Only the Strong Shall Thrive

Financially sound companies find gold in credit mayhem even as weaker players fear the game is up.

There is plenty of strength in small and midsize deals, one reason being that the middle market tends to finance more conservatively and is not as reliant on high-yield issuance.

Deals typically consist of 25 to 35 percent equity with the balance made up of senior secured debt and, in recent years, a layer of partially secured junior debt. The use of junior debt will diminish as it becomes more expensive due to investors demanding a higher rate of return, says Monomoy’s Von Burg.

But midmarket deals have not been immune to market conditions already, as banks often renegotiate the terms before closing. “Fifteen months ago people would be lined up to help you,” says Dan Reid, head of transaction advisory services at Grant Thornton. To bridge the gap, buyers and sellers will have to negotiate a lot more, he says. Solutions may include buyers putting in more equity or sellers holding part of the debt.

For the overall financing and M&A pipelines to flow again, and for the leveraged finance market to open up, deals will have to be renegotiated for the new risk reality. As of early September, appetite for high-yield securities in their bubble format was nonexistent. Banks have been busy trying to renegotiate terms with private-equity buyers and make the securities more appetizing to investors — raising yields and adding covenants to bolster investor protection. Unless restructured, these deals would fetch below-par pricing, making it uneconomical for banks to underwrite them in their present form.

That is a big departure from the height of the bubble, when banks “were able to sell these [leveraged loans used for acquisitions] after the deals closed for more than 100 cents on the dollar,” says Gary Rosenbaum, head of the finance group at DLA Piper. Home Depot, for example, had to slash $2 billion from the price of its wholesale unit in August (to $8.3 billion) in order to make the deal possible. Rosenbaum expects a lot more of that.

“There will be a lot of preparation and adjustment to financings to make them palatable,” says Mark Howard, co-head of research at Barclays Capital.

Absent an economic slowdown, which could tighten debt even more, market participants expect a return to reason rather than to a restrictive market. They also foresee a lower profile for private equity and a higher profile for strategic buyers. “Investment-grade companies will have a good and normalized access to capital in the corporate bond, commercial-paper, and loan markets,” says Howard. “Higher-yielding companies will also have access, but at a wider spread and slightly more nervous covenants.”

Avital Louria Hahn is a senior editor at CFO.

Financing’s New Language

Dealmaking language is changing, signaling less freedom for issuers and more protection for investors and banks. Gone are dividend recaps, refinancing, covenant-light deals, second-lien loans, and payment-in-kind (PIK). Back in the lexicon are market clauses, covenants, earnouts, and sellers’ notes.


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