Staples Wraps $1B High Yield Bond Offering Backing Sycamore LBO

Staples has completed a $1 billion offering of eight-year notes at the wide end of talk, sources said. Bank of America Merrill Lynch was lead on a bookrunner group that included 10 additional banks. Proceeds will be used to back the issuer’s $6.9 billion buyout by Sycamore Partners. The transaction was downsized from $1.3 billion. A concurrent first-lien term loan also backing the LBO transaction was increased by $200 million, to $2.9 billion. There has also been a $100 million decrease in funded debt, sources said. Prior to launching, the borrower had planned for $1.6 billion of the bonds, but steered $300 million to the TLB to meet investor demand. A $1.2 billion ABL facility will also be put in place to back the LBO. The buyout is expected to close in 2017. Terms:

Issuer Staples (Arch Merger Sub Inc)
Ratings B–/B3
Amount $1 billion
Issue Senior (144A/Reg S-for-life)
Coupon 8.5%
Price 100
Yield 8.5%
Spread T+637
Maturity Sept. 15, 2025
Call non-call three (first call at par + 50% of coupon)
Trade Aug. 14, 2017
Settle Aug. 28, 2017 (T+10)
Joint bookrunners BAML/UBS/DB/CS/RBC/JEFF/FifthThird/GS/C/KKR/ Natixis
Price talk 8.25% area
Notes Downsized from $1.3 billion; up to 40% equity claw @ 108.5 until Sept. 15, 2020; change-of-control put @ 101; make-whole @ T+50

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Private Equity Companies Gamble on Oil and Gas Defaulters—S&P Global

Given the apparent bottoming out of the decline in oil prices, improving credit conditions in the oil and gas sector, and the favorable financing conditions across markets currently, many distressed oil and gas companies appear to be a high-return bet.

However, risks do exist, and adding more debt to these firms’ existing loads may prove costly if interest rates rise, if the larger U.S. or European economy dips into recession, or if oil prices once again decline, S&P Global Fixed Income Research warned in a report this week.

The drop in oil prices that began in the second half of 2014 was particularly hard felt among U.S.-based shale oil producers, as this relatively expensive extraction method proved unsustainable amid an approximate 80% drop in oil prices.

“The speculative-grade default rate has risen in recent years primarily due to disproportionate stress in the energy and natural resources sector, where oil and gas companies have been struggling with falling revenue due to lower oil prices,” said Diane Vazza, head of S&P Global Fixed Income Research.

Private equity defaulters story table 2 2017-07-11(1)Moreover, many recent defaulters in the oil and gas sector have gained extra funding sources via private equity companies taking out ownership.

Recovery prospects
In terms of recovery prospects, bond prices for defaulting U.S.-based firms with private equity ownership do show some interesting distinctions among sectors. In the energy and natural resources sector, the average bond prices leading up to default were generally lower than those in other industries. But these same firms’ average bond prices were generally higher a month after default.

Generally, favorable recent bond prices for the oil and gas segment are in line with or slightly better than historical recovery rates.

The full report can be found here ($). — Rachelle Kakouris

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Rackspace Tapping High Yield Bond Market for $1.2B Backing Apollo LBO

Rackspace Hosting’s pitch for $1.2 billion of eight-year (non-call three) notes backing the company’s upcoming buyout has hit the market via lead bookrunner Deutsche Bank, sources said. Roadshows will run Oct. 17–24, with pricing scheduled for Oct. 25, sources added.

Additional bookrunners for the 144A-for-life offering are Citi, Barclays, RBC Capital Markets, and Credit Suisse. The notes are structured with a first call at par plus 75% of the finalized coupon, and an up to 40% equity clawback at par plus coupon for the initial three years. Ratings are B+/B3/BB-.

The proceeds are earmarked to help finance the $4.4 billion leveraged buyout of the company by Apollo Global Management. A Citi-led $2 billion, seven-year, covenant-lite B term loan, talked at L+425 with a 1% LIBOR floor, is also backing the transaction.

