage)
  • Strategy
  • Buy the asset with external debt
  • Make improvements to increase profitability
  • Wait for the right time to sell (exit)
  • With debt fixed, all the value goes to equity
  • Success measured in terms of Cash Multiples and
    IRR (Internal Rate of Return). IRR erodes over
    time (the 'time value of money) making private
    equity the perfect banking client.

Examples
Fund-raising
Returns
Financial Sponsors
Examples
Cash
Equity
Firm/Target
Examples
  • Source Rabobank International

17
What is an Leveraged Buy-Out (LBO)?
  • Leveraged Buy-Outs definitions
  • What is an LBO?
  • Acquisition of a company (or a controlling stake)
    using a significant amount of borrowed money to
    meet the cost of acquisition
  • Reasons for selling a business
  • Lack of capital to fund the continued operations
    of the business
  • The business is unprofitable
  • More focused strategy back to core business
  • Investment realisation
  • Reasons for buying a company through an LBO
  • Value creation

Management / leveraged buy-out
  • Managers acquire a business they have been
    managing

Management buy-in
  • External management group makes an acquisition

Leveraged build up/ platform buy-out
  • Buy-out with intention to make further
    synergistic acquisitions

Sponsored spin-out
  • New company is partially owned by previous owners

Leveraged recapitalization
  • Company borrows in order to make a cash payout to
    existing shareholders
  • Source Rabobank International

18
How do financial Sponsors create returns for
their investors
  • Section III

19
Value Creation is (increasingly) more complex
Operational value creation
  • Improved performance, e.g. EBITDA growth,
    improved working capital management, synergistic
    acquisitions, etc.

Multiple value creation
  • Clear exit strategy
  • MA skills PE manager
  • Change company profile
  • Improve market position

Most Financial Sponsors target annual returns of
at least 20, using a combination of value
creation techniques
Financial value creation
  • Leverage effect
  • Use of debt leverages return on equity
    substantially
  • Source Rabobank International

20
The leverage effect, the basic rationale behind
LBOs
Scenario B
Scenario A
40 Equity, 60 Debt
T 0
T 0
T 1
T 1
Debt
110
60
60
Debt
Equity
100
Equity
50
Equity
40
100
110
Total
100
Total
110
Total
Return on Equity is (110 - 100)/100 10
Return on Equity is (50- 40)/40 25
Use of debt increases returns significantly the
higher the amount of debt, the higher the return
on equity for the sponsor
  • Source Rabobank International

21
In order to reap returns, investment must be
exited
IPO
  • Listing of company on a stock exchange through an
    IPO

Secondary Buy Out
  • Sale of company to another financial buyer

Trade sale
  • Sale of company to a strategic buyer, perhaps in
    the same industry sector
  • Often at a higher price than a secondary due to
    synergies
  • Historically, the most frequently used exit

Recapitalization
  • Sale of stake to a newco which is then
    recapitalized with equity and debt
  • Proceeds from sale are partly reinvested into the
    equity of newco
  • More a method to receive a substantial dividend
    payment not really an exit
  • Source Rabobank International

22
Structuring LBO deals
  • Section IV

23
How are LBOs Financed?
The lower the equity cushion, the higher the
leverage effect -gt Sponsors seek maximum leverage
Sources and Uses of Funds at Acquisition
Uses
Sources
Equity Investment Private Equity
Equity Value of Target
Equity Cushion 40-60 of total Sources
Equity Investment Management
Enterprise Value Target
Third Party Debt
Net debt (total debt minus cash) of Target
and here comes Leveraged Finance
Transaction Costs
Leveraged Finance is the provision of debt to
fund acquisitions
A large part of the role of leveraged financiers
is to calculate how much of what type of debt
finance should be raised
  • Source Rabobank International

24
Debt Instruments used to finance LBOs
Senior Debt
  • Consists of term debt (used to finance
    acquisition) and working capital facilities
  • First security

Second Lien
  • Second security interest (generally on same
    assets as senior)
  • Typical bubble instrument now out of vogue

Mezzanine
  • Unsecured and subordinated debt
  • Sources of return cash interest, PIK interest,
    equity

Seniority
High Yield Bonds
  • Capital market instrument
  • Rated below investment grade
  • Generally unsecured
  • PIK Payment in Kind Interest paid out in
    additional debt, as opposed to cash
  • May be considered more a form of equity than debt

