Strategies for Growth: Access to Capital in Volatile Capital Markets Stefan Shaffer, Managing Partner SPP Capital Partners, LLC
Thesis Statement Historically, Macroeconomic Conditions Dictate Market Conditions…..But Not Necessarily in December of 2010. Accordingly, Unique Borrowing Opportunities of Historic Proportions Currently Exist, and Most Likely will not Continue.
SPP Capital Partners • A private investment bank specializing in the private placement of senior debt, mezzanine debt and equity capital. • Formed in 1989, as SPP Hambro, a subsidiary of Hambros Bank plc. • Reconstituted as SPP Capital Partners, LLC through an MBO in 1998. • Since the firm’s inception, it has completed more than 400 transactions aggregating in excess of $18.0 billion. • SPP manages the Private Capital Formation operations of 12 major banks and financial institutions in North America and Europe, through exclusive JV relationships, eight of these institutions are shareholders of SPP, including CoBank. • Has extensive relationships throughout the equity sponsor community. • Created SPP Mezzanine Partners in 2004 to make direct mezzanine investments. Currently approximately $50 million in assets under management through SPP Mezzanine Funding I & II.
Products and Industries • Leveraged Finance / Debt Capital Markets • Acquisitions and recapitalizations • Asset-based and cash flow senior debt • Uni-tranche “one-stop” solutions • Subordinated / mezzanine debt • Waiver and Amendment Advisory • Out-of-court advisory for turn-around situations • Amendments and waivers • Solvency opinions • Secondary securities sales / repurchases • Credit ratings advisory
Effects of a Weak Economy • Flight to Quality • Low Treasury Rates • High Spreads Relative to Treasury Rates • No Interest in Risk • High Yield Activity Ceases to Exist • “Risk Premium” for Leveraged Credits, Smaller Credits Exaggerated • General “Lack of Access” to Capital Across the Board
Effects of a Weak Economy U.S. 10-Year Treasury Yield Graph / Credit Spreads for U.S. Corporates, rated BBB-A (Previous Two Recessions) December 2007 – June 2009 March 2001 – November 2001 Source: Bloomberg
Effects of a Weak Economy High Yield Prices and Yields
Current Economic Conditions Quarter-to-Quarter Growth in Real GDP Growth • Continued economic growth • 2009 Q4 growth in real GDP of 5.0% • 2010 Q1 growth in real GDP of 3.7% • 2010 Q2 growth in real GDP of 1.7% • 2010 Q3 growth in real GDP of 2.0% • Forecasted growth of 2.0% through 2011 Q4 Source: U.S. Bureau of Economic Analysis Source: ISI Weekly Economic Report
Current Economic Conditions • Unemployment hovering at 9.6% • Disappointing Private Sector Hiring • 64,000 non-farm jobs added in September • 93,000 non-farm jobs added in August • 116,000 non-farm jobs added in July Seasonally Adjusted Unemployment Rate Nonfarm Payroll Employment Over-the-Month Change Seasonally Adjusted Source: Bureau of Labor Statistics, “Employment Situation – September 2010”
Current Economic Conditions • Fed announces “QE2” on November 3rd • Outlines plans to purchase $600 billion of Treasuries through June 2011 • Intended to lower interest rates and spur increased lending and investment • Large Banks, flush with new proceeds from Fed purchases will be anxious to make loans • Which will spur investment by corporate borrowers • Which will result in greater production and employment • Possible Outcomes • Increased cash in the system and higher priced bonds with diminished yields could lead to allies in riskier asset classes and drive up commodity prices • Corporations could “sit” on cash—not deploy it • Could lead to increased inflation and a “fixed income bubble” • Material declines in the dollar
Current Economic Conditions • Cash on corporate balance sheets is at an all time high already Source: BofAML Credit Strategy
Current Market Conditions • Generally, when U.S. Treasuries compress to such low levels, investors expand spreads to maintain a modicum of return. • - In this market, while the Fed is essentially subsidizing long term treasuries to keep rates artificially low, investors are compressing spreads to entice borrowers. • - In fact, for high quality issuers (the “Slam Dunks” - typically larger credits) are getting done across a wide range of maturities and are well oversubscribed with increasingly liberal covenant packages. Spreads on some of these deals have been in the mid to low 100’s. • Low US Treasury rates are usually the result of a “flight to quality” with treasuries acting as a hedge to deteriorating credit conditions. • - In this market, low US Treasures and potentially deteriorating credit conditions (a potential “double dip”), have not up-tiered investors portfolio needs. • - To the contrary, because competition for high quality credits have driven returns to such low levels, investors are eagerly bidding transactions that have greater risk profiles in an attempt to gain some modest level of return.