Rackspace made its debut in the high-yield market last September when the company printed $500 million of 6.5% notes due 2024 for general corporate purposes and to repay debt. These notes will be refinanced as part of the buyout.

San Antonio, Texas–based Rackspace (NYSE: RAX) provides cloud computing and information-technology solutions. The company has a market cap of $4 billion, according to S&P Global Market Intelligence. — Jakema Lewis/Jon Hemingway

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Steak n Shake Lines Up $400M High Yield Deal Backing Dividend

Steak n Shake is serving up a $400 million secured offering of seven-year (non-call three) bonds. Jefferies is sole bookrunner on the deal. A roadshow will run from today through next Wednesday, for pricing thereafter.

Proceeds will refinance the borrower’s credit facility and finance a dividend.

The new paper does not have registration rights, while the first call is at par plus 50% coupon.

This appears to be the company’s first bond issue, while its last visit to the loan market was in 2014, when it issued a $220 million B term loan arranged by Jefferies. The covenant-lite loan was non-callable for one year, and then at par. The financing also included a $30 million, five-year revolver. Proceeds from that deal were earmarked to refinance existing debt and fund a dividend to owner Biglari Holdings.

The issuer operates and franchises the Steak n Shake brand of restaurants, with a classic American diner design and a full menu featuring burgers, sandwiches, and milkshakes. — Luke Millar

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5-Hour Energy Scraps Financing Deal after Sale of company Falls Through

Arrangers for Innovation Ventures, the maker of 5-Hour Energy drinks, pulled the company’s two-pronged financing package this morning after the sale to Renew Group Private fell apart.

5 Hour Energy logoThe financing package included a $525 million senior secured loan and a $400 million senior note issue that had been circulating the market, according to sources. Proceeds would have backed Renew Group’s purchase and refinanced outstanding bonds.

Innovation Ventures is still evaluating plans that would allow it to refinance its debt, the company stated this morning in a press release.

Bank of America Merrill Lynch and KeyBanc Capital Markets were arranging the loan and had set price talk of L+450, with a 1% LIBOR floor and a 99 offer price on a $500 million term loan.

S&P Global Ratings rated the issuer B+ and the first-lien debt BB, with a 1 recovery rating. The proposed bonds drew B–, with a 6 recovery rating.

As reported, Farmington Hills, Mich.–based Innovation Ventures is 80% directly or indirectly owned by CEO Manoj Bhargava, who would have sold a roughly 80% stake through a trust. — Kelsey Butler

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Diamond Resorts Launches $600M High Yield Bond Offering Backing Apollo LBO

Diamond Resorts is offering $600 million of eight-year (non-call three) unsecured notes, sources say. Bookrunners on the deal are RBC Capital Markets (left), Barclays, and Jefferies.

A roadshow for the offering will run Aug. 1–4, sources noted. The proceeds will be used to back Apollo Management’s $2.2 billion purchase of Diamond Resorts. Apollo in late June agreed to acquire the company for $30.25 per share. At the time the deal was announced, the company said closing was expected over the next few months.

Take note, the issuer is also shopping a $1.2 billion seven-year term loan B and a $100 million revolver to fund the buyout. Price talk for the loan has been set at L+500, with a 1% LIBOR floor and a 99 offer price.

Expected ratings for the notes are CCC+/Caa1. On July 25, S&P Global Ratings lowered its corporate credit rating for Diamond Resorts to B from B+, noting the incremental leverage and the company’s financial sponsor ownership.

Diamond Resorts International operates a network of more than 420 vacation destinations located in 35 countries throughout the continental U.S., Hawaii, Canada, Mexico, the Caribbean, South America, Central America, Europe, Asia, Australasia, and Africa. — Staff reports

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How did ACAS become a takeover target? Answer’s in the portfolio mix

How did American Capital become a takeover target? The answer lies in the lender’s equity-heavy, low-yielding investment portfolio mix.

