Classic Layout Of A Lbo Operation

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02 Nov 2017

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Table of Contents

Table of Figures 6

Introduction 7

II. Classic layout of a LBO operation 8

III. LBO before the crisis: period of abundant liquidity 10

III.1. Evolution of the LBO market 10

III.1.a. Period of abundant liquidity 10

III.1.b. Monetary policy of the European Central Bank 12

III.2. Relation between different parties of a LBO operation 13

III.2.a. Sellers / buyers relation 13

Acquisition multiples 14

III.2.b. II. Relation lenders / borrowers 14

III.2.b.i) Flexible conditions for granting loans 15

Appeal for Underwriting 15

Flexibility in the determination of the financial covenants 15

Lower spreads 16

III.2.b.ii) Changes in sources of financing 17

III.2.c. Relations between investors and managers: 18

IV. Evolution of the LBO after the crisis: period of shortage in liquidity 19

IV.1. Market’s evolution and macro-economic trends: 19

IV.1.a. Market’s evolution: 19

IV.1.b. Role of central banks: 20

IV.1.b.i) Crisis period: large intake of liquidity on the market 20

IV.1.b.ii) Period of recovery: 22

IV.2. Impact on the various stakeholders in the market: 22

IV.2.a. Buyers/Sellers relations 23

IV.2.b. More rigid Relations between lenders and borrowers 24

IV.2.b.i) Crunching of credit loans conditions 24

IV.2.b.ii) Reduction of financial covenants 25

IV.2.b.iii) Increase in spreads 26

IV.2.b.iv) «double Luxco» Structures 28

IV.2.b.v) Changes in sources of funding: disappearance of the second link and orientation towards the High Yield market 29

IV.2.b.vi) Disappearance of the second link 30

IV.2.c. Investor relations / Managers 31

Conclusion 32

References 33

Appendix 1: ECB and Fed key rates evolution 34

Table of Figures

Introduction

Throughout the years since the creation of the Euro zone, the European debt market has grown swiftly driven by the development of M&A operations and the evolution of "Private Equity" practices in particular "Leverage Buyouts" which exploits leveraged debt as a mean for financing.

"Private equity" is defined as a practice where funds invest directly into private companies or conduct buyouts of public companies resulting in a delisting of public equity and that regardless of the situation of the company in its lifecycle (source Investopedia). Hence, several types of investments can be identified depending on the time of their intervention: Venture Capital, Growth Equity and Leveraged Buyout.

Throughout this paper, we are going to focus our study on Leverage Buyout operations and study the impact of the financial crisis on this practice.

Leveraged Buyouts funds invest by acquiring controlling stakes in mature and cash-flow stable companies. Taking the typical layout for a LBO deal, in order to finance these acquisitions, LBO funds use high amounts of debts, in the form of bank loans, subordinated and mezzanine debt, and repay these using dividends generated by the target company.

An LBO deal relies on many parameters and as all financial deals it is affected by the economic context. Therefore, it will be interesting to study how those parameters changed during the crisis and how this change affected the LBO business.

Therefore, the question that we are going to answer is:

What has been the impact of the financial crisis on the market’s parameters directly related to a LBO operation and on the relations between different stakeholders of LBO in Europe?

In order to do that, we will consider market’s parameters before and after the crisis and study the changes’ impact on the bilateral relations between the different stakeholders of a LBO operation, we will also try to look for these changes and measure their impact when comparing 2 LBO operations done on the same target company the first time before the crisis in 2006 and the second time after the crisis in 2011. It would therefore be interesting to study as a first step the evolution of the market of the LBO before the crisis. But first, as a preliminary, we are going to define the concepts and principles of this type of transactions.

Classic layout of a LBO operation

The classic layout of a LBO transaction is as the following:

Figure 1 : Classical layout of a LBO operation

A LBO operation involves several players having different interests:

Buyers: investors who are looking for an output in the short to medium term with a capital gain that would justify their risk-taking (i.e New Investors)

Sellers: investment funds intending to give up their participation in the target company.

