Blackstone and Government of Singapore Investment Corp (GIC) broke new ground for Asia's private equity industry on Tuesday after using the bond markets to raise funds for a dividend recapitalisation in Indian outsourcing company MphasiS.
Dividend recaps are a fairly widely used tool in the US and Europe, enabling private equity sponsors to take money out of their acquisitions without diluting their stakes. As such, they have been fairly controversial since loading up companies with debt to pay investors a special dividend weakens their credit metrics.
They have rarely been used in Asia and always through the syndicated loan market. Korea's MBK Partners previously executed a dividend recap in China Network Systems at the turn of the decade, followed by water company Coway in 2015.
The new deal for MphasiS follows a very similar transaction for India's Hexaware Technologies last July. However, in Hexaware's case, the private equity sponsor, Barings, had already completed a $250 million dividend recap in 2015 and then used the bond market to refinance a loan one year later.
In MphasiS's case, the dividend recap was packaged up as part of the bond deal. The transaction, which was issued in the name of Marble II, comprised a $500 million offering with a five non-call two-year structure.
Some $210.75 million of the proceeds are being paid out to Blackstone and GIC, helping them to reduce their investment cost in the company to $350 million. The original $892.3 million M&A deal closed in September 2016 according to S&P Global Market Intelligence data.
A further $267 million of the proceeds are being used to repay what remained of a $405 million acquisition loan, while $13.25 million has been placed into an interest reserve account to service the coupon payments and the final $9 million comprised the lead managers’ fees.
The transaction made a great deal of sense for the sponsors. Financing rates are at historically low levels, while MphasiS is an ideal company to layer on debt, since it does not really need it and therefore the transaction should not really affect its credit metrics.
What a difference a year makes
The pricing also underlines just how far the Asian high yield markets have moved over the past year. When Hexaware raised $300 million last July, its five non-call three-year deal carried a 7% coupon and launch yield of 7.125%, based on an issue price of 99.482%.
On Tuesday, the Ba3/BB-/BB- rated paper, in the name of HT Global, was yielding around 5.6%, roughly 150bp tighter.
But this did not appear to deter investors, and bankers pointed out that the Marble II deal achieved the tightest compression from indicative guidance to final pricing in the Indian high-yield market so far this year.
Having set out with preliminary guidance around the 5.7% level, the leads tightened it to 5.3% and priced the Ba2/BB rated offering at par.
There is a call option in 2019 at 102.65%, in year three at 101.325% and in year four at par.
Demand was also strong, coming in at $2.15 billion, with participation from 127 accounts. Last year, Hexaware attracted $1.9 billion.
The distribution statistics show that 67% was placed in Asia, 23% in the US and 10% in Europe. By investor type, funds took 79%, private banks 19% and others 2%.
The deal priced close or through fair value subject to different brokers' estimates, but managed to trade slightly above the re-offer when it broke syndicate on Wednesday.
This positive trading pattern broke the mould of recent Asian high-yield deals, which have struggled to maintain their issue prices, with investors nervous about historically tight trading levels.
Bankers attributed Marble II’s performance to MphasiS’s underlying credit strength and cash generating abilities: a point also emphasised by the ratings agencies. According to its offering circular, the company recorded a 72.33% free cash flow conversion rate in 2016.
Structurally, the deal mirrors Hexaware’s July 2016 transaction. It has the same covenant package embracing: a change of control put at 101%, an interest reserve account and a collateral account to hold any share proceeds by Blackstone and GIC.
One minor difference concerns the leverage incurrence language. Hexaware was not allowed to increase its debt levels unless consolidated-debt-to-Ebitda was below 3.75 times. MphasiS has a more stringent ratio at 3.5 times.
Marble I (owned by Blackstone 86% and GIC 14%) currently owns 60.4% of MphasiS after recently taking part in a $171 million share buy-back and dividend scheme, another popular tool for private equity funds to recoup investment proceeds.
MphasiS, which is listed on the Bombay and National Stock Exchange, has a $1.98 billion market capitalisation. In its ratings release Moody’s said bond investors are likely to be comforted by the certainty of the company’s cash generating abilities.
The outsourcing group has an 11-year strategic partnership with its former owner Hewlett-Packard, with guaranteed earnings of $900 million during the first five years. It currently derives about 77% of its revenues from the US, but Moody’s notes that only 7% of its employees have H1B visas, which may protect it from possible US trade protectionism.
Joint global co-ordinators for the bond deal were: Deutsche Bank and Standard Chartered. There were a long list of joint bookrunners comprising Barclays, Citi, Credit Agricole, Credit Suisse, HSBC, ING, JP Morgan and UBS.