The acquisition financing market showed gradual but steady improvement in 2009. In the spring of 2009, financing commitments for acquisitions by investment grade issuers, such as in the Pfizer/Wyeth and Merck/Schering-Plough transactions, were arranged as shortterm bridge loans to be quickly taken out through asset sales or capital market debt issuances. By summer, confidence had returned to the point that seasoned, but more leveraged, issuers were able to arrange financing for significant bolt-on acquisitions and refinance their existing credit facilities, as was the case with Warner Chilcott’s acquisition of Procter & Gamble’s pharmaceutical business. Most recently, private equity sponsors obtained financing commitments for new leveraged buyouts, including Blackstone’s acquisition of Anheuser-Busch InBev’s theme park business, TPG’s and CPP Investment Board’s acquisition of IMS Health (the first public to private buyout announced since May 2008) and General Atlantic’s and KKR’s acquisition of the TASC division of Northrop Grumman – though all these transactions featured lower leverage and were far smaller in size than 2007’s mega-buyouts.
Since the onset of the credit crisis, financing commitments have evolved to reflect ongoing market challenges, including higher pricing, financial covenants tied to the sponsor’s business plan and tighter negative covenants. Further, arrangers are keenly aware of the warehousing risk posed by failed syndications, and have sought to expand their syndication rights–including wider pricing and structural flex–to account for this risk. Likewise, recent well-known litigations in which parties have sought to enforce financing commitments against lenders, with results often turning on the precise terms of the commitments, have naturally caused sellers, buyers and financing sources alike to focus intensively on the conditions under which financing commitments for new transactions may be drawn. At the same time, however, new commitments may include market-accepted borrower-friendly flexibilities derived from sponsor experiences with portfolio company balance sheet restructurings over the past 18 months, such as provisions allowing below par buy-backs, exchange offers and “amend and extend” rights without unanimous consent.
Broadening Syndication Rights and Increased Flex
Prior to the 2007 credit crisis, commitment letters often gave sponsors significant control over the syndication of financing risk by arrangers prior to the closing of the acquisition. While the buyer was required to cooperate with syndication efforts, the arranger remained “on the hook” for funding through closing, and borrowers often retained broad discretion over the timing of syndication and the composition of the syndicate (including veto rights over participating lenders). Arrangers relied on their limited “flex” rights to market difficult syndications.
As the market for leveraged acquisitions began to return in early 2009, arrangers sought to expand their syndication rights. Recent transactions seek to balance the sponsor/borrower’s need for certainty (including having a known counterparty in the event that a consent or waiver is needed prior to closing) with the need for arrangers to quickly move exposure off their balance sheets.
One approach, illustrated in the Pfizer/Wyeth and Merck/Schering-Plough transactions, allowed the arranger to syndicate its commitment to a limited “club” of money center banks after announcement of the transaction, at which point the arranger was released from the syndicated portion of the commitment. In other transactions, such as Warner Chilcott’s acquisition of Procter & Gamble’s pharmaceutical business, the initial syndication was completed prior to the announcement of the transaction (with six banks each underwriting an equal portion of the total facilities, and none released from its proportional obligation until closing). Finally, several recent commitments have provided arrangers with greater flexibility to syndicate to buy-side accounts with the sponsor having consultation (rather than consent) rights as to the members of the syndicate. In most transactions, the syndication provisions require the lead arrangers to retain all rights to give consents or grant waivers with respect to the commitment until the closing of the financing.
Additionally, sponsors and arrangers are seeking out large buy-side investors, including large debt and hedge funds, to serve as anchor orders for the financing much earlier in the process than was the case in 2007. This helps test the market early in a financing, and ensures that broader syndication efforts will be successful. If appropriate, sponsors may need to address the diligence and economic needs of these investors in their bidding and negotiation timelines.
Arrangers are also mitigating syndication risk by negotiating wider pricing and structure “flex” than in 2007 financings. The degree of flex will obviously depend on fundamentals, including closing date leverage, industry conditions and the length of time between signing and closing. Pricing flex can include increases in interest rate margins (which can be taken through up-front discounts or fees), increases in minimum LIBOR and base rate floors and ticking fees on commitments that extend beyond a certain date. Structure flex can include reducing the absolute size of the senior facilities, moving some of the senior secured tranche to a mezzanine or high-yield tranche and conversion of secured term loans into pari passu secured bonds to be issued in a high-yield transaction. Both the borrower and seller must analyze the impact exercising flex may have on the basic sources and uses for the transaction to ensure that there is not a shortfall of funds at closing and/or a backdoor condition to funding.
2009 also saw a renewed focus on aligning conditionality in the financing commitments and acquisition agreement. The economic consequences to a buyer who is unable to obtain financing for a transaction are likely to be significantly greater than in 2007. Reverse break fees (or liquidated damages clauses) in recent transactions have approached or exceeded 6% of the deal consideration, and are no longer automatically symmetrical with the fees paid by sellers to terminate the agreement under “fiduciary out” clauses. Further, some buyers are agreeing to specifically enforceable covenants to complete a proposed transaction without an option to walk away by paying a reverse break fee. These covenants include the buyer’s obligation to use strong efforts to obtain the financing under its debt commitment letters and to seek to enforce the commitment against the debt financing sources.
In this context, financing sources must be clear about the level of risk they are willing to underwrite. In some transactions, a specific “bright line” condition relating to minimum EBITDA, maximum leverage or ratings can quantify the acceptable level of risk. These brightline triggers, however, are not likely to become common in private equity acquisitions with no financing out, as sponsors will strongly resist backstopping these conditions for their own account. Accordingly, key conditions, such as Company MAC, documentation and marketing period, must be carefully negotiated to allocate risk properly.