Lenders:

Senior lenders: Banks which study the worthiness of the deal and the loan credit that will be granted.

Junior lenders: Mezzanine funds that invest in mezzanine acquisition debt. These debts are subordinated to the senior debt, and thus would be reimbursed after the repayment of the senior debt.

Management team: Team that will pilot a rigorous business management model and a better resource allocation having a goal to improve operational and business results.

A LBO operation benefits from a financial leverage which consists of financing through debt instruments as long as the expected profitability (dividends) generated by the target company is higher than the interests paid by the buyer. This financial leverage represents a "balance point between the interests of the investors and the lenders" to the extent where the first seeks to reduce his capital input, while the second seeks to limit his risk.

However, the leverage of a LBO transaction is not only financial; it can be fiscal, legal and managerial too.

Fiscal leverage consists of an increase in financial charges in the income statement, therefore reducing the taxable income and resulting in tax savings. The creation of a holding company to lead the transaction allows the group to benefit from tax integration regime by reducing its tax base by an amount corresponding to the interests of the acquisition debt.

Legal leverage allows the investor to manage a group while limiting his commitment. This is possible through the superimposition of several holdings in cascade and in which he has only a relative majority.

Managerial leverage leads to improving the operational performance. This is very important because by increasing operational performance, the target company increases its profits and creates more added-value for the investors. This leverage is generated by the corporate governance system that is place; the converging interests of the management team and the investors as well as the high level of debt imply a more effective management resulting in a generation of cash flow. Related to these converging interests, Pascal QUIRY and Yann LE FUR stress out the importance of the governance system in their article " Création et partage de valeurs dans les LBO  " published in the February 2010 edition of the letter Vernimmen.net : « il y a des raisons liées à la gouvernance d’entreprise mise en place qui aligne fortement les intérêts des dirigeants d’entreprise sous LBO et du fonds par le double effet de l’intéressement financier des dirigeants de la société opérationnelle à la performance financière du fonds de LBO sur son investissement et de la contrainte de l’endettement qui les pousse à être plus efficaces dans la génération de flux de trésorerie disponibles  ».

In the first part of this paper, we are going to discuss the LBO market before the 2007 crisis by describing the financial and economical environment and studying the relations between the stakeholders. In the second part, we are going to see the evolution of these parameters and relations.

In the last part, we are going to deliver, to the extent of our ability, a genuine study comparing two LBO deals made on the same target company before and after the crisis. This study will include the detection of the parameters discussed in the parts before and their analysis.

LBO before the crisis: period of abundant liquidity

The LBO sector has experienced considerable growth before the crisis of 2007; it was a period of abundant liquidity characterized by an increasing number in LBO transactions and in the amounts invested, and by flexible terms in negotiating credit contracts.

In this first part of the paper, we will study the evolution of the LBO business before the crisis while analysing global market parameters and their impact on the relations between different parties of a LBO operation.

Evolution of the LBO market

We will study the major trends in the market up to the subprime crisis in 2007 and the monetary policy of the European Central Bank at that time.

Period of abundant liquidity

This period was characterized by good borrowing conditions on the financial markets; hence it was easy to raise funds for a LBO operation. With these conditions, LBO presented itself as an investment with high potential profit and growth.

As shown in the graph below, the number of transactions has drastically doubled between 2004 and 2005 to then reach a peak of 320 deals in 2007.

Figure 2 : Number of LBO transactions

Moreover, as shown in the graphs below, the size of LBO operations increased up to EUR 650M on average.

Figure 3 : Size (in Millions EUR) of LBO transactions

Figure 4 : Parts of LBO transactions by size

Monetary policy of the European Central Bank

The monetary policy of the European Central Bank has a direct impact on the terms of a LBO transaction. A study of the evolution of this policy in normal times and in times of crisis is therefore necessary.

