Friday Letter Not easy to clean up

This week’s attempt to delever ISS ahead of (another) possible IPO demonstrate the challenges of realising big investments, and the perils of sizeable debt components.  

We argued earlier this month that big firms, with big funds, should be doing more big deals. Based on the number of multi-billion dollar transactions since then, GPs are evidently heeding calls to deploy more capital.

They’re also under pressure of course to realise big investments made pre-crisis. But for GPs sitting on big assets, exit options are far more limited than with smaller companies, and the debt used to leverage them can be more troublesome.

Two firms finding this out the hard way are EQT and Goldman Sachs. Both, it must be said, have an impressive pedigree when it comes to big exits – EQT’s seven disposals last year amounted to more than €6 billion, for example, and included the €2.3 billion sale of Securitas to Bain Capital and Hellman & Friedman.

But when a company reaches a certain scale, it becomes much harder to find a buyer. Typically, the only options are a large corporate, or the public markets. (Other GPs are a third possible option, but a much less common one for the biggest deals, particular in this market). EQT and Goldman have tried both a trade sale and an IPO with services group ISS, and failed.

They agreed a €6.1 billion sale of the company to UK-headquartered rival G4S last November at DKr 130 a share, a deal swiftly torpedoed by the latter’s shareholders. They have also tried to float the company on several occasions, pulling the IPOs due to market volatility each time.

So this week’s investment by the ever-acquisitive Ontario Teachers’ Pension Plan and KIRKBI, the investment vehicle of Kirk Kristiansen family which also owns the Lego toy brand, marks an interesting development, not least because it brings into sharp focus another element of big deals: debt.

The €500 million proceeds from OTPP and KIRKBI’s joint investment this week will be used to pay down the debt further, the company said in a statement. That shows three things: that an IPO is still likely; that its current debt burden is too high – ISS chairman Ole Andersen spoke of the need to “significantly deleverage ahead of an IPO”; and that for whatever reason, EQT and Goldman are prepared to offer 26 percent of a company they almost sold at DKr 130 a share less than a year ago for DKr105 a share – a pretty substantial 19 percent discount for a quarter of the company. Neither was able to comment by press time.

Analysis of ISS’ balance sheet shows that since EQT and Goldman acquired the business in 2005 in a €3 billion buyout, its debt burden has spiralled upwards. Even with the €500 million injection this week, debt is still some €740 million higher than it was at acquisition. There’s no indication of how much, if any, capital has been returned to the sponsors since the buyout – dividend recaps might be one explanation for the increasing debt component.

According to Debtwire figures, total debt on its balance sheet stood at €3.32 billion by the end of 2005. But rather than paying that down over the course of the investment, the two sponsors actually increased leverage in every year until a peak was reached in 2009 at €4.61 billion.  Since then, it has been reduced slightly, to €4.60 billion in 2010 and then €4.56 billion in 2011.

That may well be a tacit acknowledgement that public market investors may not look too favourably on a company which delivered €5.25 billion in H1 revenues this year, but an operating profit “before other items” of €256 million and “profits before goodwill impairment and amortisation of customer contracts” of just €66 million. All that cash is going somewhere, and one could easily point to the burden of servicing €4.56 billion of debt as at least a large part of the cause.

So, what lessons can be learned? That in any strategic plan which features an IPO as a likely exit route, the public markets should not be taken for granted. That debt is still a dirty word to some (particularly public market investors), and leverage, while magnifying returns, can also work against you. And that as hard as it is to buy a multi-billion dollar business, it’s even harder to sell it. EQT and Goldman are past masters at both, of course, but ISS increasingly looks like an investment which won’t deliver the returns it might have done.