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IFR-KKR's Perpetual buyout tests recovery of leveraged finance

(The following story appeared in the Oct. 30 issue of IFR Asia, a Thomson Reuters publication)

HONG KONG, Oct 30 (IFR) - Buoyed by the successful syndication of Healthscope, Asia-Pacific leveraged finance bankers are now mulling a far bigger challenge: the loan to back Kohlberg Kravis Roberts' KKR.N planned US$1.73bn buyout of Australian fund manager Perpetual.

While the Healthscope loan breezed through syndication, picking up a handful of institutional investors and a mix of small and mid-sized regional banks on the way to a solid 28.6% selldown, the Perpetual buyout offers a sterner test of the capacity of the region’s recovering leveraged finance industry.

A successful deal could pave the way for more leveraged acquisitions in Asia’s financial sector, but bankers warn that the nature of the target limits the pool of banks that can lend, and the risks associated with the deal are greater, and more difficult to assess.

“There is not a lot of precedent in this part of the world for this kind of deal,” said one Australia-based loans syndicator.

Perpetual said last week KKR’s offer was too low but it would continue talks and hand over limited financial information to the private equity firm, hinting that it may agree to a higher bid.

KKR has engaged Credit Suisse, Nomura International, Barclays Capital and local boutique BKK as advisers, and the banks are currently gauging appetite for a loan to back the buyout.

Lev fin bankers said they would expect the debt to be at around A$420m-$525m (US$411m-$513m), assuming leverage levels of about 3.0 times to a maximum 3.5 times Ebitda.

With no comparable deal in the Asia-Pacific region, the buyouts of British fund manager Jupiter Asset Management by private equity group TA Associates in 2007 and of Gartmore Investment Management by sponsor Hellmann & Friedman Advisors in 2006 may offer better comps.

Both deals were completed with conservative leverage levels of 3.0 to 3.5 times.

In contrast, Carlyle Group and TPG Capital raised A$1.55bn at leverage levels of 4.0 times senior debt to Ebitda and 4.7 times total debt to Ebitda for their A$1.99bn acquisition of Healthscope.

With a mandated lead arranger group of 17 and a total of 30 lenders, including eight Asian banks lending A$245m in general syndication, the Healthscope acquisition showed the appetite available for the right structure at the right price.

But leveraged loan bankers viewed Healthscope as a safe bet - like all successful Asian LBOs completed since the Lehman Brothers bankruptcy. The healthcare services provider is supported by taxpayer-funded and non-cyclical revenues, while the loan is secured over physical assets.

“Even if the company fails, you have access to the … actual buildings. You sell them,” said one banker from a lender to the buyout loan.

And while the US$915m-equivalent LBO loan backing KKR’s buyout of Oriental Brewery in South Korea in 2009 was a gutsy deal at the time - the first leveraged buyout to enter the Asian market after the Lehman collapse - the target was a duopoly South Korean beer producer, the very definition of a safe bet.

“Safe bet” is not the way leveraged loan bankers would describe the Perpetual buyout. Many describe it as “interesting”, others add that it is “certainly one to watch”. The question is how many will watch, and how many will participate.

Some banks that participated in the Healthscope syndication simply cannot lend to buyouts of financial institutions as an institutional policy. These banks take the view that the lack of physical assets as security and the inherent volatility of the sector make such deals off-limits for leveraging.

“It will be a test, because many banks do not have the skills to appraise the asset. You need to be able to assess how regulations and investors affect the earnings,” said a Hong Kong-based M&A banker whose bank does not lend to buyouts in the financial sector.

The same source noted the risk inherent in the nature of the assets, saying: “The assets include people, the fund managers standing in the company, and if it goes wrong, they can walk. The sponsors need to align their interests with these guys. So do the banks.”

Not surprisingly, Perpetual’s star fund managers, John Sevior and Matt Williams, have received considerable coverage as “kingmakers” since KKR’s bid was announced, based on their pivotal role in any buyout deal.

A further risk, say leverage bankers, is the volatility of earnings derived from managing investments. If stock values tumble, so does the value of funds under management.

“[Perpetual’s value is] strongly correlated to the stock exchange, which makes it volatile,” said another Hong Kong-based buyout banker studying the transaction. “If the funds under management fall, gearing rises as the Ebitda compresses quickly.”

This is why the gearing was kept low on both the 722m pound (US$1.15bn) LBO of Jupiter and the buyout of Gartmore, which featured a 300m pound term loan B, structured in line with the US market and targeted mainly at funds.

Both the 2007 recap of Gartmore and the 510m pound senior debt backing the Jupiter buyout were covenant-free financings, featuring bond-style incurrence tests only, structures that targeted institutional investor liquidity and avoided tripping gearing covenants.

Those structures, however, have been off the table since the onset of the financial crisis. Asia’s leveraged finance volumes remain far short of the US$20bn-plus completed in 2007, and the industry is still recovering from a number of restructurings in Australia and New Zealand that are preventing banks from proposing risky structures and high leverage multiples.

“This is not 2006 or 2007, so you won’t see covenant-lite loans. That won’t happen,” said another Australian loans syndicator studying the asset.

In the deal’s favour, however, is the renewed confidence in leveraged structures in the Asia-Pacific market on the back of the Healthscope deal, and another successful syndication of an LBO loan for education services company Study Group International. That means the region’s leveraged finance bankers are keen to at least run a rule over the deal despite the risks.

Confidence in underwriting is also back. The OB financing in 2009 helped reintroduce that concept when it comes to LBOs when the deal, underwritten by HSBC, JP Morgan, Nomura and Standard Chartered Bank, became one of the standout successes of the year. The SGX loan last week also emphasised the return of underwriting, after ANZ and Deutsche Bank agreed to back a US$3.5bn acquisition loan.

The risks are far higher on Perpetual, though, but confidence in underwritten structures has certainly returned.

“There’s a long way to go, and they’re not close to structuring a deal yet - just engaging banks right now,” said the Australian loans syndicator.

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