Buying Power: Treasurers Turning to Trade Receivable Securitisation
Private Equity activity is on the increase – both globally and from a European perspective. Following a low point in 2003 (compared to the frenzy of activity around the millennium) we are now seeing a steady rise in LBO’s and – just as importantly – successful exits (witness Celanese, Eircom and Pacific Brands). According to Dealogic, “Unprecedented liquidity in the debt markets, large capital raisings by buy-out groups combined with a rich source of deals at a time when corporate acquirers are scarce, have fuelled the sector’s growth.”1 Goldman Sachs’ financial sponsors group has forecast a’vibrant’ year for Private Equity in 2005.
In 2004, Private Equity accounted for 15 per cent of Global M&A deal value reaching an all time high of $294.4bn, a 60 per cent increase on 2003, according to KPMG2. In Europe, Private Equity is up 25 per cent compared to 2003 with deals worth $147bn, representing 21 per cent of M&A deal value. In Germany, where overall M&A activity is generally flat, financial sponsors accounted for 37 per cent of deal making rising from 28 per cent the previous year. Activity in France and the Netherlands increased notably on the back of large retail deals. In fact, France became the third most active country in 2004 rising from sixth in 2003, according to Dealogic’s research. Volume increased 108 per cent with $133.8bn in 2004 compared to $64.3bn the previous year.
However, there is also some sentiment in the market that an imbalance has emerged between sponsors’ demand and the volume of quality targets. Despite the fact that the number of quality opportunities have grown, this is viewed to have been outstripped by demand for high yield investments. Deloitte’s has been quoted as saying “[Sponsors] expect the average holding period for investments made in 2004 to be four to five years. The usual duration of a buy-out investment is 3-4 years, so the expected lengthening of holding periods may reflect the log-jam of investments awaiting realisation. The sentiment could also suggest that [sponsors] may require more time to create value in their companies….”
Debt burden is a growing issue for LBO companies. KPMG2 has remarked on “…concerns about a credit bubble in parts of the private Equity sector. Multiples of debt rose markedly over the year, in some cases reaching six or seven times earnings before interest, tax, depreciation and amortisation.” A 2004 research report from Demica3 examined whether financial pressure on European companies is currently decreasing in line with positive economic indicators in Europe. The picture that emerges from the research tells a story of polarisation. Financial stress has increased for all rated companies in Europe. However, the increase has been absolutely marginal for A rated companies (3 per cent), substantial for B rated companies (36 per cent), and punishing for sub-investment grade companies (49 per cent). The sound appear to be getting sounder, but the highly indebted (by definition LBOs), with some notable exceptions, are in danger of failing. This highlights the importance and urgency for sub-investment grade companies – many of which are post-LBO corporates – to reduce their weighted average cost of capital.
In order to control the level of borrowing that issuers have to offer the market, thereby controlling interest cost and/or making higher levels of working capital available to develop value in buy-out companies, more and more Private Equity sponsors are turning to securitisation post-LBO in the individual companies that they have bought out. Importantly, lower margins achievable via securitisation can improve debt service coverage for other financiers.
A number of trade receivables securitisation transactions for post-LBO corporates have been conducted over the last two years, with Private Equity buyers and their acquired corporates using the relatively low-cost capital markets proceeds to pay off more expensive long-term debt and free up development capital. Companies need to have the right profile to qualify for these transactions – namely, a high quality receivables portfolio of at least €200m in size, spread across number of jurisdictions – however the associated benefits are proving too favourable for Private Equity sponsors to overlook. Funding margins of up to 100 basis points under the cost of the Senior A debt are typically achievable.
Using the securitisation proceeds to push debt repayment schedules brings a valuable reduction in amortization pressure, and transforms the post-LBO balance sheet of the corporate.
In order to validate and understand the precise pressures felt by Private Equity houses in post LBO finance restructuring, Demica commissioned a research study amongst experts in the top 40 European Private Equity players. The research aimed to quantify the role of securitisation in post LBO financing.
The first part of the research focused on the cost of leveraged finance. The majority of respondents (57 per cent) felt that leveraged finance would become more expensive over the next two years. Another 29 per cent felt that leveraged finance interest costs would remain stable, while only 14 per cent believed it would reduce. Clearly, the consensus view is that leveraged buyouts would become more costly to finance. If we combine this with the earlier prediction from Deloitte about lengthening exit periods, it would appear that there is a growing need for flexible restructuring following an LBO, either to reduce debt servicing burden, or alternatively to extend available working capital, or both.
This pressure was corroborated by our second finding: a total of 67 per cent of respondents feel there is an increasing focus on the terms of’carve out’ provisions in financing agreements. These provisions offer greater flexibility to accomodate alternative financing structures following a buyout.
62 per cent of our survey respondents believed that the role of securitisation in providing alternative sources of liquidity, and its impact on amortisation/repayment schedules, were becoming more important. To put this in context, they estimated the proportion of LBO structures to be using securitisation today to be some 11.9 per cent, rising to 16.3 per cent by the end of 2006. This represents a growth rate of 37 per cent in the use of post LBO securitisation over the next two years.
In conclusion, this research puts important key metrics on the role being played by securitisation in managing debt service burden and working capital liquidity after a leveraged buyout. The majority of private Equity organisations are evidently conversant with trade receivables securitisation and the benefits it offers, to the extent that they see it growing strongly. Although there is a natural lid on the proportion of leveraged corporate finance that can be raised through securitisation, we can conclude that it’s potential is by no means yet fully explored. We expect to see activity continue its strong growth rate to the end of the decade and beyond.
1 Financial Times, Private equity deals are close to $300 billion for year, 22 December 2004
2 KPMG, 2004: First hard evidence of M&A recovery, 15 December 2004
3 Demica, The Rich get Richer, October 2004