As mentioned previously, the pre-crisis period was characterized by abundant liquidity therefore an exceptional intervention by the Central Bank and the use of non-standard methods seemed unnecessary. The strategy put in place was working, and the primary objective was to ensure price stability for the medium term in the Euro zone.

Quick overview of the ECB’s policy in normal times

In an article figured in the monthly bulletin of the ECB (October 2010 number) entitled: "The ECB’s Response to the Financial Crisis", the ECB presents the monetary policy in a non-crisis period as the mechanism of transforming interest rates into price, illustrated by the following diagram.

The key interest rates set by the Central Bank influence those of lending banks, having a direct impact on household consumption, the demand for goods and the fixing of prices and therefore the expected value of inflation.

In normal times, the Central Bank influences interest rates of the money market by setting key interest rates and managing the liquidity in the euro area. Once the interest rates are fixed, the ECB implements its monetary policy by allocating necessary liquidity for the banking sector to be able to meet existing demand as well as reserve requirements.

The key interest rate was set to a relatively high level – 4% in 2007 – and the inflation was at 1.5%.

Relation between different parties of a LBO operation

In this part of the study, we are going to focus on the relations between different stakeholders in a LBO transaction, in particular the relation between the sellers and the buyers, the lenders and the borrowers and finally the investing funds and the managers.

Sellers / buyers relation

Before the crisis in 2007, the number of LBO funds was increasing and the barriers to raising funds were low, this led to an increase in the competition between LBO funds wanting to invest in target companies. This competition resulted, first, in an increase in the multiples [1] and in the acquisition price, second, in the acceleration of asset disposal process and third in the signing of credit contracts favourable to the sellers (mainly including a decrease in the number of guarantees).

The sellers were therefore in a position of power in the negotiation of credit agreements, choosing, in the case of identical corporate values, the buyer who accepts the least restrictive contractual terms.

In addition, Lending Banks also participated in the acceleration of the acquisition process by proposing well elaborated and engaging Term Sheet models. This method was developed further with the creation of the process "Staple Financing" which consists of the delivery by the seller to the potential buyers at the same time as the Information Memorandum, a pre-established funding proposal.

Acquisition multiples

Acquisition multiples are ratios used in the "valuation by multiples" method which estimates the value of a company by comparing it to the values assessed by the market for similar or comparable company.

The graph below shows the evolution of the multiples.

Figure 5 : « Multiples » financial ratios’ [2] evolution

II. Relation lenders / borrowers

This period of abundant liquidity was favourable for senior lenders who benefited from low refinancing costs. Taking into consideration this favourable context, along with low credit risk and increasing competition in this sector, the conditions for obtaining loans became less strict and consequently more favourable to the purchasing funds: a strong appeal to underwriting emerged due to the low risk and certainty of successful syndications, flexibility in setting the levels of financial covenants (Leverage ratios and Gearing) and low levels of spreads due to a low cost of refinancing and a lower risk.

On the other hand, the number of LBO increasing along with the appeal to higher leverage allowed for new methods and means of financing to develop: Mezzanine and "Second lien".

These methods have the advantage of providing additional risk segmentation, varying means of financing and smoothing debts fixings.

Flexible conditions for granting loans

Appeal for Underwriting

As we mentioned earlier, this period was characterized by a favourable credit market and low risk with low refinancing costs. Therefore, banks turned more and more to underwriting [3] and the amounts guaranteed by the underwriter were covered rapidly after the syndication because of the strong competition in this sector.

The development of the securitisation like CLO funds vehicles also contributed to the increase in the underwriting.

Flexibility in the determination of the financial covenants

Banks benefiting from plenty of liquidity, allow themselves to increase the amounts of loans granted, resulting in a surge in the level of leverage.

Figure 6 : Evolution of leverage in a LBO financing

The part of over 5x leverage ratio increased after the internet bubble from 50% in 2002 to 80% in 2007.

