The suppliers of mezzanine debt, the middle slice of the capital structure sitting between senior debt and equity, might be a minority group, but right now they seem a pretty contented one. Over the next two years, there is more than US$600 billion of private equity ‘dry powder’ reaching the stage where its managers must either use it or lose it – and we all know that those guys aren’t big fans of handing money back. That means a lot of transactions to be financed. However, according to Tripp Smith, a senior managing director of the Blackstone Group’s mezzanine finance division, there is only about US$10-15 billion of his kind of capital extant in the world today. “I would challenge you to find a bigger imbalance in the capital markets right now,” he said in his opening remarks to last month’s Mezzanine Finance 10 Seminar, held in Melbourne and organised by Conexus Financial, publisher of Investment Magazine.
For the relatively small population of mezzanine finance managers, news like the shut-down of the collateralised loan obligation (CLO) market, the diminution of the high yield market to all but a role refinancing CLOs, and the reluctance of banks to provide committed capital is all very welcome news indeed. “A banker will be fired if they’re found with a bridge loan on their books today,” Smith enthused. “It’s amazing, but right now a company would rather have some mezz debt from some little-known manager than a bridge loan from Morgan Stanley, because the investment banks just don’t want to own this stuff.” Mezzanine capital is sometimes referred to as ‘private high-yield debt’, because it’s most often put to work by companies which cannot access the public high yield markets, usually because the deal size they represent is below the US$100 million threshold required to access the bourse.
According to Matthias Unser, who runs a mezzanine debt multi-manager fund for Deutsche Bank Private Equity, about half of the refinancing wave alluded to by Tripp Smith will be met by insolvencies, new high-yield bonds and an “amend and extend” approach to existing senior loans. However the sources of debt financing for medium-sized companies – whether or the deal is in need of cash is a merger or acquisition, a recapitalisation, a buyout or injection of growth capital – have dried up since 2007. Unser said that such permutations of financing as ‘second liens’, ‘unitranche notes’ and ‘warrantless mezzanine’ had all but disappeared since the collapse of Lehman Brothers. Mezz debt…with a little equity on the side According to Paul Echausse, the managing partner of BNY Mellon Alcentra Mezzanine Partners, mezzanine capital often includes both debt and equity features. The coupon is improved by either a warrant, representing a long-term right to purchase equity and typically costing 1c for each notional share, or the ‘payment in kind’ of interest through direct equity participation. However, most managers presenting on the day said that warrants attached to deals had become much scarcer since 2004.