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Direct lending shifts gear in Formula One deal

Friday, 12 Oct 2012 | 6:17 AM ET

* Formula One bond proves funds have deep pockets

* Direct lending poses a threat to syndication

* Underwriting junior capital remains tough

By Natalie Harrison

LONDON, Oct 12 (IFR) - Formula One's USD1bn high-yield private placement proves investors will lend large amounts of cash to top quality businesses, even for aggressive dividend recapitalisations, and could pose a challenge for banks if it becomes a broader trend.

This sidestep of capital markets is not the best of news for leverage finance bankers who are scrambling to recoup lost fees from failed leveraged buyout auctions this year for companies such as Birds Eye Iglo.

Formula One's second dividend deal of the year - that will be paid to private equity owner CVC - follows a postponed listing in Singapore that would have generated massive fees for the banks involved.

The private placement has made up for some of that, especially for the bond's bookrunner Goldman Sachs, which also advised CVC on a stake sale and was a joint global co-ordinator on the IPO.

But the willingness of investors to lend on this scale should concern bankers.

What is more, this is not the first time in recent months that financial sponsors have pre-arranged millions of euros of funding from a growing investor base looking to fill a gap left by the retrenchment in bank lending.

EMEA leveraged loan volumes totalled USD72.44bn in the first three quarters, down 42% year-on-year, according to Thomson Reuters LPC data. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

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Banks' increasingly expensive and often limited underwriting capacity has also provided a catalyst for this bypassing of capital markets.

Earlier this year, for example, private equity groups Blackstone and BC Partners pre-arranged a EUR650m private high-yield bond to part-fund the buyout of Permira's Birds Eye Iglo business.

"Directly lending is a threat to banks. Definitely. But it probably has more to do with banks not wanting to underwrite junior pieces of capital, and the cost of doing that," said one banking source.

"A privately arranged deal is probably more expensive than a public deal, but sponsors are not paying fees on a bridge loan and they also lessen the risk of being left with the expense if the market turns."

Formula One's seven-year subordinated dividend deal - one of the biggest of the year - pays a coupon of 9.25%.

UNIQUE BUSINESS

Asset managers such as Alcentra, Babson Capital, European Credit Management, GSO Blackstone and Intermediate Capital Group have all raised new funds to help plug the gap left by banks, but their focus has predominantly been on mid-cap companies.

The size of the Formula One bond, therefore, has garnered attention.

However, bankers remain convinced that trades of this size will be the exception rather than the rule, and that capital markets will in general fund the majority of big ticket deals especially for senior secured debt.

Formula One's business is widely regarded as unique, with exceptional cash flows and brand recognition that left investors almost falling over themselves to lend to it.

Part of that confidence is driven by CVC's track record of deleveraging the business, as well as its established relationships with funds that participated in two separate share sales, amounting to USD2.1bn, this year.

CVC reduced its stake in Formula One to 35% from 63.4% after those deals to BlackRock, Waddell & Reed, Norway's Norges Bank Investment Management and Ivy Investment Management.

Some of those funds, if not all, were likely to have bought the bond alongside limited partners, market sources said.

CVC's flexible corporate finance strategy is impressive.

Especially so in an environment where the majority of private equity firms are struggling to exit businesses bought at inflated prices in the 2006-2007 boom days, as public listings and merger and acquisition activity remain challenging.

"For high profile, well-known credits like Formula One, there are a small number of investors that will write 100 million plus tickets," another banking source said.

But for larger transactions in particular, direct lending would continue to be reserved for high-quality credits with stable cash flows and a track record of deleveraging - like Iglo and Formula One, he added.

That's not to say there is no place, or support, for alternative asset managers. Bankers recognise the need for such funds, especially as the high-yield bond market has a tendency to seize up at times of heightened stress in the eurozone sovereign crisis.

"The public bond market is there for the taking, but with disintermediation from loans to bonds, direct lending offers a different way of doing business, and banks should embrace the change rather than ignoring it," the banker added.

(Reporting by Natalie Harrison, IFR Markets; editing by Alex Chambers & Julian Baker)

((natalie.harrison@thomsonreuters.com)(+44 207 542 2687)(Reuters Messaging: natalie.harrison.thomsonreuters.com@reuters.net))

Keywords: FORMULA ONE/DIRECT LENDING