These high levels of debt reflect the low level of capital injected by the Sponsors in the financing of LBO operations.

Figure 7 : Evolution of the equity contribution in a LBO financing

Lower spreads

Strong competition in this practice has led to a decrease in the profit margins of most stakeholders, each trying to propose the most competitive offer.

Figure 8 : Evolution of the spreads

Spreads have reached their lowest level in 2007 (205.9 bps for band A and Revolving Credit and 254.5 bps for Bullet bands).

Changes in sources of financing

The graph below shows the evolution of the different sources of financing of LBO operations.

Figure 9 : Evolution of financing sources of LBO operation

Before the crisis, they were mainly 3 types of debt: senior, mezzanine and Second lien (subordinated debt).

Senior debt: Investors having senior debt in their portfolio have the priority to be repaid, including in the event of default. The advantage is in the low premium paid by the borrower which is less expensive than that applied to other creditors due to the low risk. This explains the strong propensity of borrowers to move towards this kind of funding, these, wanting to play in the best of financial leverage, tend to incur debt as much as possible in the form of senior debt, and this in the conventional compliance boundaries with financial covenants.

The subordinated debt: a Subordinated lender is repaid after the senior lender which implies more risk taking and therefore the premium is higher. This is the case of mezzanine funds and the "second liens".

Mezzanine funds: Funds granting subordinated debt in the form of 'hybrids' securities. The graph above shows that the share of Mezzanine debt in financing LBO operations decreased progressively over the years in favour of a new type of funding: the second liens.

Second liens: it is an intermediate product between senior debt and mezzanine. It is less risky than mezzanine debt and therefore cheaper.

In conclusion, the favourable situation before 2007, which has been characterized by a strong liquidity in the market and an increasing competition for providing funds, led senior lenders to ease the conditions of loans and that through a strong use of underwriting, reduced profit margins, more flexible covenants levels involving a lesser share of equity form the part of the investment funds. In addition, in 2004, a new type of debt emerged "Second liens", and allowed an additional level of debt between senior and mezzanine.

Relations between investors and managers:

Investors and managers in a LBO operation have convergent interests, they both aim to create added value and increase the profitability of the target company. Investment funds expect to obtain a high positive return on their investment at the time the LBO operation terminates and the management team, who are sometimes involved in the fundraising, are rewarded when a threshold for the rate of return is reached. Also, their financial incentive packages are related to the performance of the company under LBO. They are therefore doubly motivated to manage well the company when they are in charge.

Before the crisis, the vast majority of companies under LBO overachieved or at least met the projections expected in their business plan and the rate of return threshold was reached easily. This allowed for managers to be in the position of power when negotiating their reward remuneration. In the years preceding the crisis, the number of target companies was reduced implying more competition between investing funds and putting managers in a more powerful situation so they could negotiate the best terms of their incentive package.

This increased bargaining power resulted in a decrease in the threshold of the required rate of return triggering the financial benefits of the managers (it decreased from an average of 25-35% to 20-30%).

In conclusion, the study of the LBO market before the crisis, a period characterized by abundant liquidity and a favourable macroeconomic environment, shows of good relations between different stakeholders. But with the subprime crisis, followed by a global financial crisis following the collapse of Lehman Brothers, market conditions defiled excessively impacting these relationships.

In the next part, we are going to address the impact of the financial crisis on the different stakeholders in the LBO market.

Evolution of the LBO after the crisis: period of shortage in liquidity

Market’s evolution and macro-economic trends:

Market’s evolution:

The abundance of liquidity known before the crisis was abruptly halted due to the collapse of the sub-prime mortgage system in the US in September 2007. This crisis has evolved progressively turning into a banking crisis because of the involvement of several banks in the securitization operations and the presence of these structured products in their portfolios.

Banks, anxious to offset their losses, have carried out massive sell-off of shares resulting in so the collapse of share values on financial markets: Lehman Brothers went bankrupt in September 2008, and several international financial institutions have seen their situation deteriorate significantly due to the loss of most of their investments.

