Deal mechanic is the column where, over the coming months, we'll be drawing on a number of specialists who can deliver a range of perspectives on a deal's structure, financing, logic and implications. Although the aim is not to judge, it certainly is to critique.
Elsewhere in this issue you will find an assessment of the leveraged finance market in Europe as well as notes from our US correspondent as to how and when the LBO market will revitalise in the US. So the deal mechanic is looking back at a European leveraged transaction that usefully marks out how and when such deals can get done. The object of the exercise is the year's most high-profile leveraged buyout, the acquisition of British Telecom's directories business, Yell, by Apax Partners and Hicks, Muse, Tate & Furst, which provides some telling insights as to the logic of leverage.
Announced on May 25 this year, the acquisition of Yell by the two private equity firms immediately caught headlines in both Europe and the US. Some were driven by the boost the deal would give to the finances of Yell's beleaguered former parent who was desperately trying to reduce its £30bn debt mountain. Others wondered at the logic of the deal in what many regarded as a dull backwater to a hardly appetising sector. In fact Yell involved two of the three sectors that made up that once-cherished and now reviled term, TMT. A media business tied to the telecoms industry: who would pay £2.14bn for that?
As subsequent transactions in the directories world have confirmed (SEAT Paginalle, Thomson, Telenor Media and the as yet mooted VNU World Directories), private equity firms love the idea of solid cashflows. The bankers too can get very comfortable with their uncomplicated business models. And the sector is clearly consolidating, so if you can be the last man standing after the build-up there will be some compelling exit alternatives.
Yell consists of the UK Yellow Pages, the leading classified advertising directory business, and the US-based Yellow Book, a sector-leading yellow pages publisher that has taken and shaken its competitors in the United States. British Telecom said Yell's fiscal 2001 operating profit was £208m on revenues of £774m, giving it an impressive operating margin of 27 per cent. Net assets came to £695m.
The two private equity firms, who were equal partners, were quick to see that here was a business that could sustain significant leverage, even though banks were already turning other private equity deals away. The bid that won the day, made up of £2.04bn in cash and £100m in loans, included £690m of equity provided by Apax Partners' funds (Apax Europe IV, Apax Europe V and Apax Excelsior VI) and Hicks, Muse, Tate & Furst's funds (HMTF Europe Fund and HMTF Equity Fund V). Accounting for 32 per cent of the transaction value, the equity tranche was certainly not as small as it might have been, thus reflecting the rapidly changing climate for raising leveraged finance. Nonetheless, the two firms managed to raise £1.45bn of debt from Merrill Lynch and CIBC, equivalent to nearly 68 per cent of the transaction value.
As part of the financing, a high yield bond was also issued. Comprising a £250m tranche priced to yield 10.75 per cent, a $200m tranche also priced at 10.75 per cent and a $150m tranche of zero-coupon senior discount notes with a yield of 837 bp, the issue was Europe's largest this year. The proceeds refinanced the £500m bridge loan that was part of the original £1.45bn debt facility.
How did the buyers manage to get the deal done? A purchase multiple of eight times with an opening leverage multiple of around six times seemed more reminiscent of the easy credit days of the mid- to late-90s. The answer included Yell's 30 per cent plus EBITDA, the far less cyclical nature of the business (compare it with the acquistion of Lafarge's speciality materials division that saw a purchase multiple of 5 times and opening leverage of less than four times) and the forecast earnings growth of the business upon which a significant part of the de-levering is based. The economic after-effects of September 11 make this last element of the strategy look less certain but early reports suggest that Yell's business are continuing to generate strong revenues.
Thus far, the banks as well as Apax and Hicks Muse can still claim to have closed what many regard as the landmark leveraged deal in Europe for 2001.