| NEW YORK
NEW YORK Jan 4 Bull markets produce innovation.
The latest novelty in U.S. leveraged loans is a
pre-capitalisation or pre-cap financing, which allows companies
to keep existing financing and capital structures in place if
they are sold.
Pre-cap loans reappeared in 2012 after debuting in 2005. Six
were completed in the U.S. last year and they look set to remain
a feature of 2013.
The structure is good for private equity buyers and sellers
which save paying a new set of fees. Change of control
provisions are not triggered, which usually prompt an expensive
The portable pre-cap structure is less popular with
investors, which are wary of losing control over who they are
Pre-caps remove a happy dilemma for private equity firms -
whether to refinance and take a dividend from a portfolio
company or wait and sell the business later - by allowing them
to do both.
"It's very compelling for a private equity sponsor who has
been in an asset for a while, who wants to monetise but is not
ready to sell yet," said Jeff Cohen, co-head of U.S. loan
capital markets at Credit Suisse, which pioneered the
structure and completed five deals last year.
Credit Suisse led a $1.06 billion credit, a $660 million
term loan B and a $350 million second-lien loan for Atlantic
Broadband in March 2012 to refinance existing debt
and provide a $345 million dividend to owners ABRY Partners and
Oak Hill Capital.
A few months later, Atlantic Broadband was sold to Canadian
cable company Cogeco Cable for $1.36 billion, which
used the $660 million term loan B to fund part of the purchase.
Easing buyout concerns
Pre-caps are useful in a weak M&A environment and a hot
capital markets climate as they ease buyout barons' concerns
that they could be missing a refinancing window and give
investors a supply of high-yielding paper.
Outside a bull market, investors would not give up their
right to choose their borrower. Even yield-hungry investors are
disdainful of the structure, which one source called an
abrogation of his fiduciary duty. Other lenders with a more
sanguine view argue that companies are the same regardless of
"We are sensitive. But you can't make a blanket rule that
you won't do it," said Jonathan Insull, managing director at
Crescent Capital Group. "Each one has its own set of
Investor reservations and several failures mean that only
top companies qualify for precaps. NEP Broadcasting
pulled a dividend effort and Hyland Software dropped the
"It requires a very strong market and a very strong
transaction. You need a very attractive credit that is going to
draw heavy oversubscription" said Tracy Mehr, managing director
The investment bank completed P2 Energy Solutions' latest
$355 million debt tap as a pre-cap, which waived the
change-of-control provision from the close of the deal until the
end of 2012.
Some restrictions have been put in place around acceptable
buyers, equity contributions and leverage tests. The duration of
change-of-control waivers is also usually capped.
The largest precap to date - Kronos's $1.9
billion dividend recapitalization, structured by Credit Suisse
for Hellman & Friedman and JMI Equity, came with conditions.
Change of control provisions will only be waived for a
maximum 18 months if the new owner is a private equity company
with assets above a certain size, makes a mimimum equity
contribution and meets a maximum debt incurrence test when the
M&A deal closes.
The structure has given Kronos more financing options and
saved $15 million to $20 million in additional financing costs
which will boost profits for the selling sponsor, Cohen said.
Bankers do not see the pre-cap becoming a market norm, as
covenant-lite loans are now, as it is only used in specific
circumstances. This will not stop buyout firms trying to make
the latest innovation a trend.
"Certain sponsors are looking to make this into a permanent
feature," said Richard Farley, a partner at Paul Hastings. So
far, though, "No one has bitten."