But the bond markets have been too good anyway. Mobile Telesystems issued a 10-year, euro-denominated bond in May and was planning sales in November equivalent to $819 million with 7-year and 10-year maturities. “Institutional investors are reaching for a longer tenure to get a reasonable coupon,” Kornya says. “If a company has stable cash flows, there will be low volatility, and [if necessary] the bonds can be bought back from the market at a good price.”
The bond market could remain healthy for another two years, since spikes in corporate rates run in five-year cycles, says Tenex Capital Management’s Bedi. “There will be an increasing emphasis on quality companies, and those guys are going to be given incredibly preferential rates.”
Smaller middle-market companies that don’t need at least $300 million of debt may find little comfort in the successes of a Mobile Telesystems. But private-placement debt can provide a capital structure that resembles a large company’s. This long-term fixed-rate credit is privately negotiated and distributed, has maturities of 5 to 20 years, and is held to maturity by investors, generally insurance companies and pension plans. The market usually does $30 billion to $50 billion a year in issuance.
“We’re having one of our most active years ever,” says Allen Weaver, senior managing director at Prudential Capital Group, a provider of long-term private capital.
Ninety percent of the dollars Prudential Capital invests for itself and others are investment-grade. The borrowers are generally industrial or service companies with good earnings histories, low volatility of earnings, and solid cash flows, says Weaver. The borrowing rates usually track the public market, with some premium because the private market is fairly illiquid.
While privately placed debt doesn’t replace a bank facility, it diversifies the funding base and lessens dependence on banks, Weaver says. There is also a “confidentiality advantage” if the borrower needs to fund an M&A deal stealthily.
Of course, it’s one thing to have a solid roster of capital-raising options and another to take advantage of it. Experts say that capital-building is still essential to good risk management: middle-market companies that foresee bumps in earnings should be in capital-raising mode continually next year, says Bedi, and think of their lenders as even more important than their equity holders. “They are going to keep you solvent,” he says.
Large companies, on the other hand, should aggressively lengthen their maturities. Counsels Bedi: “Even if you’re a great company, you never know when the rainy day might come, so you should have too much capital, not too little.”
Vincent Ryan is senior editor for capital markets at CFO.
Turning the IPO on Its Head
Any transaction with the words reverse and shell in its description can give CFOs the willies. But through the first 10 months of 2010, close to 200 companies had entered the equity markets via a technique known as the “reverse merger.”
A reverse merger is the bargain-basement way to go public: a private company sells itself to a publicly traded “shell” company and then takes control of the shell. The transaction is usually done in conjunction with an infusion of money from private investors. The private company’s owners end up holding as much as 95% of the shell company.
Reverse mergers don’t supplant traditional initial public offerings. They typically raise only $3 million to $5 million. But the private company gets a public listing without paying hefty underwriting fees.
Many of these transactions get done through the over-the-counter securities market, so the newly public company has time to “season itself” before the stricter corporate-governance regulations of large exchanges, says David Bukzin, a founding partner of accounting firm Marcum LLP.
Reverse mergers could be an excellent strategy for companies “that are in industries Wall Street typically loves or that want common stock for acquisitions,” Bukzin says. Financial sponsors also use them to increase the liquidity of their investments.
A key to such transactions is to raise enough capital to get to the next phase of the company’s growth plan, says Bukzin. If the market sees the potential, the price and liquidity of the stock improve and a larger share offering and an uplisting to Nasdaq or the NYSE become possible.
Still, taking over a failed company (which is what many shell companies are) is filled with potential minefields. The shell company may come with pending litigation, for instance, or a damaged balance sheet. That could take months to clean up, adding expenses the reverse merger was supposed to avoid. — V.R.