‘Liquidity may, if anything, become tighter’

Jonathan Guise co-founded debt advisory boutique Marlborough Partners in November 2010 alongside William Allen, David Parker and Romain Cattet. The team traces its genesis back to Blenheim Advisers, the debt business set up by Guise and Allen in 2003 and subsequently sold to Houlihan Lokey in 2007.  PEI caught up with Guise in Marlborough’s office on London’s Savile Row to talk about the challenges faced by financial sponsors in the European mid-market: Marlborough’s sweet spot.

Jonathan Guise

How serious is the so-called “refinancing wall” in the mid-market?

Much more serious than many imagine. Much has been made of the liquidity that a buoyant high yield market will offer to alleviate concerns over the refinancing wall, but this is unlikely to affect the bulk of mid-market financings, where the size is too small for a traditional high yield issuance.  We do expect to see an increase in private placements in the mid-market – when single or small groups of private investors replicate a high yield issuance on a take on hold basis in the mid-market  – however we do not believe there will be sufficient volumes to provide a full solution, given the size of the problem. We are, therefore, taking the refinancing wall very seriously and do not want our clients to have to refinance when there is a fight for available capital.

Have financial sponsors set about tackling the issue in the right way? and early enough?

Some have taken debt liability management seriously and have already refinanced the majority of their near- to medium-term debt maturities. There are many funds, however, that have assumed the market will recover and liquidity will return, driving leverage up and pricing down. While leverage has started marginally to trend upwards, pricing has been fairly stable and liquidity remains tight. The opportunistic tapping of high yield bond appetite has, and will continue to be, a crucial avenue for larger refinancings, but mid-market sponsors are feeling increasingly uncomfortable with the assumption that banking market liquidity will return any time soon. With sovereign and corporate debt refinancings set to peak ahead of the leveraged refinancing peak in 2013-14, there is growing realisation that liquidity may, if anything, become tighter.  There is, therefore, significant risk for all but the strongest credits in waiting too long before refinancing.

How useful will the bond market be for financial sponsors in 2011?

First, it is important to remember that the high yield market is currently driven by the corporate market. 2010 European high yield issuance was around 80 percent corporate and 20 percent private equity.  Of that 20 percent, nearly all of the issuance – aside from two or three deals, such as CVC’s Sunrise or Lion Capital’s Picard – was refinancing. We expect this mix to continue in 2011, albeit with an increasing number of sponsors taking advantage of new deal issuance as they become more comfortable with the product. However, it is also important to remember that the high yield market remains fickle and, as either interest rates rise and/or additional sovereign crises occur, the market may shut for indefinite periods. We are therefore strongly of the opinion that an issuer should monitor the market carefully and issue opportunistically.

What about other potential solutions or sources of capital to plug any equity gaps in the mid-market?

We believe there will be an increasing number of situations in which there is demonstrable equity value, but where a refinancing is necessary and the level of leverage exceeds market appetite. In many of these situations, sponsors will not want to provide new equity and will therefore need a form of “gap” capital, which the banks will be able to treat as equity but which doesn’t unnecessarily dilute the incumbent equity. A number of mezzanine funds are starting to market PIK and preference share products for this purpose; we expect to see a number of alternative capital providers follow suit.