Ares Capital, which trades on the Nasdaq under the ticker ARCC, announced on May 23 it would buy American Capital in a $3.4 billion deal, excluding the company’s mortgage management businesses. American Capital trades on the Nasdaq as ACAS.

One of American Capital’s strategies was its trademarked One Stop Buyout, where it could invest in debt ranging from senior to junior, as well as preferred and common stock, acquiring control of an operating company through a transaction.

However, the accumulation of equity did not allow the company to maintain the steady dividend growth that investors had grown to rely on.

In November 2008, the company stopped paying dividends and began evaluating them quarterly to better manage volatile markets. At the same time, American Capital announced an expansion into European middle market investing through the acquisition of European Capital. Also that year, American Capital opened an office in Hong Kong, its first office in Asia.

The news of the dividend policy change triggered a plunge in American Capital shares. Shares have persistently traded below book value since.

At its peak, the One Stop Buyout strategy accounted for 65% of American Capital’s portfolio. It has since slashed this to under 20% of the portfolio, of which less than half of that amount is equity. It continues to sell off assets.

In a reflection of the change in investment mix, S&P Global Ratings placed Ares Capital BBB issuer, senior unsecured, and senior secured credit ratings on CreditWatch negative, as a result of the cash and stock acquisition plan.

“The CreditWatch placement reflects our expectation that the acquisition may weaken the combined company’s pro forma risk profile, with a higher level of equity and structured finance investments,” said S&P Global analyst Trevor Martin in a May 23 research note.

At the same time, S&P Global Ratings placed the BB rating on American Capital on CreditWatch positive after the news.

“The CreditWatch reflects our expectation that ACAS will be merged into higher-rated ARCC upon the completion of the transaction, which we expect to close in the second half of 2016. Also, we expect ACAS’ outstanding debt to be repaid in conjunction with the transaction,” S&P Global analyst Matthew Carroll said in a research note.

Not the first time
But Ares Capital says it has a plan. In 2010, Ares acquired Allied Capital, a BDC which pre-dated the financial crisis. On a conference call at the time of the deal announcement, management said it plans a similar strategy for integrating American Capital, of repositioning lower yielding and non-yielding investments into higher-yielding, directly sourced assets.

Ares Capital managed to increase the weighted average yield of the Allied investment portfolio by over 130 bps in the 18 months after the purchase, and reduce non-accrual investments from over 9% to 2.3% by the end of 2012, Michael Arougheti said in the May 23 investor call. Arougheti is co-chairman of Ares Capital and co-founder of Ares.

“The Allied book was a little bit more challenged, or a lot more challenged, than the ACAS portfolio is today,” Arougheti said. Ares Capital’s non-accrual investments totaled 1.3% on a cost basis, or 0.6% at fair value, as of March 31.

“Remember, that acquisition was made against a much different market backdrop. And so, while the roadmap is going to be very similar… this can be a lot less complicated that that transaction was for us.”

The failings of American Capital’s strategy reached fever pitch last November, when the lender capitulated to pressure from activist investor Elliott Management just a week after it raised an issue with the spin-off plan.

American Capital’s management had proposed in late 2014 spinning off two new BDCs to shareholders, and said it would focus on the business of asset management. However, in May last year, management revised the plan, saying it would spin off just one BDC.

But Elliott Management stepped in, announcing in November that it acquired an 8.4% stake. It later increased its stake further, becoming the largest shareholder of American Capital. The company argued that even the new plan would only serve to entrench poorly performing management, and called for management to withdraw the spin-off proposal.

American Capital listened. Within days, American Capital unveiled a strategic review, including a sale of part or all of the company.

One reason for the about-face was likely its incorporation status in Delaware, which made the board vulnerable to annual election. Incorporation in Maryland, utilized by other BDCs, is considered more favorable to management, in part because the election of boards is often staggered.

Although American Capital had shrunk its investment portfolio in recent quarters, it had participated in the market until recently.