The banking crisis led to a crisis in confidence between all financial institutions. Credit institutions refused to grant credits in these circumstances, resulting in a lack of liquidity and the inability of banks to meet their commitment.

This crisis had a significant impact on LBO activities which have recorded a sharp decline in terms of amounts invested. The graphs below show a shy recovery in 2010 and 2011 and an increase in the number of operations, but remains well below the pre-crisis period.

Figure 10 : Evolution of the invested amounts in LBO

Figure 11 : Evolution of the invested amounts in LBO (divided in blocks)

Role of central banks:

The study of the role played by central banks in the post-crisis era is very important because it significantly affects means of financing and the behavior of senior lenders, key stakeholders of the LBO market.

The role played by central banks is different in times of crisis and the recovery period. We should therefore study the two periods.

Crisis period: large intake of liquidity on the market

This period can be divided into two phases:

a period characterized by a financial turbulence following the subprime crisis

a period characterized by the intensification of the financial crisis after the collapse of Lehman Brothers.

Period of financial turbulence following the subprime crisis

On August 9th, 2007, severe tensions appeared in the global interbank market. They are the consequence of the crisis of confidence experienced by market’s participants as well as the uncertainty on the financial health of the various stakeholders and their liquidity situations. These tensions represented a real threat to impair the orderly functioning of the European monetary market with the ability to cause a blockage of the payment system.

As a countermeasure, the ECB immediately granted Euro zone banks access to the amounts needed to fill their needs in liquidity on the basis of a weighted day-to-day rate. Given the severity of this crisis, a total of EUR 95 billion were retrieved from the ECB.

In the purpose of countering the increased risk on the stabilization of prices in the medium term and as a response to increased inflationary pressures, the ECB decided in July 2008 to increase its rate by 25 bps (from 400 to 425 bps). This increase shows that the primary objective of the ECB remained the maintenance of price stability.

Period of intensification of the financial crisis

Following the bankruptcy of Lehman Brothers on September 15th 2008, the period of financial turbulence has turned into a global financial crisis. The increasing uncertainty of the financial performance of several major international banks, has led to a collapse of the activity in a large number of financial markets. Due to this instability, short-term interest rates increased to reach record levels.

Taking into account the unfavorable context of the financial markets, the ECB was quick to respond and (concurrently and in coordination with other central banks such as the Fed and the Bank of England) and lowered its key rate by 50 bps, then in the months following by 325 bps to get to a level of 1%.

In addition, in order to maintain a constant supply of liquidity in the euro, the ECB adopted during 2008 a number of non-standard measures, referred to as Enhanced Credit Support, applied especially on banks of the euro area. First the ECB ensured to various financial institutions in the euro zone unlimited access to liquidity, second, they extended the list of collateral for refinancing operations in order to facilitate access to liquidity as well as to limit the risks weighing on the balance sheets of banks and third the ECB announced its intention to implement operations of refinancing with longer maturities (6 months in a first step, and then up a year) also in order to improve the liquidity of the various lending banks, to further reduce money market spreads and to continue to reduce the money market interest rates.

In conclusion, following these various developments in the financial market triggered by a set of successive crises, the European Central Bank has demonstrated awareness and flexibility in their response in terms of adjusting the supply of liquidity for the European banking sector. Indeed, by the reduction of key rates to historic levels (1% towards end of 2008) and the establishment of a set of not standard measures, it has remained faithful to its primary purpose of maintaining the stability of prices in the European market.

Period of recovery:

This period of recovery was marked first by a gradual return to normal standards on the financial markets, which led to the stopping of the exceptional measures undertaken during the period of crisis and an orientation towards a more standard policy. In a second time, the sovereign crisis which started in 2010 led to the re-emergence of tensions in some sectors, notably the EU government bonds market.

