Investors are wrestling with the structure of the $705 million deal for Rexnord Corp., a covenant-lite deal that might not be as lite as its title suggests. A $580 million term loan has no covenants; a $125 million revolver has one -- a senior secured leverage ratio. But the term loan and revolver are pari passu with a cross default relationship. So if the revolver defaults, the term loan will also default.
"The revolver has covenants and you are pari passu with it," said one investor who does not plan on committing to the deal. "If the revolver defaults, then the term loan defaults, so even though you don't have covenants, you kind of do." During a conference call for the deal, one investor asked--with an incredulous tone--for the banks to again explain how the deal has no covenants.
The market has seen a number of covenant-lite deals this year. But Rexnord, which was described as "covenant extremely-lite," is different from its counterparts because typically both the revolver and term loan would have some type of financial covenant, whether it is a leverage ratio or a coverage ratio.
Merrill Lynch and Credit Suisse last Tuesday launched syndication of the deal, which backs Rexnord's $1.825 billion acquisition by Apollo Management fromThe Carlyle Group. Pricing is LIBOR plus 2% on both tranches. The term loan is covenant-lite because it has a relatively low level of secured leverage, one banker said. There is also $420 million of senior unsecured bonds due 2014 and $420 million of senior subordinated bonds due in 2016. Lehman Brothers and Bear Stearns are non-lead arranger book runners. Calls to officials at Merrill Lynch, Credit Suisse and Apollo were not returned.
The proposed ratio for the covenant is four times leverage, although final documentation has not been submitted. Leverage on the senior secured is about 2.8 times. Overall leverage, if you count $10 million of add-backs the company had, will be 7.1 times, 6.7 times adjusted for synergies, according to Moody's Investors Service. Jim Reilly, v.p. and senior analyst at Moody's, said, "My understanding is that it is pari passu and it's a cross default situation between the two agreements. If there is a default on the revolver, it would automatically pull in the term loan." He explained, however, that the ratings agency has not seen final documentation on how it would work, but this is what it expects. "This is even an exception to new deals. I have not seen one with this type of structure," he added. The two tranches are pari passu on rights of payment and collateral.
"Senior lenders are not looking at total leverage," the investor said who anticipated there might be some push to get it restructured. "They are just looking at [senior secured] leverage and not thinking about the rest."
Moody's assigned a B1 to the bank facilities, a B3 to the senior unsecured bonds and a Caa1 to the senior subordinated bonds. Standard & Poor's assigned a B+ to the bank debt and CCC+ to the notes. Based in Milwaukee, Wis., Rexnord manufactures motion technology products focused on power transmission products for the industrial and aerospace markets. Calls to Thomas Jansen, executive v.p., finance and cfo, were not returned.
A Carlyle spokesman said the firm had considered an auction process while at the same time filing an S1. He said it decided a complete exit, rather than a partial exit through an IPO over time, was the best step and called the sale an "extraordinary success." RE Rexnord, Merrill Lynch and Credit Suisse ran the auction.