Some equity sponsors are blocking certain buyside accounts from participating in new deals after those investors played hardball in distressed situations involving the sponsors. Sources pointed to Thomas H. Lee Partners' conflict with Highland Capital Management--which progressed to the point where the world's second biggest manager of leveraged loans is banned from participating in the bank deals for Michael Foods and Simmons Co.--as the most extreme play in a game that has been going on behind the scenes for some time. It is possibly the first time such language has been written into credit agreements, and market players cringe over what it might mean for liquidity.
"This is definitely not just T.H. Lee and Highland," said a banker, adding, "Every financial sponsor has had a bad experience with someone else." He said typically the underwriting banks are told to limit the invitees, and not to assign "difficult" investors a piece of the debt or sell to them in the secondary. But in this case, T. H. Lee told the underwriters to insert into credit agreements for Simmons and Michael Foods that Highland cannot participate in the new bank debt.
Officials at the private-equity shop and James Dondero, president of Highland, did not return calls. Other officials at Highland declined comment. Goldman Sachs and UBS led the Simmons transaction and Banc of America Securities, Deutsche Bank and UBS led Michael Foods. Officials at the banks either declined comment or did not return calls. Mark Witmer, treasurer of Michael Foods, referred questions about the credit agreement to the publicly available document and also T.H. Lee Managing Director Kent Weldon, who did not return calls.
A portfolio manager that plays in both the par and distressed arena stated that there is a group that includes firms such as Angelo Gordon, Black Rock, Black Diamond, Oaktree Capital Management and select hedge funds that are considered "difficult" by some sponsors. "It's their reaction to the hedge funds and distressed investors over the distressed cycle," said the portfolio manager. "It's our fiduciary responsible to maximize recovery," he noted, explaining that during the distressed period tensions ran high between some sponsors and distressed funds. One par investor not barred from any deals said of one buyside firm: "They tortured companies during distressed negotiations." And a banker provided the follow-up. "Now when financial sponsors are doing new deals, they exclude them." Portfolio managers and traders at these firms either declined comment or did not return calls or e-mails.
Though market participants said the T.H. Lee situation is extreme, it has several important ramifications. "It sets a precedent to reduce liquidity in the market," said one loan investor, who contrasted the practice with the idea that the loan market is developing into a capital market. One banker added that the market does not want to see this precedent and for other sponsors to act on it. Interestingly, the recent recap for T.H. Lee company TransWestern Publishing, does not exclude Highland. One banker took this as a sign that this is far from easy to get into a credit agreement.
Blocking investors could prove very problematic if any company that barred distressed investors ran into trouble. "There is a subset of people you don't want to eliminate," said a manager concerned about the situation. These distressed investors can make up 85-95% of the market and that "creates a world of hurt to those trying to sell out."
From The Michael Foods Credit Agreement
* "Eligible Assignee" shall not include (i) Holdings or any of its Affiliates or Subsidiaries or (ii) Highland Capital Management, L.P. or any of its Affiliates or Subsidiaries.
* Any Lender may at any time, without the consent of, or notice to, the Borrower or the Administrative Agent, sell participations to any Person (other than a natural person or Highland Capital Management, L.P. or any of its Affiliates or Subsidiaries)