During the year 2009, financial markets started to show signs of stabilization led by decreasing interest rates and the recovery of the stocks and bonds markets. Banks credit rates also fell, in line with the decline in the market interest rates thus justifying the effectiveness of the measures implemented during the crisis.

In light of this recovery during 2009, the Central Bank announced in December 2009 a phased withdrawal of the non-standard measures taken during the crisis, as well as a possible increase in interest rates, having reached their lowest level during the crisis.

The sovereign debt crisis, which started in early 2010, was characterized by an increase in spread on Treasury bonds, particularly because of uncertainty about the sustainability of public finances in the light of increased government deficits.

The sovereign debt crisis resulted in an unprecedented increase in prices of government bonds which forced the European Central Bank to introduce the Securities Market Program, a program aiming to allow several interventions on the public and private debt markets as well as the securities market in order to ensure liquidity in dysfunctional market segments and to restore the good flow of the monetary policy.

Impact on the various stakeholders in the market:

The advent of the crisis and the shortage of liquidity had a negative impact on the macroeconomic environment and the various stakeholders in the financial markets. In this part, we will study the impact of the crisis on the relations between the different participants in the LBO market.

Buyers / Sellers relations

Borrower / Lenders relations

Investors / Managers relations

Buyers/Sellers relations

Following the crisis, banks became much more sensitive to the concept of risk management and demanded therefore substantial Due Diligences studies be completed thoroughly. Assets and liabilities collaterals, which had almost disappeared until then regained surface.

The position of power in the contractual relations has been therefore reversed: Buyers became more demanding, asking that credit agreements were drawn up in their favor and imposing detailed warranty contracts. On the other hand, banks seeking to protect themselves against the risk of default, required guarantees as prerequisites to signing any contract.

Furthermore, given the context of the crisis, sellers remained demanding in terms of their exit amount, and due to the absence of a consensus, preferred to postpone the deals to a later time. On the other hand, buyers, constrained by tight conditions of credit agreements, see their margin for maneuver shrink leading them to offer lower prices. These divergent interests between buyers and sellers have led to limit the number of transactions, or at least delay the signing of any transaction.

Figure 12 : « Multiples » financial ratios’ evolution (including after the crisis)

The years 2006-2007 experienced the highest acquisition multiples after the period of euphoria that dominated the LBO market. Funds who bought their way into deals during this period, found themselves in a delicate position, and therefore preferred to wait more opportune moments to consider an exit with the highest gain possible.

One of the solutions was to reinvest instead of a complete exit, in the case where the seller is not satisfied by the exit price, he reinvest and wait for the next exit.

Also, the seller also grants credit-sellers to buyers, in addition to the senior debt or mezzanine, knowing that this modality of financing had almost disappeared before the crisis. In the context of this kind of credits, the seller accepts that a part of the price be transformed into a loan to the acquiring entity. The main interest for the purchaser is to involve the seller. Indeed, if the operation fails, it will be unlikely for the seller to recover the amount of his loan. For the seller, the interest is to sell at the desired exit price.

More rigid Relations between lenders and borrowers

During the crisis, senior lenders and mezzanine funds found themselves in a difficult situation. Liquidity cost has increased and banks were obligated to restrict the conditions for granting credit loans: lesser use of underwriting, increased margins, reduced financial covenants, additional security required in credit agreements, protection against abusive backups in French law by the superimposition of new structures (the Luxco Double system).

On the other hand, the period of shortage in liquidity has led to an increasing recourse, since late 2009, to the high-yield bonds market (at the expense notably of mezzanine debt).

It would be interesting to examine in more detail the different aspects mentioned above.

Crunching of credit loans conditions

The tightening of the conditions for loans is reflected in the contracts as follows:

Introduction of two new clauses: MAC and Price Flex

MAC (Material Adverse Change) clauses are systematically included in the contracts for all financing transactions. These clauses allow lenders to cancel their commitments in the event of a significant adverse event (that can affect either the borrower or the market) between the signing of the contract date and the date when the funds become available.

