(Bloomberg) -- Little more than two years ago, Clayton Dubilier & Rice’s purchase of UK grocer Morrisons became a case study of what can go wrong for bankers who back big private equity buyouts. The firm’s latest effort to snap up a French headache-pill maker shows just how forgiving Wall Street can be.
CD&R this week entered exclusive talks with drugmaker Sanofi to buy half of its consumer arm, Opella. Getting burned on Morrisons back in 2022 hasn’t stopped a horde of banks from fighting to provide funding on the €16 billion ($17.3 billion) deal, one of this year’s few largescale buyouts. It’s evidence of life coming back to the leveraged-finance market as interest rates start to turn — and of debt bankers’ desperation to start generating proper fees again.
Some 22 banks have snagged an underwriting role, according to people with knowledge of the matter who aren’t authorized to speak publicly, far more than normal for deals like this. To win a spot, bankers had to offer cut-price interest rates and swallow unattractive terms such as agreeing to provide a novel type of extra leverage, a fallback option not included in CD&R’s eventual bid.
One underwriter says while he’d have preferred a fatter slice of the €8 billion or so debt package, Opella is a decent asset and no one wants to miss out on any big financing right now. A dearth of deals means private equity sponsors are keen to keep as many banks as possible happy to safeguard relationships.
“When you have a market with relatively low volumes and you have such a significant transaction with great fundamental credit metrics and which ticks all the boxes, that’s the type of deal everyone wants to be on,” says Apostolos Gkoutzinis, a partner at law firm Milbank, which didn’t work on Opella.
The situation also demonstrates buyout firms’ lasting power when setting the terms with fee-starved bankers.
It’s all a long way from early 2022, when Goldman Sachs Group Inc. and other underwriting banks ended up saddled with billions of euros of WM Morrison credit they struggled to get rid of. An initial plan to syndicate the debt was delayed after a new Covid variant emerged. Then Russia invaded Ukraine, interest rates spiked and the specialist funds who buy these loans balked.
Banks lost tens of millions of dollars on this and other buyouts as debt markets were upended. Elon Musk’s purchase of Twitter was even more painful.
Leveraged finance has been a Wall Street profit engine for decades. But “levfin” bankers have spent an extended period in the doldrums as base rates remained stubbornly high, deals scant — apart from less lucrative corporate refinancing — and private credit firms muscled in on their patch.
CD&R’s Opella offer is a sign that banks aren’t planning to let private-capital rivals have it all their own way, especially on prize deals.
Direct lenders have been frozen out from the senior financing. Goldman Sachs is again a lead underwriter, alongside another top coordinator on the ill-starred Morrisons buyout, France’s BNP Paribas. The equity side of the deal has a French flavor, too, with the state taking a roughly 2% stake to protect its interest in a national champion.
Crowded Table
To grab a seat at a crowded table of debt providers, however, even Wall Street’s finest have had to accept a smaller bite of the pie. Given the sheer number of underwriters, the seven so-called global coordinators were restricted to single-digit shares of the fees, according to people with knowledge of the transaction. The top banks each got about €13 million to €14 million, the same people say, or roughly 8% of the pot.
Smaller banks will get a far smaller share, but it’s a boon for them to be part of a blue-chip transaction.
Bankers’ clamor to get on the Opella ticket got noisier after another large European private equity deal, CVC Capital Partners’ attempt to buy Deutsche Bahn AG’s €14 billion logistics arm, lost out to a rival trade bidder.
The knockdown borrowing costs offered to Opella tell a similar story. They’re tight enough to exclude any competition from private credit firms, who’ve sold themselves on the promise of chunky returns to investors.
For the European part of the loan package, the rate was 350 basis points above its benchmark, and the US component 325 points, narrow enough to give banks limited headroom if any more nasty macroeconomic surprises crop up, as with Morrisons. Leverage on the deal, with debt about six times earnings and 7.5 times if an additional slug of junior debt is factored in, is punchy too.
Bankers were confident about underwriting the deal given resurgent demand in credit markets and the eagerness of investors to deploy unused cash piles. One underwriter expects that process won’t happen before March.
The bitterest pill for the Opella banks was signing up to supply so-called “back leverage,” even if they didn’t have to ingest it in the end.
Leveraged buyouts are paid for by a combination of the equity stake in a company bought by the PE firm and the much larger slug of debt provided by the underwriters. Back leverage is when the buyout firm also asks banks to lend them another chunk of cash to help pay for their equity.
This appeals to some private equity managers because it lets them target bigger deals and juice returns. Banks are far less keen because it’s another capital outlay and ratchets up loan risks on already highly levered deals.
“It’s a developing area, and investment banks are thinking about these types of products more,” says Milbank’s Gkoutzinis. “But it may not always be something they can do in significant volumes.”
To get a role on Opella’s financing, CD&R asked banks to sign up to a back leverage deal of more than €1 billion, according to people with knowledge of the deal. The firm opted instead to include a so-called “payment in kind” component to the financing arrangement, which defers interest payments in exchange for a higher eventual bill.
People with knowledge of the situation say back leverage was only a backstop option in case the PIK wasn’t approved, but that it could be used on future CD&R deals. The firm is one of only a handful of its peers to occasionally float it as an option, according to market participants.
One advantage of appointing 22 banks as underwriters — effectively drawing in almost all of the players in Europe’s leveraged-finance market — is that it dilutes a €1.2 billion revolving credit facility that’s also part of the Opella funding package. As with back leverage, bankers dislike RCFs because they have to set aside capital for them, so sharing the load has its appeal.
Given the scarcity of deals, several bankers wonder whether the trend for large underwriting groups will persist on other marquee buyouts.
“As these are plum mandates and a sweet spot for investment banks, I think we’ll see the banks staying very close to their respective key PE clients over the coming period,” says Jeremy Duffy, a partner at law firm White & Case in London.
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