PE Panorama: Junk debt comes with strict covenants for a reason

13 November 2017   Category: News, Asia, Global, Singapore, USA, Europe, Sweden   By Paul Mackintosh

There’s a lot of private equity (PE) news around, but here’s one item that ought to particularly concern investors in the asset class – and those concerned about its practices and governance.

According to reports in the Financial Times (FT) and elsewhere, US buyout major Hellman & Friedman (H&F) is soliciting consent from bondholders in its investee company Verisure, a Swedish alarms manufacturer, to raise 1.8 billion euros (US$2.08 billion) in new debt, partly in order to finance a 1 billion euro dividend.

And just last month, it was reported that Singapore’s GIC, already a limited partner (LP) in H&F’s funds, had bought a 9% stake in Verisure from H&F.

Verisure’s investor relations page welcomes visitors to “Europe's fastest-growing monitored security company”. On November 6, the company announced there that “it intends to commence a consent process in respect of its senior facilities agreement”.

A separate statement dated November 3, which (perhaps coincidentally) is flagged as “Carrot” in its browser ID tab, declares that the company “has commenced a consent solicitation”.

Both statements argue that the group has demonstrated “sustained growth in its subscribers and cash generation while also deleveraging”.

Currently, the covenant terms for the bonds held by investors in H&F’s leverage on Verisure prevent issuance of new debt to such a level, according to the reports. H&F is now offering those investors a fee to lift the restrictions. Goldman Sachs, which recently secured a similar consent solicitation for a Swedish corporate client in May, is lead adviser, according to the FT.

Dividend recaps in PE investments have shown an uptick for over a year now, as debt investors’ hunger for yield allows general partners (GPs) to extract value from their investments prior to actual exits. The practice has generated quite some adverse comment, though.

When indebted US shoe chain Payless went bankrupt in the spring of 2017, creditors went to court alleging that debt-financed dividends totalling some US$400 million, obtained by PE investors Golden Gate Capital Inc and Blum Capital Partners, had contributed to the company’s collapse. The case was settled in June, but concerns around the practice have not gone away.

Now, Verisure does appear to be in a buoyant enough position to afford more debt; but market players are still reportedly urging bondholders to reject the deal.

H&F originally co-invested with Bain Capital in Verisure in 2011. It then bought out Bain Capital in 2015, paying some 574 million euros. After the GIC deal, a dividend recap would likely take H&F’s original equity stake off the table entirely.

Junk debt comes with strict covenants for a reason. And risk sharing with LPs becomes more of a concern when the GP has less skin in the game. With such handsome payouts to itself and its co-investors, there’s already enough cause for concern over alignment of interest between the PE investor and its investee company.