Price flex and flex framework clauses have also been included allowing for an increase in prices and some changes in the structure in the event of significant changes in the market.

A decrease in Underwriting related to the disappearance of the CLO and other securitization vehicles (SPV)

The crisis also had some repercussions on syndications operations. While underwriting operations were very common before 2008, these disappeared progressively after because banks weren’t able to support all the risks, especially following the disappearance of securitization techniques.

Reduction of financial covenants

One of the financial consequences of the rigidity of the terms in credit agreements resulted in setting more strict levels for financial covenants.

Figure 13 : Evolution of leverage in a LBO financing (including after the crisis)

As shown in the graph above, leverage levels decreased significantly after the crisis because of the more stringent conditions in the fixing of financial covenants. While 50% of transactions had a level of leverage higher than 6.0x in 2007, this share decreased strongly over the years that followed, and is located at a level below 5% in 2009. Therefore borrowing funds found their means of financing reduced; leaving them with fewer margins of maneuver and obliged them to invest more equity in the financing of their operations, systematically reducing the return on their investment.

Figure 14 : Evolution of the equity contribution in a LBO financing (including after the crisis)

The share of equity in LBO financing increased therefore from 33% in 2007 to 50% in the years following the crisis.

"Equity Cure" clauses were also introduced in credit agreements, enabling the borrower, in the case of "breaking" covenants, to inject the necessary funds that will allow him to cover this situation and avoid a prepayment of credit.

In this tense and uncertain environment for credit loans, funds that traditionally invest in Large Cap operations preferred to switch and focus more on Mid cap because it doesn’t require large equity inflows.

- With the aim to protect banks against default and to preserve their liquidity, conditions and information about early reimbursement were added in the new credit documentations (early repayment clause mandatory in the event of assets disposal).

Increase in spreads

To be able to counter the increase in costs of liquidity, banks increased the price charged to the borrower.

The prices of the various tranches of LBO operations have increased significantly from the year 2008 (250-350 pbs) to reach approximately 450-500 pbs in 2010

Today, the standard price for LBOs ranged from 425 pbs (for bands A and Revolving) (200 bps in 2007) and 475 pbs (for the Bullet slices) (250 bps in 2007).

Switch from bullet structures to depreciable asset:

All-Bullet structures (consisting of a 100% reimbursement at maturity) encountered before the crisis, that have the advantage of being more favorable to the borrower taking into account the absence of periods for depreciation no longer exist today. Indeed, banks, forced to meet profitability ratios, require the borrower a minimum share of depreciable slices. The distribution of the slices based on the YTM rebate to 06/30/2011 is as follows:

«double Luxco» Structures

"Double luxco" structures, most commonly used today in the financing of significant size deals like Cerba, Spoteless and Picard Surgelés, are innovations of the French Law. They are designed to overcome the disastrous consequences for creditors of the inconvenient procedure of backup against ad hoc structure. This procedure occurs while there is no default in payment by the debtor but when asked for, it has for consequence to suspend any payment to creditors and the latter cannot exercise any legal action against the debtor to obtain payment of a debt. Therefore it was necessary to implement a new system likely to bring some comfort to investors particularly foreign ones, the "Double Luxco" structure perfectly meets this need.

NEWCO

Figure 15 : Double Luxco structure

The sponsor shareholders create a company in Luxembourg called Luxco 1

Luxco 1 creates a subsidiary also in Luxembourg called Luxco 2

Luxco 2 creates a French subsidiary called NEWCO to be the holding company for acquisition and which will be the borrower.

NEWCO will acquire the assets of the target company.

Security interests provided by the "Double Luxco" structure are as follows:

Luxco 1 will be bail to the banks for the loans extended to NEWCO and will give in as guarantee the securities that it holds in Luxco 2 (guarantee under the Luxembourg law).

