This Deal Shows How the Junk-Credit Market is Still Irrationally Exuberant

Wolf Richter,

One of the biggest such deals ever, happening now: How investors allow a group of PE firms to extract $3.75 billion from a company after they’d already extracted billions.

Junk-rated Asurion – which is based in Nashville, has 16,000 employees in the US and elsewhere, and sells insurance and extended warranties for smartphones, tablets, consumer electronics, and the like – is borrowing $3.75 billion via two “leveraged loans.” The proceeds along with some “cash on hand,” as Moody’s says, are to be funneled to the PE firms – Madison Dearborn, Berkshire Partners, Providence Equity Partners, and Welsh, Carson, Anderson & Stowe – that acquired the company in a leveraged buyout (LBO) during the LBO boom in 2007.

“One of the largest credits of its kind,” is how LCD, of S&P Global Market Intelligence, described it. These loans are also “covenant-lite”– meaning they offer investors fewer than normal protections.

This money is not used for anything productive, or to acquire another company, or to expand operations, or to increase revenues. It simply extracts cash from the company and in the process loads it up with debt.

These two loans will bring the company’s total term loans to $11.3 billion, according to Moody’s, which rates the company “B1,” four notches into junk (here’s my cheat-sheet on credit rating scales). Moody’s considers the deal “credit negative” due to the increase in debt and the “large payment to shareholders.”

The deal will increase Asurion’s debt-to-EBITDA ratio to 6.5x-7.0x, up from 5x before the deal, Moody’s estimates. EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure of operating cash flow that excludes interest expenses, but interest expenses are massive for a company with $11.3 billion in junk-rated loans outstanding, so it’s a good thing to exclude it.

Among other “credit challenges,” according to Moody’s, is Asurion’s “practice of borrowing substantial sums from time to time to help fund payments to shareholders.”

These transactions were used to allow the PE firms to cash out, and equity interest shifted to other investors, which include sovereign wealth funds and the Canadian Pension Plan Investment Board. By now, the PE firms’ stake has dropped to “less than 30%,” Moody’s said.

The banks arranging the two leveraged loans are Bank of America Merrill Lynch, Morgan Stanley, Goldman Sachs, Barclays, Credit Suisse, and Deutsche Bank, according to LCD. Commitments are due by noon on Wednesday, June 27.

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Leveraged loans – they’re called that because they’re extended to junk-rated and highly leveraged companies, such as Asurion – are too risky for the banks to keep on their books. So banks sell them to loan mutual funds, or slice-and-dice them into structured Collateralized Loan Obligations (CLOs) and sell them to institutional investors. The banks get the fees but slough off the risk to mutual fund investors, pension beneficiaries, and other sitting ducks.

Given the still pandemic chase for yield, anything goes. Leveraged loans and CLOs have turned into a booming market. And issuance has soared. LCD explains:

Dividend deals such as Asurion are seen as opportunistic issuance in the US leveraged loan market, meaning issuers – or their private equity owners – take advantage of investor demand to originate credits, the proceeds of which are returned to the owners. The U.S. leveraged loan market has been red hot of late as investors crowd the floating-rate asset class thanks to ongoing and expected interest rate hikes.

The current price talk indicates a yield to maturity of around 5.5% for the $2.25-billion first-lien loan due November 2024 (rated Ba3); and about 9.5% for the $1.5-billion second-lien loan due August 2025 (rated B3).

Lenders love it: They’re offered a “consent fee” of 50 basis points (half a percentage point) on the $2.25 billion first-lien loan and of 75 basis points on the $1.5 billion second-lien loan.

After the transaction is complete, Asurion will have $11.3 billion in leveraged loans outstanding, not including its senior secured first-lien revolving line of credit of $230 million, according to Moody’s:

  • $2.5 billion senior secured first-lien term loan, due August 2022.
  • $3.2 billion senior secured first-lien term loan, due November 2023.
  • $3.3 billion (includes the $1.5 billion increase of the current transaction) senior secured second-lien term loan due August 2025.
  • $2.25 billion 6.5-year senior secured first-lien term loan.

This is the type of transaction that is typical for PE-firm-owned companies. Only this one is a much larger cash-out than most, and comes on top of Asurion’s prior massive cash-outs. It is this type of transaction that is heavily involved in the brick-and-mortar retail meltdown. Many of the retailers that had been acquired by PE firms during the LBO boom before the Financial Crisis, or in LBOs afterwards, are now filing for bankruptcy and some are being liquidated, such as Toys ‘R’ Us.

This risky strategy is survivable for a flawlessly-run company in a booming industry when an irrationally exuberant junk-credit market will fund anything.

But when credit tightens, or when there’s a hiccup at the company, or when there’s a structural change in the industry – in retail, it was the shift to e-commerce and the arrival of new competitors – or worse, if two or all three happen at the same time, as they often do, these companies that have to be totally focused on cost-cutting to deal with their debts, and that do not have the resources to adjust and move forward, get run over by events. And creditors are left to wail and gnash their teeth.

So yes, the PE firms behind Asurion are smart cashing out at this point in the credit cycle. But it’s the kind of deal that should give the Fed the willies when it looks back at his easy-credit handiwork over the past nine years.


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