26 April 2018, 10:33 GMT
Back in 2003 when Paula Radcliffe broke the marathon world record, it was Flora - the margarine brand - who sponsored the London Marathon. After a 14-year association with the race, Flora’s owner Unilever called time on that partnership in 2009. Unilever are now finally exiting the business completely having announced the sale of their spreads division to KKR in December 2017 for a valuation of €6.8 billion.
Why did Unilever decide to sell? As a mature, ex-growth business, it no longer fitted the profile for an equity-friendly, high potential growth brand in the Unilever stable. But from a sponsor’s point of view we think this provides a compelling opportunity for investing in and refocusing on a large, high quality business.
‘High quality’ are often words not associated with LBOs (leveraged buy-outs), with many investors bearing long memories of highly geared investments in questionable companies during the pre-crisis LBO boom that triggered a wave of painful defaults in 2008-2009. This far into the current economic cycle, the high yield market is rightly wary of the rising risk of a leveraged, credit-unfriendly M&A boom. Associated with such late cycle dynamics are some negative by-products that frequently hurt credit returns over the longer term: including generous adjustments to reported earnings, over-selling of companies’ growth potential, and ever-loosening bond covenants. Indeed, Flora is the latest example of a deal with both sizeable earnings add-backs and weak documentation protection.
However, we do believe that the Flora LBO is an example of a good value proposition for high yield investment portfolios. Although we expect the company’s revenue growth to remain under pressure, we think there is scope for intensification on cost cutting, investment in optimisation initiatives including IT, and optionality in emerging markets. Even from a standing start the business is already highly cash generative, meaning there is ample underlying free cash flow to cover debt interest payments. Importantly, KKR is an industry-leading sponsor, and has significant ‘skin in the game’ with an equity cheque of €2bn.
Flora is not the only high-quality LBO to come to the European high yield market in recent months. Ceramtec, a German LBO owned by BC Partners which came to market in November 2017, has a market share of over 90 per cent of the ceramic hip replacement market and EBITDA margins of 37 per cent. Verisure, a security and alarms business owned by Heldman and Friedman which refinanced in the same month, has been growing at over 20 per cent per year and has EBITDA margins in excess of 40 per cent. Both Ceramtec and Verisure are core holdings for our European high yield funds.
What about the valuation for Flora’s debut high yield bond issue? The European high yield universe now yields 2.8 per cent on a yield to worst basis, a historically low yield for a generally high quality (BB- average rated) universe. KKR’s Flora Euro new issue printed at 5.75 per cent, over double the yield of the universe, due to its lower rating (B- equivalent) and higher leverage (6.1x adjusted) than the average of its high yield peers. Against the single B peer set Flora’s yield is still materially higher, with Bs yielding 4.3 per cent on average. For a company that we think is at the ‘high quality’ end of the LBO spectrum in Europe, it represents a good risk adjusted investment within European high yield as KKR gets its teeth into the spreads business.
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