Return expectations
  • Source Rabobank International

25
Average Debt Structure seen over the last 12
months
Senior Term Loan A
60
80
Senior Term Loan B
30
Senior Term Loan C
10
20
Intermediate Capital
  • One size does not however fit all and structures
    are highly dependent on the company and market
    conditions!
  • Source Rabobank International

26
Key Terms of Most Important Debt Instruments
Senior debt Senior debt Senior debt Senior debt Subordinated Debt Subordinated Debt Subordinated Debt
Revolving Credit Facility Tranche A (TLA) Tranche B (TLB) Tranche C (TLC) Second Lien High Yield Debt Mezzanine
Purpose Finance working capital swings Finance acquisition and transaction costs Idem TLA Idem TLA Idem TLA Idem TLA Idem TLA
Term 5 years 5 years 6 years 6,5 years lt 10 years 7-10 years 5-10 years
Amortisation No amortisation required but often clean down period Fully amortised during term Bullet Bullet Bullet Bullet Bullet
Pricing Generally same as TLA E500bps E550bps E575/600bps n/a1 n/a1 E1300bps (cash, PIK and/or warrants)
Investors Banks Typically Banks Typically Institutional Investors Typically Institutional Investors Typically Institutional Investors Typically Institutional Investors Typically Institutional Investors
  • Note 1 No current pricing can be determined for
    these instruments as there is currently no
    primary activity involving these products

27
Structuring the debt the qualitative angle
  • Section V

28
Factors to take into consideration when
determining suitability to leverage company
Level of business risk
  • The lower the business risk the more stable the
    cash flows of a company
  • Stable, predictable cash flows provide comfort
    for higher amounts of debt
  • Market position, margins, etc. what are the
    defensive characteristics of the target?

of purchase price
  • Banks need to form a view on the purchase price.
    Did the Financial Sponsor pay too much will the
    exit proceeds be sufficient to repay the debt?
  • A certain amount of the purchase price should be
    equity if things go wrong the equity providers
    should take the first hit

Sponsor / Management
  • Relationships and reputation of the equity
    providers are also important drivers of the
    amount of debt banks are willing to lend
  • Given burden of debt on business high quality and
    committed management vital
  • Often committed through (substantial) equity
    investment
  • Source Rabobank International

29
Repayment sources of LBO debt
Debt components are structured to capture
different sources of repayments
Cash flow
  • Principal source of repayment in LBOs
  • In most cases all remaining cash flow (i.e. after
    payment of amortisation and interest) is used to
    prepay debt (cash sweep)
  • Not the preferred source of cash as over time
    marketability and asset valuations volatile

Asset disposals
Refinancing
  • Dependent on
  • Credit supply
  • Market appetite/perception
  • Companys historical performance
  • Some level of refinancing risk is often
    acceptable
  • Source Rabobank International

30
Cash flow most important source of debt service
Key component of a leveraged finance bankers
work is forecasting cash flows
Operating Profit (EBIT)
Cash Tax charges
-
Increase in Net Working Capital
-
Interest
Capital Expenditure
-
Principal
Cash available for debt Service
  • Source Rabobank International

31
Lender protection mechanisms
Mechanisms
Purpose
A set of preconditions that must be satisfied
before the borrower can request drawdown or
facilities be made available
Conditions Precedent
Protect repayment sources
Representations Warranties
Statements by which the borrower gives certain
assurances to the lenders, and on which the
lenders may rely
Influence strategy
Undertakings Covenants
Agreements by a borrower to undertake (positive)
or not to undertake (negative) a action. A breach
is considered an event of default
Signal deterioration
Events of Default
Negotiating power
Contractually specified events that allow lenders
to accelerate repayment of debt
Borrowers grant security over important assets,
to provide the banks with a last source of
repayment in case of serious distress
Security
Last source of repayment
  • Source Rabobank International

32
Examples of typical LBO covenants
Financial
  • Total/senior Net Debt / EBITDA
  • ICR
  • Debt Service Cover
  • Maximum capex
  • Cash sweep
  • No dividends
  • No further indebtedness
  • Guarantor cover test

Non-financial
  • No acquisitions, mergers, joint ventures,
    disposals
  • No change of ownership/ management
  • Maintenance of assets, intellectual property,
    security and insurances
  • Compliance with (environmental) laws
  • Transactions at arms length basis
  • Delivery of (monthly/quarterly/annual)
    information, budget
  • Hedging
  • Source Rabobank International

