Premier Foods: Public life after private equity

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Premier Foods, the UK food manufacturer that owns Hovis bread, Branston pickle and Quorn, exemplifies the difficulties that former buyouts face when the burden of high leverage is submitted to the public glare.

The company was floated on the stock market by Hicks, Muse, Tate & Furst, the private equity group, in July 2004. Interest payments on its debt pile were a factor in driving the company to a loss at its maiden set of results and, in spite of its relatively weak financial position, the company made a series of acquisitions in subsequent years.

Since last summer, however, Premier has been hit by a series of problems that have made its debt look particularly burdensome.

The challenges facing the company at the end of 2007 – rising raw material costs due to food inflation and increased interest payments on its debt burden – were magnified by the company having bought RHM, the bread maker, in February of 2007. The timing of the deal was unlucky, as wheat prices were to rise throughout the year and these were to prove hard to pass on to retailers.

Premier was among the first non-financial companies to issue a profit warning related to the rising cost of leverage after the credit squeeze took hold in the summer of last year. Its evident challenges saw Premier’s share price fall sharply in January following a weak trading statement.

Rumours were circulating that the company was on the verge of launching a rights issue to shore up its balance sheet and investors began to ask questions about its banking covenants.

But a month earlier, Premier had started investigating ways of strengthening its financial position without recourse to the equity markets. The profit warning added a fresh impetus to the effort. For a one-off fee of £12m, ($23m) Premier succeeded in renegotiating the coupon on its bank debt, accepting an additional 15 basis points.

It also raised a further £125m of working capital and secured looser covenants on its facilities. The covenants are now designed to give it maximum flexibility at the end of the first half of the year, and will tighten once more come December.

At the same time, the company announced asset sales and halved its dividend, while also slowing the pace of capital expenditure beyond that required for the integration of recent acquisitions.

The measures may have felt painful at the time, and many analysts said they smacked of desperation. Premier shareholders have certainly suffered: despite a recent rebound, the shares still trade at less than half their value a year ago.

But bankers now agree that the company’s pre-emptive action saved itself potentially much greater pain further down the line.

Financing has since become harder to come by, although this will also limit the price realised from any asset sales. Analysts say it is still likely that Premier could raise only about £250m at most from disposals.

The group remains highly leveraged. Net debt is £1.6bn and the pensions deficit is £123m, against a market capitalisation of £1.1bn. And in spite of the more flexible banking terms, net debt at the end of this year cannot exceed 4.5 times earnings before interest, tax, depreciation and amortisation. This means the group will need to ensure that ebitda does not fall more than 5 per cent this year on a pro-forma basis, although analysts still expect it to rise by about 11 per cent.

That said, Premier’s shares are on an upward trajectory, although they have yet to reach their level prior to speculation over a potential rights issue taking hold.

“It is invariably wiser for companies to face up to their financing issues early on and, from the outside, it appears that this is what Premier did,” says Nick Soper, head of debt advisory at Investec, the investment bank and asset management group.

Nevertheless, Premier’s experience serves as a stark reminder that, while heavy gearing can magnify returns for equity investors when things are going well, leverage works in the opposite direction when the cycle turns.

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