CLOs underlie loan market’s pile into corporates

Aggressive roll-up M&A strategy? Check. Unfavourable reporting announcement? Check. Margin loan written against chief executive’s shares in the company? Check. Some questionable financial arithmetic? Check. Share price collapse? Check.

The recent history of UK flooring firm Victoria Carpets may bear some unfortunate similarity to that of South African furniture retailer Steinhoff at the end of last year – minus, of course, any suggestion of fraud.

The firm, which suffered a 37% collapse in its share price from 604p on Friday, October 26, to 380p on Wednesday, October 31, shows how the legacy of loose credit tells a familiar story across corporates large and small.

Its shares traded as high as 882p in May this year and a £60.5 million equity placement in August was priced at 827p a share.

Its shares fell at the end of October, however, after the AIM-listed firm issued a profit warning – down by between 1% to 1.5% percentage points compared with consensus market forecasts – and news that it planned to issue €450 million of senior secured notes due in 2023 to repay its existing two-year senior bank facility.

Neither went down well with shareholders and the mooted bond deal had to be abandoned in the face of investor resistance.

Like Steinhoff, Victoria pursued an aggressive M&A strategy made possible by unprecedently favourable conditions in the debt and equity markets.

Like Christo Wiese at Steinhoff, Victoria executive chairman Geoff Wilding took advantage of this exuberance earlier this year to take out a margin loan secured against his stake in the business; he holds 17% of Victoria shares.

Unlike Weise, who used the loan to buy shares in the firm’s IPO, Wilding has not drawn the facility – but his stake is now worth a lot less than it was: Victoria’s share price had recovered to 450p by Tuesday.

Soul searching

The €1.6 billion margin loan extended to Wiese in September 2016 has prompted much soul searching amongst the investment banks left holding the bill when the firm’s share price cratered.

Victoria has bought 13 companies since 2012 across the UK, continental Europe and Australia, boosting its ebitda stream from £5 million in 2014 to £65 million by the end of March this year.

Like Steinhoff, it has undertaken serial acquisitions that have not been smoothly incorporated into the wider business and it will now have to do even larger acquisitions for future deals to be earnings accretive.

Victoria’s aborted bond deal was needed to refinance a €445 million bridge loan from Barclays and HSBC, which – along with the August equity raise – had backed the acquisitions of Keraben and Saloni, two Spanish ceramic tile manufacturers.

Although the bond deal was a refinancing, price guidance for the double-B rated credit had risen from 4.5% to 5.75% by the time it was pulled on Tuesday.

One of the concerns that some investors had was persistent, large-scale adjustments to ebitda that involved adding back exceptional costs associated with its acquisitions, to arrive at an “underlying” figure.

Illuminating

This type of corporate behaviour is symptomatic of the late stage in the credit cycle. What is particularly illuminating in Victoria’s case, however, is the suggestion that it is now reportedly assessing a floating-rate note option – in part – after some reverse collateralized loan obligation (CLO) enquiry, according to CreditSights.

The loan market now dominates sub-investment grade financing, but predominantly for sponsors. When a corporate credit that bond investors have pushed back on gets financed in the loan market, that is further evidence of the weight of money now chasing leveraged loan exposure of all hues, driven by the burgeoning CLO market.

Lenders can generally get comfortable with the erosion in lender protections in private-equity deals, because the weight of dry powder that sponsors need to put to work means that they are putting up equity cheques of 50% or even more in leveraged-buyout deals.

Lending to a double-B rated corporate on similar terms is a different proposition altogether.