The search for yield in corporate debt has led to a revival in covenant-lite loans, with Ineos, the largest privately owned company in the UK and the third-largest chemicals company by revenue in the world, leading the way.
Formed by a management buyout of the petrochemicals operations of BP in 1998, Ineos, rated B1/B+, has lived ever since with high leverage, growing through bolt-on acquisitions of large divisions from other global chemicals companies.
Last year, it sought to reduce its risk profile by carving out its volatile refining business into a joint venture with PetroChina. The Chinese company paid $1.015 billion in cash for its half share in the joint venture’s revenues. In April, seizing on strong first-quarter operating results, especially from its newer US operations, it sought to refinance its senior credit facilities in a $3.8 billion package and extract the best terms by playing off competing demand between US and euro investors in high-yield bonds and loans.
The wind behind it
The company’s chemical crackers are predominantly gas-fed, while those of many of its competitors are oil-fed. The shale-gas phenomenon in the US has seen the price of gas fall sharply, almost doubling the earnings of Ineos’s large polymer division in Texas. Ineos had the wind at its back.
It also learned valuable lessons in February when it launched the first leg of the refinancing with a €500 million floating-rate note and an $850 million high-yield bond. Key US investors told the company that if it launched a bigger bond to take out more of its 2013 and 2014 maturities, pricing would be lower than for a smaller bond. It shows how concerned investors are by refinancing risk. Ineos eventually sold a $1.75 billion bond priced 40 basis points cheaper than it would have had to pay for a deal half that size.
Ineos and its bankers played it smart with the second, more complex refinancing package in April. "The company initially came out with $1.5 billion in loans and $2.2 billion in bonds," says Malcolm Stewart at Ondra Partners, a long-standing adviser to the company. That was not where it intended to end up.
"Every investor in the world knows the strength and depth of the US high-yield bond market and that it could have absorbed the entire refinancing," Stewart says. "So, initially showing a large high-yield bond gave every incentive to loan investors to submit large orders on tight terms."
Ineos, seemingly at the 11th hour, surprised the market by dropping the euro high-yield bond component completely and reducing the US high-yield bond to just $775 million. Instead, it raised a $2 billion six-year, covenant-lite leveraged loan, a $375 million three-year covenant-lite loan and, the biggest surprise of all, a €500 million six-year covenant-lite leveraged loan. This made the deal the largest covenant-lite loan ever for a European borrower and the largest globally since the credit crunch began in 2008.
Graeme Leask, chief financial officer of Ineos, says: "The market was clearly encouraged by the continued performance of the Ineos Group and its ability to deliver its business plan. Ineos continues to perform well during difficult economic conditions. We delivered a strong performance in 2011 and have seen a positive start to 2012. In combination with our continued focus on cash management and liquidity we have significantly de-levered the Group and through this refinancing strengthened its financial position."
Staggering achievement
Michael Moravec, head of European high-yield syndicate and co-head of EMEA leveraged finance origination at Barclays, global coordinators of the financing alongside JPMorgan, adds: "This was a staggering achievement by the company, which has both eliminated all its near-term maturities, taken refinancing risk off the table and converted its entire debt structure away from maintenance covenants to simple incurrence covenants."
Maintenance covenants are much more onerous for borrowers, especially in cyclical sectors such as chemicals. The ratings agencies grew nervous in the second half of last year that a declining European chemicals sector could make it hard for Ineos to maintain interest-cover ratios without risking technical covenant breaches and needing to seek costly covenant waivers from its lenders, as it did in 2009.
"This company has never come close to missing an interest or amortization payment, but a couple of poor quarters and those covenant waivers cost it hundreds of millions of dollars in higher interest charges and fees," says Stewart. The company has since striven to transform and stabilize itself, with the PetroChina deal being the most important step.
Moravec says: "This refinancing package now allows the company much greater flexibility to operate in a cyclical sector. Management can concentrate on what it does best, which is managing a chemicals business."
Even by the standards of covenant-lite loans, the terms on the Ineos deal were much less restrictive and more akin to a bond deal. Most covenant-lite loans have dividend restrictions and further debt-incurrence restrictions that are stricter than on high-yield bonds: the Ineos loans do not. An additional advantage of loans compared with bonds is that they are pre-payable at par with no penalty.
The package also includes new debt of more than €400 million above the amount needed to refinance the company’s existing credit facilities.
While Moody’s chose not to upgrade the Ineos corporate family rating on the back of this refinancing because of this increased leverage, the ratings agency notes: "By postponing large debt payments, Ineos’s management will be able to undertake more capex than in the past.
"It has a number of organic growth-focused projects in its pipeline that could be executed in 2012, 2013 and beyond, with the aim of improving the capacity and efficiency of its manufacturing base and exploiting new growth opportunities." Standard & Poor’s upgraded the company to B from B- with a positive outlook, citing the refinancing and better than expected earnings.
| Ineos’s debt maturity profile |
| Before financing |
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| After financing |
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| Source: Moody’s |
Well supported By the time the company came to launch its refinancing, it found US investors keen to invest in foreign companies with sizeable US earnings Moravec says: "The US dollar leveraged loan was extremely well supported and we took a lot of reverse enquiry every since the company, which is extremely well known by all high-yield investors and whose debt is widely traded and quite liquid, signalled that it was looking to refinance. And while covenant-lite leveraged loans are much more nascent in Europe, there was reasonable demand there too because the use of proceeds was to refinance deals in which a lot of CLOs had previously been invested."
CLO investors are not paid for sitting on cash. They have to invest and typically have a three-year term limit. Spotting this, Ondra suggested the inclusion of a three-year US dollar tranche, which drew an $850 million order book and allowed Ineos to raise some funds 100bp cheaper than on the six-year loan. The two refinancings in February and at the end of April have taken the average cost of Ineos’s debt, excluding securitizations, down from 8.5% to 7.5%.
In May, German bathroom and kitchen fittings company Grohe was able to increase a €100 million covenant-lite loan by €75 million, taking advantage, like Ineos, of demand from CLOs seeking to maintain exposure to the company’s credit being refinanced by the new deal.