Among recent deals, American Capital helped arrange in November a $170 million loan backing an acquisition of Kele, Inc. by Snow Phipps Group. Antares Capital was agent. In June 2015, American Capital was sole lender and second-lien agent on a $51 million second-lien loan backing an acquisition of Compusearch Software Systems by ABRY Partners. — Abby Latour

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Qlik Technologies record $1B loan signals direct lending growing up

With today’s record $1 billion loan to fund an acquisition of Qlik Technologies, BDCs are giving notice that direct lending is moving far beyond its middle market roots to challenge traditionally distributed debt financing.

Ares Capital Corp. is leading the $1.075 financing, announced today, which is the largest-ever unitranche credit facility by a BDC. Unitranche combines different tiers of debt, which normally would have different interest rates, into a single loan.

Private equity firm Thoma Bravo is buying Qlik, based in Radnor, Pa., but founded in Sweden, which provides data visualization and analytics software. Shares trade on Nasdaq under the ticker QLIK.

Golub Capital, TPG’s dedicated credit and special situations platform, or TSSP, and Varagon Capital Partners are also joint lead arrangers.

It remains to be seen if this is the advent of a new lending landscape in which unitranche deals of $1 billion or more are commonplace. The acquisition financing for Qlik Technologies stemmed from a period in the loan market when primary issuance was stalled due to financial market volatility that disrupted usual syndication channels.

Leveraged finance market conditions have since improved. Admittedly, the deal’s structure would be a tougher decision by Thoma Bravo in current conditions than those of two months ago, when risk-averse investors shunned complex-story credits or pushed for economic and structural concessions to levels that made buyouts unattractive.

What’s more, this transaction isn’t expected to close until the third quarter, when financial market conditions could be far different than those offered in what is, for now, a buoyant environment for credit. Minimizing risk due to the syndication process is far more attractive to a buyer in most cases.

The transaction is subject to shareholder and regulatory approvals.

A merger deal announced last week stoked expectations that larger loan deals may be ahead from BDCs. Ares Capital, which trades on Nasdaq under the ticker ARCC, announced on May 23 it would buy rival lender American Capital, which trades on Nasdaq as ACAS, for $3.4 billion.

Ares management made no secret of the fact that the company’s purchase of American Capital would allow Ares to originate larger loans, thus generating more underwriting and distribution fees.

In an investor presentation about the purchase of American Capital, Ares pointed out how volatile market conditions had led to enhanced pricing and terms, and increased regulatory burden for banks was opening opportunities for them.

Market volatility—as well as increased regulatory scrutiny of commercial banks that emerged more than two years ago—had already opened the door to club-like transactions by BDCs, which will likely hold the majority of the debt for the Qlik deal.

BDCs are able, and willing, to accept higher leverage levels than banks. In the case of Qlik Technologies, the transaction is expected to result in leverage of more than 6x, sources said.

What’s more, the company generates most revenue outside the U.S., and EBITDA is highly adjusted, creating a structurally complex deal, sources said. Significant cost savings are expected through the buyout.

Such adjustments can present hurdles for banks looking to gain internal approvals to underwrite debt deals, and the prospect of a new alternative financing channel could spur renewed interest in buyout business.

Notably, the $1.075 billion unitranche loan for Qlik Technologies accounts for around one-third of the roughly $3 billion purchase price. Under terms of the acquisition, Qlik shareholders will receive $30.50 in cash per share.

Ares Capital says it is committed to holding a large portion of the financing. At the same time, Ares Capital said it would lead a syndication process to attract more lenders to the credit facility, but only a small part is expected to be syndicated.

“We believe this transaction is representative of the growing acceptance of direct lending as a mature asset class, and we believe our market leading position puts us in the forefront of this paradigm shift,” said Kipp deVeer, Ares Capital CEO, in a statement today.

Ares Capital is no stranger to larger-sized deals.

