The execution of a carve-out from a multinational company can often be tricky.
But private equity firms Baring Private Equity Asia and Onex are quickly managing to establish their $3.55 billion leveraged buyout of Intellectual Property & Science (IP&S) from Thomson Reuters as a standalone entity.
They closed the deal on October 3 and renamed the company Clarivate Analytics. The funds also named David Liu, who was previously head of China at Thomson Reuters, as the firm’s new head of Asia — helping them accelerate a sales push in the region.
These moves will help the new firm overcome the challenge of realising cost savings and reducing leverage.
The private equity firms agreed in July to pay a high price tag of 11.3 times 2015 Ebitda using a mix of debt and equity – but strong cash-flow generation should help pay debt down steadily, said Jean Eric Salata, the founding partner of Baring Private Equity Asia, in an interview with FinanceAsia.
Investors will certainly hope so. Clarivate paid a chunky 7.875% coupon when it turned to bond investors for $500 million of funding in September. The yield on the Caa2/B- bond has moved down by 60bp in the secondary market — a sign that credit investors are more bullish now — but that does nothing to cut the fixed coupon costs for Clarivate.
The carve-out process will also add to the company's costs. Scott Zari, an analyst at S&P Global Ratings, has warned that the carve-out will " meaningfully impact both its annual Ebitda and free operating cash flow through 2018".
Moody’s, meanwhile, calculated the company’s pro forma non-GAAP financial leverage at about 7.5 times as of June 30 — although Salata said it was now much lower.
Salata pointed to the firm’s high proportion of subscription-based recurring revenues, around 80% last year, and strong sales growth in Asia as reasons for confidence.
“We think the Asia component is already fairly substantial but also the fastest growing,” said Salata.
Clarivate Analytics’s focus on intellectual property as well as research and development is very much in line with demand in China and India for value-added services. “This is why Asia revenues are growing faster than across the rest of world,” said Salata.
Headquartered in Philadelphia, Clarivate Analytics owns a collection of subscription-based businesses that provide customers with access to scientific literature, patents, trademarks, pharmaceutical information and other curated content carved out of Thomson Reuters.
Clarivate Analytics already earns about a fifth of its $961 million annual revenue in Asia and — perhaps more importantly for lasting revenues — about a third of subscription revenues are already generated in the region.
That is good news, since subscription revenues are growing at a 10% compound annual growth rate in Asia versus the 4% seen globally between 2013 and 2015, said Salata.
Execution risk remains a key challenge as the firm lacks an operating history and will incur costs setting itself up as an independent entity before it can start its four-year plan to cut annual costs by $50 million before 2021 and pay down debt, according to credit analysts.
While private equity can do much to improve a portfolio company’s fortunes, the entry price is crucial to a successful private equity investment.
Baring Asia has a history of very successful investments. Baring Asia III, one of the top performing funds of its vintage in Asia, gave a net internal rate of return to investors of 138% as of March, 2008.
However the funds agreed to put in about $1.635 billion of their own equity for Clarivate Analytics — a commitment which worried some of their investors. “It’s a red flag for us,” said one of the investors, known as limited partners, in one of Baring’s funds to FinanceAsia.
But Salata sounded a note of confidence that investors would come to appreciate the deal more in the future.
“We think valuation is reasonable … the business doesn’t provide a commodity-type service,” said Salata. “We underwrite to mid-20s [IRR] on everything we do,” he added.
Private equity is leaning increasingly on leverage to give an extra boost to returns, taking advantage of razor-thin interest rates in much of the world.
Moody’s said that although leverage on Clarivate Analytics of about 7.5 times as of June is high compared with a mean leverage of 6.6 times for other B3-rated industry peers globally it thinks that the business model can accommodate a more leveraged capital structure due to the firm’s strong revenue visibility, high Ebitda margins and relatively stable positive free cash flow generation.
The acquisition was partly funded by a $1.45 billion senior secured term loan and $600 million in senior unsecured notes with very weak covenants, according to Moody's.
During the marketing of the financing, the funds upsized the senior term loan by $100 million and downsized the senior unsecured note by the same amount, resulting in a slightly lower interest expense for the company.
“The financing was very well received by the market,” said Salata, who noted the funds were able to lower pricing on the notes by 100bp during marketing.