PIK toggle challenge handed to Europe

Fri Feb 1, 2013 10:38am EST

LONDON, Feb 1 (IFR) - Payment-In-Kind toggles could be about to hit European shores after two of the region's issuers announced dollar deals this week in a move that some bankers predict could be replicated with euro-denominated bonds.

Chemicals business Orion Engineered Carbons and education provider Nord Anglia have structured slight variations of the risky subordinated instruments that re-emerged in the U.S. late in 2012 for the first time since the financial crisis.

Both deals will finance dividend payments to respective financial sponsor owners Rhone Capital and Baring Asia Private Equity, and give the issuers greater flexibility, and potentially cheaper financing, than non-cash pay PIKs.

PIK toggles differ from the non-cash paying PIK deals, which that are more familiar structures in Europe, in that issuers aim to pay coupons in cash rather than in kind - providing that the company has performed well and has enough money to do so.

The higher interest cost issuers bear if they do not pay cash, acts as an incentive for them to structure deals in a way that makes cash payments plausible.

"If the market remains in good shape, there is no reason why PIK toggles couldn't work in euros for European issuers," said one senior leveraged finance banker.

BESPOKE TRANSACTIONS

Luxembourg-based logistics company Dematic and specialty chemical producer Taminco dipped their toes in the dollar PIK toggle market last year. Like them, Orion and Nord Anglia have timed their transactions to coincide with good market conditions to achieve attractive pricing.

All four deals yield around 9%, and the various coupons step up by either 50bp, 75bp or 100bp, if the issuer pays in kind instead of cash.

The 6NC1 USD425m Orion deal, which was upsized by USD35m, has a "pay if you can" structure. The issuer pays the 9.25% coupon in cash if it has enough money, or 10% if it pays in kind, although it must pay the first and last coupons in cash.

Goldman Sachs was physical bookrunner on the deal, while Barclays, JP Morgan and UBS were joint bookrunners.

Nord Anglia, meanwhile, has a "pay if you want" structure. It can pay all cash, all PIK, or a cash/PIK combination of 25%/75%, 50%/50%, 75%/25% respectively. To compensate investors for that flexibility, the issuer must pay a larger 100bp step-up for not paying a cash coupon.

The borrower's USD150m 5NC2 bond priced on Friday via sole bookrunner Goldman Sachs, bang in line with guidance with a coupon of 8.5% and OID of 98 to yield 9%.

BRIDGE TO EXIT

Although current market conditions are conducive to dividend recapitalisations, PIKs can be more useful to extract value from a business when companies face greater restrictions on cashflow movements.

"The main difference between a dividend recap and a PIK deal is that with a PIK you do not have to increase senior debt and burden the operating company with a cash paying bond that could add more stress to the company in terms of servicing its debt," the banker added.

The other benefit to issuers is their bespoke nature.

"It really all comes down to what the owners want to do in 6, 12 or 18 months time, and what restrictive payments from the operating company to the holding company are possible, and then it boils down to how you negotiate with investors," said the banker.

Short-call features - usually 1 or 2 years - are a low barrier for sponsors to hurdle if they want to exit.

That's certainly a prospect for Nord Anglia, another banker said.

The company's Ebitda has grown by a third to around USD80m since its bond debut last March, and leverage has fallen by a turn from 4.1 to 3.1 on the back of its booming Chinese business and growing revenues in Dubai.

The company's enterprise value is estimated between 9 and 11 times Ebitda - or between USD720m and USD880m - a banking source said.

"There is still plenty of cash left post the dividend to give investors an equity cushion, and it's not as cyclical as other recent companies that have issued PIK toggles like Michael Foods and Orion," said the second banker.

"It's also an emerging market play. So if the company has grown this much already, it could soon have USD100m Ebitda, which is perfect for an IPO. This is bridging a gap for an IPO potentially."

CASH INJECTION

Baring also provided some reassurance that it would pay in cash after injecting USD20m into the Holdco, which it has pledged to pay the coupon, as well as USD4m of management fees that it has not taken from the Opco over the past two years.

It has also pledged to use the annual USD2m management fees to pay the cash coupon, and should have less restrictions on cashflow movements between the group as a result of the company's solid performance.

Some investors said they were open to PIKs and PIK toggles - provided they are compensated enough for the risk.

"Effectively PIK toggles are Holdco subordinated bonds, which is effectively equity sitting behind all senior secured bonds and any other credit at the operating level," said one investor.

"For that type of risk, I want something for that, especially if the deal is small."

Nord Anglia's senior secured bonds are currently bid around 111 and are yielding 6.1%. "The pricing is fair on Nord Anglia, but it's not giving much," the investor said.

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