A takeover is never simple, particularly if it involves a lot of debt. Add to that an acquirer that is based offshore but does all its business in China, and it only becomes more complicated. And that’s before you factor in possible US political resistance.
The deal in question, Chinese meat producer Shuanghui International’s $4.7bn pursuit of Smithfield Foods in the US, could become the largest takeover of a US business by a Chinese one.
But while national pride and food safety may be at stake in Washington, Asian loans bankers have another set of concerns.
Including assumed and new debt, the total transaction could be valued at $7.1bn, including the $4.7bn that Shuanghui wants to pay in cash for Smithfield’s shares.
Bank of China has underwritten a $4bn loan for Shuanghui that will finance the takeover, together with $3bn of debt that Morgan Stanley is arranging in the US market for Smithfield, which will be non-recourse to Shuanghui. That piece includes a $1.5bn 364 day bridge loan.
The Bank of China loan is a challenging one for Asian lenders. Top of their list of concerns is that Shuanghui is a Hong Kong-based holding company, which makes all its money through operating subsidiaries in mainland China.
This means Shuanghui will have to rely on cash flows from China to service the debt — raising fears that creditors to the operating companies might be repaid before lenders to the holding company, or that any government-induced interruption in making payments offshore could harm lenders.
Loans bankers don’t like being structurally subordinated in this way, and the large deal size only adds to the pressure.
Shuanghui’s indebtedness also worries some. Having had relatively little debt, the combined group will have about $7bn to service after the takeover.
Another factor that has riled some bankers is the $1bn underwriting ticket needed to get in at the senior phase. On a $4bn loan, Bank of China has invited around 15 international lenders to join at this level, suggesting it is not entirely confident of getting the majority onboard.
The fact that Shuanghui is also a first time borrower brings little relief to bankers, who will think carefully about chipping in such a sizeable amount for a largely unknown credit.
But you can always rely on loans bankers to take the most pessimistic view. The fact is, the structure of Shuanghui and the nature of its acquisition are what have shaped the deal this way. Instead of complaining, bankers could learn a lesson from the bond market.
Structural subordination at Chinese borrowers is a familiar concept in the bond world — and bondholders have learned to live with it, thanks to strong covenants that protect their recourse to repayment from the operating companies if something goes wrong.
Loans bankers would do well to ensure they also negotiate a comprehensive covenant package with Shuanghui, to protect their rights.
EuroWeek understands that, at this stage, Shuanghui’s loan covenants include a cap on debt of five times Ebitda, a minimum net interest coverage ratio of 1.5, and a requirement that the company’s consolidated net worth not drop below $2bn.
China has many large companies, which are increasingly flexing their muscles and looking around the world for acquisitions. Many of these deals will also involve large amounts of debt, high leverage and offshore holding companies.
If international lenders in Asia want to remain relevant, they need to find a way to get comfortable with the Chinese bankruptcy law issues, and develop structures that enable them to take on more challenging risks.
Shuanghui’s chunky loan will test lenders’ willingness to engage in a highly leveraged deal with structural subordination. It is a test they need to pass.