March 22 (IFR) - John Malone helped fund Liberty Media’s $2.6bn purchase of a 27% stake in Charter Communications this week with a margin loan, an increasingly popular funding mechanism in the US.
Margin loans, collateralised by the underlying stock, help leverage returns and limit the cash funding costs of a deal.
“Margin loans are relatively new in the US. They are more common in Europe but the technology transferred West about 18 months ago,” said one equity derivatives banker.
“If you’re bullish and you want to achieve an IRR target (target internal rate of return), you can get there a lot faster by using a margin loan.”
Liberty Media on Monday entered into a definitive agreement to purchase 26.9m shares of Charter, as well as 1.1m warrants, from Apollo Management, Oaktree Capital Management and Crestview Partners for US$95.50 per share, a 6% premium at the time.
A portion of the total consideration is expected to come from a combination of “cash and new loan arrangements”, the companies said in a statement. The purchase is expected to close early in the second quarter of 2013.
Charter Communications shares closed Thursday at US$102.36, 7.1% above the agreed upon purchase price. Assuming a 70/30 split of cash and leverage, Liberty Media has returned about 10.3%, excluding the costs of the margin loan and any value to the warrants.
In addition to levered returns, margin loans can provide the added benefit of certainty on execution.
“Either the buyer or seller can have the financing pre-packaged prior to closing,” said a second derivatives banker. “Having the packaging self-contained simplifies the negotiations.”
A seller could arrange the funding before even identifying a buyer.
Another appealing factor is that margin loans are off-balance sheet, mitigating pressure on credit ratings from additional term borrowings.
The lower cash consideration is certainly attractive to private equity firms. Bain Capital, for example, used a margin loan to help fund its purchase last April of a 30% stake in Genpact for US$1bn from General Atlantic and Oak Hill. That kept cash-call commitments to limited partners in addition to levering returns.
“Margin loans make a lot of sense for private equity and sovereign wealth funds on concentrated investment,” said one of the bankers. “They are secured loans to buy stock on non-recourse basis, and provide flexibility to deploy cash elsewhere.”
Margin loans are also used in private market transactions. A chief executive with significant capital tied up in company stock can margin those holdings, freeing up cash to diversify investment holdings or purchase other assets.
Those contemplating using margin loans in the US can learn from the European experience. Five years ago, banks were restructuring rather than originating equity financing transactions, particularly for Russian and Middle East clients where the LTVs had been particularly aggressive. The business has matured since then and comprises a significant portion of corporate equity derivatives revenues each year.
LTVs should not be a concern for regulators in the US as lending cannot exceed more than 50% of equity collateral - part of the reason margin loans have been so slow to cross the Atlantic. In the Charter Communications deal, it is expected to be 20%-30%.