33
Subordination of debt facilities
Structural
Maturity
Legal
  • Derived from the corporate structure
  • Junior creditors as creditors of holdco rank
    behind creditors of subsidiaries lower down in
    the group structure
  • When a holding company and its subsidiaries
    become insolvent, the creditors of the opcos
    will be paid out before any distribution is made
    to holdco as shareholder in the subsidiary
  • Only if holdco receives a distribution from the
    liquidator of a subsidiary will holco be able to
    meet the claims of its creditors
  • Timing of interest payments and principal
    payments
  • Senior debt should mature prior to junior debt
  • Contractual or collateral
  • Only once senior debt has been repaid, can the
    proceeds of security be used to repay junior debt

Example of structural subordination
Shareholders
Holdco 1
Mezzanine
Holdco 2
Senior Debt
Opcos
Senior Debt
  • Source Rabobank International

34
Selection of recent Acquisition Finance
credentials
  • Deal flow is picking up
  • Source Rabobank International

35
What is currently happening in the Leveraged
Finance market
  • Section VI

36
European Leveraged Loan Market Update
  • High Yield
  • Significant developments over the past two years
    in the European HY market are reflected in steady
    issuance volume
  • The YTD issuance volume is EUR 29.7mln equivalent
    (incl. USD deals) compared to EUR 40.6mln (incl.
    USD deals) by the same point last year, with
    especially February and March showing strong HY
    issue volume in Europe
  • However the continued European macro economic
    uncertainty has resulted in a significant
    slowdown in primary activity in the European HY
    market
  • The market has been starved of new issues for
    more than a month as of May 11th, although the
    drought finally broke last week with a GBP
    525mln, dual-tranche offering from Four Seasons
    Healthcare and an EUR 400mln offering from Kabel
    Deutschland this week. Still the market is some
    way away from re-opening fully or at the right
    price for most single B credits
  • As European sovereign debt issues have dominated
    headlines since the second half of 2011, a flight
    to quality has seen the European indices widen
    significantly since August 2011, with the
    European Single B index trading over 430bps wider
    than the US Single B index
  • As a result European issuers with significant
    assets or operations in the US have taken
    advantage of stronger primary conditions in the
    US (ytd USD proceeds from European issuers
    reached USD 15.8bln)
  •  Loan Market
  • In the 5 months to 31st May, loan issuance was
    EUR 14bln, 35 behind the corresponding result
    for the previous year, but a significant
    improvement on previous months with May volume
    EUR 5.3bln, which included 2 EUR 1bln
    financings, providing the boost. Significantly,
    US issuance by European borrowers in the 5 months
    to 31 May was even higher at EUR 15.5bln
  • Secondary pricing has declined again in recent
    weeks, with flow names bid at just over 94
    compared with just over 96 in March, the peak
    this year. By contrast, the Broad Secondary
    Composite, reflecting the mid-market  names, was
    still down in the mid 80s, just below 85,
    compared with a high YTD of 85.60.
    Notwithstanding the disparity, both sets of
    prices are being influenced primarily by macro
    factors
  • The relative lack of activity is reflected in
    higher multiples for both large market deals,
    such as BSN and Iglo (4.5x senior, 6.5x total),
    where there is significant  extant liquidity, and
    smaller mid-market deal, such as St.Hubert, which
    is attracting bids at up to 5.5x total and for
    which there is no existing liquidity
  • So, yet again there are signs of the market
    hotting up in terms of arranging bank bids, with
    institutional investors reserving their
    positions, the intimation being an investment
    rollover is not guaranteed if the terms are not
    right
  • Mezzanine issue this year has been tiny at c.EUR
    300mln, but due to the parlous state of the HY
    market, BSN is now said to be structuring with
    mezzanine, although Iglo is still looking to the
    bond markets
  • Everything is better in the US YTD, in terms of
    issuance, higher leverage for borrowers (4.5x vs
    4.3x  senior on average) and, of course, CLO
    issuance, at c.USD 14bln this year from 33
    vehicles, versus zero in Europe

37
European Leveraged Loan Market Snapshots
  • Monthly US vs Europe High Yield Issue Volume (in
    USD bn)
  • Monthly New-Issue Leveraged Loans vs. HY Bonds
    (in EUR bn)
  • Broad Secondary Market Avg. Bid vs Flow Names
    (Dec 04-Jun 12)
  • European iTraxx Crossover vs European High Yield
    Indices

38
Questions?
  • Section VII
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