Staggering demand

Year-end is nigh, and buyout investors have good cause for optimism. The receptivity of equity markets to IPOs finally looks as though it is improving. Deal pipelines remain healthy. Economic prospects look relatively good too. And, most noticeably perhaps, debt providers are bullish in their outlook, particularly in the US. It is appropriate, then, that this month's Deal Mechanic, for the first time since this magazine was established, should cast its critical eye across the pond.

In November, the US leveraged debt market experienced what can only be described as a feeding frenzy, with 18 transactions being priced in the high yield bond market during the first week alone. The leveraged loan markets saw similar activity levels, and underwriters are confident there is still more to come. Issuers were the main beneficiaries, and only pricing levels suffered to an extent. Few transactions illustrate this better than the recent financing for industrial water treatment company Ondeo Nalco.

Strong fundamentals
The deal appealed to the credit markets for a number of reasons. First of all, it was big: vendor Suez S.A. of France agreed to sell the company for $4.2bn to a consortium comprising Apollo Management, The Blackstone Group and Goldman Sachs Capital Partners. Then there was the quality of the company itself. Ondeo Nalco is fundamentally a desirable credit story: it is within an industry acknowledged to be stable; it has scale and diversity, serving over 60,000 customers in 130 countries around the globe across and a broad range of segments from municipal governments to petrochemicals; and it is a renowned technical innovator with a high level of profitability. In short, it is among the leaders in its field.

A further fillip was the class of those backing the transaction, with blue chip sponsors and an arranging group for the debt facilities consisting of Citigroup, Bank of America, JP Morgan, Deutsche Bank, Goldman Sachs and UBS. Finally, and this is the facet which really set the deal apart, appetite for the debt was genuinely global, with reverse enquiries heating up transatlantic phone lines. This was a cat well and truly out of its bag and being hotly pursued by debt investors with voracious appetite.

Nevertheless, although there was a sense of anticipation of things was to come, the launch seemed fairly normal at first. There was wide interest, but in the mix were also one or two more sceptical tones. Was the leverage too high? Senior debt to EBITDA was a modest 2.5x, but total leverage was a fairly mighty 5.8x. Would the price be right? The term loan B was launched at a relatively mean 275bp in a market that has regularly seen such tranches sold at 300 to 325bp if not more, and no up-front fees were offered. Also, the financing was to be done in two parts. First of all, a high yield issue totalling $1.85bn in four tranches was expected – US Dollars and Euros, each comprising senior and senior subordinated notes. In addition, loans were on offer made up of a $250m revolving credit facility, a $300m term loan A – both priced at 250bp – and the above term loan B weighing in at $1.1bn. Such a hefty B tranche would have seemed odd in a European context where the A loan in any structure is typically the larger one. In the US however, chunky B loans have been common for some time now, as demand for larger deals has mainly come from non-bank buyers.

In the end, the sceptics needn't have worried. The sheer scale of demand was staggering – so much so in fact that the arrangers were able to do the deal on even better terms. All tranches of the bond were priced at the tight end of price talk, with the Euro-denominated notes reportedly being 4 to 5 times subscribed – an impressive level for high yield paper. The situation was exacerbated by the late decision to cut the size of the bond to $1.65bn, as a result of which all tranches were bid up heavily in the aftermarket after breaking above par. As the bond was made smaller, the size of the term loan B was pushed to $1.3bn, with allocations still being cut to around 50 per cent of what investors ordered. The price of the facility was also reduced to an almost miserly 250bp. No matter: the loan became, and to date remains, one of the most actively traded in the market.

The moral of the story? Clearly, good fundamentals remain the key to success. Nevertheless, such frenetic activity has been largely absent from the market for some time now, and bodes well for 2004. A candidate for ‘leveraged deal of the year’? We wouldn't bet against it