New mezzanine

When Hutton Collins, the London-based mezzanine and specialty finance boutique, opened for business earlier this year, it set out to offer a mezzanine proposition with a difference. Its debut deal, launched this summer, appears to be a step towards achieving this goal. The €300m mezzanine facility jointly arranged with Royal Bank of Scotland to support the €1.9bn acquisition of Télédiffusion de France (TdF) by Charterhouse Development Capital, CDC Ixis Equity Capital and Caisse des Dép^ts, is indeed a little different.

Its size is the first characteristic that stands out – and one of the reasons why several competitors described the deal as ?racy.? Although Hutton Collins and Royal Bank are not alone in having structured a mezzanine piece this size – CIBC World Markets also launched a very large facility recently as part of the funding for Elis, the French linen services company sold by BC Partners to PAI – it is still a bold step for a firm that is yet to raise its first fund. To underwrite the facility, Hutton Collins would have had to pledge a significant amount of the €115m commitment from its cornerstone investor, Abbey National Treasury Services, and called on the bank to provide additional capital from its balance sheet.

A risky move? The transaction itself carries a debt multiple that is comparatively high in relation to the purchase price, 4.9x and 7.5x pro forma EBITDA respectively. However, the firm is what practitioners would call ?a good debt business.? TdF consists primarily of the French domestic network of broadcasting towers for television, radio and mobile telephony. There is potential upside as digital terrestrial broadcasting and UMTS/3G mobile communications pick up. But the business already benefits from that holy grail of leveraged financiers, contractual revenues. TdF's cash flows certainly provide support for a leveraged structure, assuming that the French keep watching TV, listening to the radio and using their mobiles, which seems a perfectly reasonable assumption to make.

Buyers to take their PIK -or warrants
So the deal may be big, but the risks don't seem to set it apart from other LBOs. However there are some structural features that do. The TdF facility is effectively a two-in-one: the buyer has a choice of an innovative warrantless piece with cash interest of Libor plus 5 per cent and rolled up interest – or payment-in-kind (PIK) – accruing at a rate of 6.5 per cent per annum; or a more traditional mezzanine tranche with cash interest paid at Libor plus 3.75 per cent, 5.5 per cent PIK and warrants. (The Elis facility, by contrast, consists solely of a cash/PIK tranche and is warrantless.) Some investors, including CDO funds for example, are likely to prefer the warrantless tranche as, to all intents and purposes, it is a high yield substitute.

Given that the facility is among the largest ever to be distributed, the inclusion of two different structures in order to appeal to the investor community as widely as possible is a shrewd manoeuvre. What is even more striking though is the fact that the final proportions of each piece will in effect be determined by how much demand each is going to attract in the market.

This may seem a minor aspect, but consider the approach. Details on the number of warrants attached have not been released, but what is clear is that if the ultimate realisation of those warrants results in a return greater than the equivalent of 2.25 per cent per annum, the holders of the warrantless piece will have lost out relative to their fellow investors. Put another way, the introduction of the warrant, if things go right, holds out the prospect of more value to be retained by the mezzanine providers, and a greater share of the upside to be given up by the shareholders. Add to that the fact that, through the flexible tranche structure, the number of warrants surrendered is to be decided by the market, rather than being absorbed by the underwriters though the provision of predetermined facilities, and you begin to appreciate the subtlety. In essence, while designed to attract as many buyers as possible, the facility is also structured to pass some of the underwriting risk back to the transaction sponsors. An innovative touch and quite possibly an indication of what's to come.