In the heady days before the credit bubble burst in 2007, private equity firm KKR, the inventor of the jumbo leveraged buyout, completed two transactions that could not have had more contrasting receptions in the leveraged loans market.
One was so flooded with demand in syndication that bankers working on the deal called it the most popular transaction ever.
The other was such a disaster that the bookrunners were left drowning with £9bn of debt unsyndicated on their balance sheets.
Fast forward to 2012, however, and Henry Kravis’s firm is set to make up to 2.7 times its original equity investment on that "disaster". But sponsor and lenders alike are facing huge writedowns on the other. This is the story of Alliance Boots and PagesJaunes.
French directories company PagesJaunes, with its funky holdco-opco debt structure, was 15 times oversubscribed despite a reverse flex when it kicked off the 2007 leveraged loan market — a fearless time where anything was possible.
Pharmacy chain Boots, the unwanted poster child of the excesses of the leveraged finance market during the boom, had its syndication pulled later that same year.
Yet it is Boots that looks to have found a most remarkable of exits, with US pharmacy chain Walgreen having bought 45% of the firm and standing ready to buy the rest in 2014. PagesJaunes, on the other hand, is a sad tale of too much debt amid declining revenues.
PagesJaunes, the operating company, has switched off the only revenue stream of the holding company Mediannuaire — its dividend payments, leaving it unable to make its debt payments. Lenders to the holdco could be left with nothing, but even the opco investors are not hopeful of 100% recoveries.
How could the leveraged loan market have had such a failure of judgement?
The answer bankers give is the scale of the shift in market sentiment between January 2007, when PagesJaunes was done, and when Boots was launched later in the year.
But that simply underlines the fact that performance in syndication is an inadequate indicator of the quality of a deal. And that it is herd behaviour and market temperature that drive investment decisions, not fundamental credit quality.
PagesJaunes’ success in syndication is particularly shocking. Given the recent restructurings of Yell Group, Seat and European Directories — thanks principally to the hardly unexpected rise of the internet — it seems extraordinary that banks were able to sell billions of euros of debt in these companies’ names.
In light of the experiences of Alliance Boots and PagesJaunes, the levfin industry must ask itself whether its incentive structures are right.
Something must be flawed, whether it’s CLOs being too heavily incentivised to put money to work when repaying cash would sometimes be more sensible (something many loan investors lament as a reason for the market overheating), or whether it’s the upfront fees received by both fund managers and underwriters for doing their job. After all, the quality of a debt instrument is only proven when it has been repaid.
It will take years to assess whether lessons have been learnt, although it is at least true that LBO deal structures are a lot more conservative now.
But as banks find themselves having to compete harder and harder for business in leveraged finance, it would be prudent for all market participants to remind themselves of past mistakes. The "market conditions" excuse will not wash.