Last year, Ares Capital closed an $800 million loan for American Seafoods Group, another example of a non-regulated arranger capturing lending business that usually would have gone to a large bank. American Seafoods used proceeds to refinance debt and fund a bond exchange.

The amount of Ares Capital’s exposure to this investment has since shrunk.

As of March 31, the fair value of the American Seafood investment in Ares Capital’s investment portfolio totaled $81.7 million, including first-lien debt, second-lien debt, equity, and warrants. The largest of these was a $55 million, L+900 second-lien loan due 2022, with a fair value of $53 million.

The per-share purchase price for Qlik represents a 40% premium over $21.83, which was the average share price in the 10 days prior to March 3.

On March 3, activist shareholder Elliott Management unveiled an investment in Qlik Technologies, a move that prompted the company to put itself up for sale. Later that month, Qlik hired Morgan Stanley to explore a possible sale of the company, Reuters reported. — Abby Latour

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Senate hearing opens discussion on BDC regulation changes

A hearing by the Senate banking committee showed bi-partisan agreement for BDCs as a driver of growth for smaller U.S. companies, but exposed some rifts over whether financial companies should benefit from easier regulation.

BDCs are seeking to reform laws, including allowing more leverage of a 2:1 debt-to-equity ratio, up from the current 1:1 limit. They say the increase would be modest compared to existing levels for other lenders, which can reach 15:1 for banks, and the low-20x ratio for hedge funds.

A handful of BDCs are seeking to raise investment limits in financial companies. They argue that the current regulatory framework, dating from the 1980s when Congress created BDCs, fails to reflect the transformation of the U.S. economy, away from manufacturing.

BDCs stress that they are not seeking any government or taxpayer support.

They are also seeking to ease SEC filing requirements, a change that would streamline offering and registration rules, but not diminish investor protections.

Ares Management President Michael Arougheti told the committee members in a hearing on May 19 that although BDCs vary by scope, they largely agree that regulation is outdated and holding back the industry from more lending from a sector of the U.S. economy responsible for much job creation.

“While the BDC industry has been thriving, we are not capitalized well enough to meet the needs of middle market borrowers that we serve. We could grow more to meet these needs,” Arougheti said.

In response to criticism about expansion of investment to financial services companies, the issue of the 30% limit requires further discussion, Arougheti said.

The legislation under discussion is the result of lengthy bi-partisan collaboration and reflects concern about increased financial services investments, resulting in a prohibition on certain investments, including private equity funds, hedge funds and CLOs, Arougheti added.

“There are many financial services companies that have mandates that are consistent with the policy mandates of a BDC,” Arougheti added.

Senator Elizabeth Warren (D-MA) raised the issue of high management fees of BDCs even in the face of poor shareholder returns. Several BDCs have indeed moved to cut fees in order to better align interests of shareholders and BDC management companies.

She said that Ares’ management and incentive fees have soared, at over 35% annually over the past decade, outpacing shareholder returns of 5%, driving institutional investors away from the sector, and leaving behind vulnerable mom-and-pop retail investors. Arougheti countered by saying reinvestment of dividends needed to be taken into account when calculating returns, and said institutional investors account for 50–60% of shareholders.

Warren said raising the limit of financial services investment to 50%, from 30%, diverts money away from small businesses that need it, while BDCs still reap the tax break used to incentivize small business investment.

“A lot of BDCs focus on small business investments and fill a hole in the market. A lot of companies in Massachusetts and across the country get investment money from BDCs,” said Warren.

“If you really want to have more money to invest, why don’t you lower your high fees and offer better returns to your investors? Then you get more money, and you can go invest it in small businesses,” Warren said.

Brett Palmer, President of the Small Business Investor Alliance (SBIA), said the May 19 hearing, the first major legislative action on BDCs in the Senate, was a step toward a bill that could lead to a new law.

“There is broad agreement that BDCs are filling a critical gap in helping middle market and lower middle market companies grow. There is a road map for getting a BDC bill across the finish line, if not this year, then next,” Palmer said, stressing the goal was this year.