Current Market Conditions U.S. 10-Year Treasury Yield Graph / Credit Spreads for U.S. Corporates, rated BBB-A (11/2007 – 11/2010) Source: Bloomberg
Current Market Conditions • Investment grade borrowing spreads are already at their lows
Current Market Conditions High Yield Prices and Yields North American High Yield CDX Index
Current Market Conditions Volume of Institutional Loans and High-Yield Bonds • High Yield Issuance Up Dramatically • Year to date, high yield bond issuance is • $237,126 million, comprised of 487 issues • 97.2% increase from 2009 • Year to date, leveraged loan issuance is • $298 billion • 80% increase from 2009 Middle Market Leveraged Loan Volume (EBITDA < $50 million) Middle Market Issuance Up dramatically Source: S&P Loan Stats Source: Markit.com
Current Market Conditions • Investors actively seeking risk Source: Piper Jaffray Debt Capital Markets Update
Current Market Conditions • Mezzanine investors are extremely hungry • Pricing consistently 14%-18% for Subordinated Notes • - <$15MM EBITDA deals pricing 16%-18% • > $50 MM EBITDA deals pricing at 13%-15% • Leverage tolerances in excess of 4X for deals commonplace on large end (> $20MM of EBITDA) of the market • - 3.5X for Leveraged Recaps or “Storied” Credits; • - Continued Competitive Landscape • - Credit Opportunity Funds, BDCs all actively bidding deals • Insurance company participants creating pricing pressure; • “Coupon only” deals readily available; • Prepayment provisions highly negotiable, very investor specific. • Slight tightening of non-call provisions where investors are “cutting book” to attract assets • Greater scrutiny on retail sector deals in light of potential weak 2010 Christmas expectations. • Warrants routinely requested for • - Storied credits • - Greater than 4X TD/EBITDA • Recaps; • Upfront fees average 1%-2%;
Current Market Conditions Leverage Cash Flow Market at a Glance
Current Market Conditions Typical Subordinated Debt Termsheet Security • Senior Subordinated Notes (the “Subordinated Notes”) Maturity • Five years from Closing • Aggregate Internal Rate of Return (“IRR”) of Approximately 14%-18% • IRR Components:12% cash interest, 2% - 6% PIK interest. Pricing • The Subordinated Notes will be subordinated to prior payment in full of the principal of, and premium, if any, and interest on any senior debt, and senior to any subsequently issued subordinated indebtedness, and any convertible indebtedness, upon any distribution of the assets of the Company upon any dissolution, winding up, total or partial liquidation or reorganization of the Company. Subordination Terms Mandatory Prepayments • No amortization; payable in full at maturity. • Pre-payable per the following indicative schedule: • Year 1: No Prepayment • Year 2: 2% of the principal amount outstanding • Year 3: 1% of the principal amount outstanding • Year 4: par Optional Prepayments • Free Cash Flow to Fixed Charge Ratio of 1.05x growing to 1.10x in later years • Total Debt to EBITDA ratio of 4.50x, reducing to 4.00x in later year Covenants Default Provisions • Cross Acceleration on all senior indebtedness of the Company
View of 2011 Market Conditions • SHORT TERM: • Weak Growth, but Growth Nonetheless • Weaker Dollar due to “QE2” • Short Term: High commodity prices: “Yay For You!” • Short Term: Continued Aggressive Risk Tolerance: “Yay For Me!” • LONGER TERM: • Gradual Restoration of a Traditional “Growth” Macroeconomic Conditions • - Upward Sloping Yield Curve with Higher Interest Rates for Longer Maturities • - Increased Employment • - Higher Housing Values • Restoration of $12 Trillion Lost Value in American Household Wealth in Recession • Unless, GDP goes negative, then its Run for the Exits For Everyone – • - Flight to quality • - Same market dynamics as December 2008 and 2009 Q1 • - Starting Point is a nation that is net loss of $8 Trillion in Household Wealth
View of 2011 Market Conditions FOMC Target Federal Funds • History has shown that the window of opportunity to arrange a financing when rates are favorable is actually quite narrow. • When the FOMC makes a change in the target federal funds rate, there tends to be a series of subsequent changes that follow, and it happens very quickly • In the past decade, the three largest changes have been approximately 500 bps and have occurred in roughly two years or less