Friday Letter Looking for the upswing

Opportunities for Asian mezzanine providers have been thin on the ground up to now, so why has Babson Capital Management thrown its hat into the ring?  

With the formation of an eight-strong team based primarily in Sydney, Babson Capital Management this week joined Intermediate Capital Group and Asia Mezzanine in putting a foot on the ground as a specialist mezzanine provider in Asia.

Though the firm has prior relationships in the region – and existing investments including the $15 million in senior subordinated notes with warrants committed to Chinese steel casting business Yingliu International last year – some observers may be raising their eyebrows at the claim of Babson managing director Michael Hermsen that Asia “offers attractive opportunities for profitable mezzanine investing”.

The fact is, so far, these opportunities have largely failed to materialise. In a region with much less buyout activity than Europe and North America, where mezzanine is as much part of private equity financing structures as senior debt, mezzanine has struggled to shake off a reputation for being overly expensive and unnecessary.

There were those who felt the economic downturn – and the subsequent unwillingness of banks to lend – may open up a financing gap to be filled by mezzanine players. But even in a mature buyout market like Australia, which is Babson’s primary target, the trend so far has been for GPs to up the size of their equity commitments.

“Rather than give away the economics to the sub debt guys, sponsors would rather fund the gap themselves and have a clean structure with senior debt only and equity sitting underneath it,” said Lyndon Hsu, managing director and head of leveraged finance for Asia with Credit Suisse, in an interview with PEI Asia earlier this year.

However, despite the lack of traction gained so far, there are many who remain confident mezzanine will gain ground in Asia in 2010. Hsu predicted the development of a meaningful market for primary issuance sub debt “at sensible yields from a sponsor’s perspective, meaning 12 to 14 percent without warrants”, by the second half of 2010.

Joseph Ferrigno, managing partner at Asia Mezzanine, said earlier this year the use of mezzanine finance in primary transactions will increase as buyout activity picks up across Asia in 2010, albeit under “increasingly strict covenants and other restrictions placed on borrowers by senior lenders”.

Babson will be hoping it has timed its entry into the market just right to catch the upswing. However, with the keen focus on mezzanine pricing seen in the region, whether the opportunities will prove to be as profitable as hoped remains to be seen.