Luxco 2 will be bail to the banks for the loans extended to NEWCO and will give in as guarantee the securities that it holds in NEWCO guarantee under French law).

NEWCO as borrower will give in as guarantee the securities of the target that it acquired (guarantee under the French law).

These structures have experienced considerable growth in 2010 and have been used in almost all of the Large Caps operations (Spoteless, Cerba, Picard surgelés..). They have the advantage of offering more flexibility to the senior lenders by excluding the possibility of calling onto the application of the safeguard procedure on the Luxembourger holdings because their centre of interest is outside the French territories.

Changes in sources of funding: disappearance of the second link and orientation towards the High Yield market

The graph below shows the evolution of the different sources of financing of LBO operations.

This chart calls for several comments:

Disappearance of the second link

Since 2008, second-link bands have virtually disappeared as a mean for financing LBO operations; banking institutions found them too risky (structurally subordinated to the senior financing) and the mezzanine funds found them unprofitable considering the given risk (pricing around 9% against Mezzanine at 12%).

-Taking into account the constraints and the firmness imposed in granting credit by senior lenders and mezzanine funds, borrowers are turning to the High Yield market. This market has the advantage of being much more liquid, and has much more flexible financing conditions. Eventually, it could replace the mezzanine debt that is becoming more and more expensive.

Liquidity in the High Yield market plays an important role since 2009. But its role would be more important in the upcoming years and that for two reasons.

The establishment of a wall of debt in the short term (2012-2015) which will be at the maturity of LBO operations contracted during periods of euphoria (2005-2007), corresponding of a total of around EUR 400 billion.

These different loans should be repaid, and thus for the most part, refinanced. Given the constraints of liquidity of senior lenders, High Yield financing will develop more.

Conditions for credit loans which are granted by senior lenders will continue to deteriorate following the application of Basel III. This will impose on banks to respect new liquidity and solvency ratios, and having the effect of reducing the financing capacity of different European senior lenders.

Investor relations / Managers

The financial crisis and the unfavorable market environment have weakened the situation of a large number of companies under LBO, thus leading to a non - conformity with the anticipated financial projections. IRR levels attained and decreased valuation ratios pushed investors to extend the duration of the operations and to wait until they could achieve a good performance level consequently a good return on their investment.

This decline in situation has negatively impacted "management packages". Indeed, the management team found itself doubly disadvantaged:

The deterioration in the financial situation of the company led to an IRR often not allowing reaching the required threshold for management remuneration packages.

Some managers having heavily invested in times of euphoria, found themselves in a difficult and compromised situation.

These two consequences of the bad economic environment made these "management packages" uninteresting for unmotivated managers, often seeking a way out to limit their losses.

Unlike the period of euphoria and ample liquidity where managers enjoyed a strong position in negotiating "managements packages", the period of crisis has led to a lack of motivation of these managers leading to a decline in the performance of the company and therefore generating IRR levels that do not allow the outbreak of their remuneration. The principle of "alignment of interests" was therefore broken leading funds and management teams to review and renegotiate these remuneration packages to cope with the new situation.

Conclusion

Although far from the levels of before 2008, the years post crisis are marked by the resumption of the LBO following the revival of investment and signing major acquisitions including during the year 2010. LBO firms have also not known the predicted catastrophe; the model could thus demonstrating some aspects its solidity and proves its legitimacy

Very flexible during the golden years, the conditions of granting of credits are hardened and the structures of the conventions of credits are more to the advantage of borrowers. The gradual return of debt is confirmed over time but is still generally cautious. In the current context marked by access to the still limited debt and an overall decrease of the leverage effect, the bank debt market Outlook remain flouent due to the Basel III framework that banks are not to identify and which is not yet pass way says in the price. The companies were turned to alternatives like High Yield Bond but this last is currently funding sources of the difficulties with the crisis of sovereign debt thus blocking certain operations of acquisitions and could be problematic in the future.



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