Unitas Capital’s May 2011 purchase of Netherlands-based hydraulics firm, Hyva Holdings, sets a structural standard for future acquisitions in the region.
The $723 million acquisition from 3i is the first sponsor-backed acquisition in Asia to be fully-financed by high yield bond. The $375 million Rule 144a/Reg S bond offering of 8.625% senior notes due 2016 replaced bank loans initially put in place at the time of the bidding.
Its covenants fused US and European elements with Asian market practices to give bondholders deeper protection than previous high-yield products in the region.
The deal secured share pledges, intercompany loans and banks accounts in China, India, Brazil and Europe. It also incorporated streamlined intercreditor terms in covenant packages on all debt instruments involved, including a super senior revolving credit facility.
Kirkland & Ellis partner, Ashley Young told delegates at IFLR’s Asia M&A Forum that due to the diversity of insolvency regimes in the region future deals with high-yield bond element were likely to follow the Unitas-Hyva structure. An intercreditor agreement would also be required to balance the interests of the high-yield bondholders and the lenders of the super senior revolving credit facility, as with similar European structures, in the absence of insolvency procedures similar to Chapter 11 of the US Bankruptcy Code.
Linklaters’ partner David Irvine, who represented the banks on the deal, said the use of high yield bonds to finance Asian M&A transactions and refinance acquisition debt benefited both sponsors and banks.
To the sponsors, high yield bond covenant packages offer much more flexibility in terms of post-acquisition activity than the more restrictive maintenance covenants and negative undertakings in senior loan facilities, the typical form of acquisition finance.
And as high yield bonds tend to involve bullet repayments paid in one lump sum at maturity, they place less pressure on the issuer’s cash flows than senior loans in Asia, which typically amortise over five-year periods. Sponsors are also able to put more debt into a high yield bond financing. This will further increase the deal’s internal rate of return (IRR).
High yield bond financing is an elegant solution from a bank’s perspective too, as the product doesn’t place any demands on the banks’ balance sheets.
He predicted increasing creativity between banks and sponsors for future high-yield bond financed M&A transactions in the region. Structural innovation would be needed, for example, to consider how to adequately demonstrate certainty of funding to the seller.
As the majority of sponsor-backed acquisitions are driven by auction, sellers require a degree of comfort regarding the availability of funds to complete a buy-out.
This is usually provided by the banks providing senior debt, but for high yield bond financings banks need to take on the market risk to provide a bridging facility to issuance of the bond and provide funding certainty, Irvine explained. In the current market, banks may be unwilling to take on that bridge risk.
HSBC director Jonathan McCullagh agreed. The limited appetite of Asia-Pacific banks to take bridge risk was particularly notable for the more difficult 'China holdco' acquisition finance structures. He also expected the cost of capital to remain a key consideration for prospective high-yield bond issuers in Asia, and in some cases a limiting factor.
Young warned that the cost of such financing, and currency swaps incorporated into them, could end up being prohibitive for some of jurisdictions around region.
McCullagh said this explained the absence of high yield from Australian corporates and LBOs, given the priority that local corporates put on hedging their currency exposure and additional pressure that the higher all-in cost puts on credit metrics.
But he was confident that high yield bond financing would remain high on the menu of capital structure options for the time being, as a good source of liquidity while US dollar bank market liquidity remains limited for leveraged deals