We all dream of turning back the clock. As the debt fueling mergers and acquisitions becomes ever-more expensive as interest rates rise, dealmakers have particular reason to yearn for the past. Some smart investors are crafting new deals that exploit the post-pandemic merger wave’s legacy of cheap credit.
The interest rate on high-yield loans to large borrowers from banks has roughly doubled to 10% since late 2021, reckons investment bank Configure Partners, while private lenders now charge about 12%. That’s a problem for corporate matchmakers. Corporate debt usually features change-of-control provisions that require it be paid off if the borrower changes hands. That forces buyers to refinance old cheap loans with new expensive ones.
But there are ways for inventive financiers to repurpose financing from the now-deflated boom. Borrowers issued $1.6 trillion of cheap junk-rated loans and bonds in 2021 alone, according to S&P Global. That opens up plenty of potential loopholes which could allow borrowers to keep their old loans even after a deal.
One option is to get a permit. Lenders explicitly allow a company’s so-called “permitted holders” - typically its management or long-time investors - to assume responsibility for the debt. This provision enabled Clayton, Dubilier & Rice to keep Cornerstone Building Brands’ debt in place after taking the maker of windows and roofing private for $5.8 billion last year. The buyout firm first invested in the company in 2009.
This approach is especially appealing because it’s one of the few areas of “stealth portability” that has crept into debt contracts, people familiar with the matter said. Syndicated loans tend to have a wider range of definitions of who qualifies as a permitted holder than bond contracts, opening up new options for dealmakers.
Close reading of the fine print can also reveal other ingenious options. For example, one definition of a change of control is where the majority of board seats change hands. CD&R made use of this provision in February when it agreed a $7 billion deal for Focus Financial Partners. It bought a controlling stake in the wealth manager but allowed previous owner Stone Point Capital to retain most of the board seats. That means the company’s debt can stay put, news service 9fin reported.
Public companies can also find some extra room for maneuver in debt contracts. Changes of control are frequently defined as non-permitted holders crossing an ownership threshold. But bond documents may allow a buyer to effectively attribute its individual shareholders as an acquired company’s new owners, thereby staying below the threshold for a change of control. Mortgage servicer Mr Cooper’s $324 million acquisition of Home Point Capital in May used this trick to avoid refinancing $500 million of bonds.
These provisions, known as public-company exceptions, can be a crucial lure for snagging a buyer. Take home automation provider Vivint Smart Home’s search for a buyer last year. Prospective suitors were discouraged by the freeze in debt markets, while the company’s bankers warned that it would be impossible to refinance Vivint’s debt at attractive terms, according to Securities and Exchange Commission filings. When the company eventually agreed to sell to NRG Energy in December, the merger agreement carefully spelled out that its $2 billion of debt would be rolled over, committing both sides to measures that avoid triggering a forced refinancing.
A final trick to avoid change-of-control clauses is for companies to take out loans secured by their assets which can be transferred to a new owner. Blackstone ushered in a funding shift as part of its $10 billion takeover of QTS Realty Trust in 2021 by issuing commercial mortgage-backed securities tied to the data center group’s specific properties. These remain in place even if the operator changes hands. This helps explain why dealmaking in data centers has not been affected by the broader slump in activity. The recent auction of Compass Datacenters attracted bids at 2021-era valuations.
Of course, these clever schemes can only go so far. Serial acquirers will need the support of lenders to finance new acquisitions. Poisoning relationships for the sake of one transaction could be counterproductive. Deal structuring antics can also draw lawsuits. — Reuters
Jonathan Guilford has covered financial news across Europe and the United States for 10 years. He joined Reuters Breakingviews in 2021 from Dealreporter, where he led risk arb coverage strategy from New York while covering the technology, media and telecommunications space
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