Technically, the hearing record is still open. The Senate banking subcommittee for securities and investment could return with further questions to any of the witnesses. Then, senators can decide what the next stop will be, ranging from no action to introduction of a bill.

Pat Toomey (R-PA) brought up the example of Pittsburgh Glass Works, a company that has benefited from a BDC against a backdrop that has seen banks pulling back from lending to smaller companies following the financial crisis, resulting in a declining number of small businesses from 2009 to 2014.

The windshield manufacturer, a portfolio company of Kohlberg & Co., received $410 million in financing, of which $181 million came from Franklin Square BDCs.

“Business development companies have stepped in to fill that void,” Toomey told the committee hearing. “For Pittsburgh Glass, it was the best financing option available to them.”

FS Investment Corp.’s investment portfolio showed a $68 million L+912 (1% floor) first-lien loan due 2021 as of March 31, an SEC filing showed.

Arougheti cited the example of OTG Management, a borrower of Ares Capital. OTG Management won a contract to build out and operate food and beverage concessions at JetBlue’s terminal at New York airport JFK, but was unable to borrow from traditional senior debt lenders or private equity firms due to its limited operating history.

Ares Capital’s investment in OTG Management included a $24.7 million L+725 first-lien loan due 2017 as of March 31, an SEC filing showed. — Abby Latour

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Claire’s announces PIK exchange of notes held by Apollo, CEO resigns

Claire’s Stores has entered into an agreement with funds managed by affiliates of Apollo to swap out their subordinated debt holdings for new PIK notes.

The agreement comes after the company’s equity sponsor acquired a significant portion of the existing debt through open market purchases, a move that would potentially give Apollo a greater position around the bargaining table in the event of a bankruptcy filing.

According to an 8-K form filed with the SEC, the company has agreed to exchange $174.4 million held by the funds of the $259.6 million 10.5% senior subordinated notes due 2017 for new $174.4 million of 10.5% PIK subordinated notes due 2017.

The new notes will be paid in kind with respect to the June 1 coupon, and may be PIK, paid in cash, or 50/50 on the Dec. 1, 2016 interest payment. Though the company will save some cash through this exchange, analysts at Citi expressed concern that this could suggest a need for liquidity to stay compliant with the first-lien leverage ratio, and also that Apollo is not jumping to equitize the subordinated notes, which has been part of its base case scenario.

Claire’s also announced today the appointment of Ron Marshall as its new CEO. Commenting on the hire, Citi Analysts note that Marshall has been at the helm of a number of struggling companies that no longer exist in their original form, including A&P, Pathmark, and Borders.

“We view both pieces of today’s news as potentially tactical on the sponsor’s part in terms of the decision and timing, as lower bond prices are preferable in the event Apollo buys back more bonds (to gain control elsewhere in structure and more optionality) or attempts to negotiate with existing lenders,” Citi analyst Jenna Giannelli said in a note.

“Our thesis has been one in which Apollo utilizes its leverage as the majority owner of the ’17s and agrees to equitize, in exchange for cooperation with existing lenders elsewhere in the capital structure. We don’t think it makes sense for the Sponsor to tap into the small basket available at International subs, given the little value it would recover on the notes, still looming ’19 maturities and over levered structure,” Giannelli said.

The first-lien 9% notes due 2019 traded down 2.5 points, at 67.5, trade data show. Unsecured 8.875% notes due 2019 were trading in small batches in the high 20s, which is unchanged from recent valuation, the data show.

Hoffman Estates, Ill.–based Claire’s Stores operates as a specialty retailer of fashionable jewelry and accessories for young women, teens, and children worldwide. The company was taken private by Apollo Management in early 2007 for roughly $3.3 billion. As of January 30, 2016, Claire’s total debt was approximately $2.41 billion, consisting of notes, U.S. credit facility, Europe credit facility, and a capital lease obligation. — Rachelle Kakouris