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This article is provided to FT.com readers by Debtwire—the most informed news service available for financial professionals in fixed income markets across the world. www.debtwire.com


Few private equity shops have taken advantage – in every sense – of recovering capital markets with the abandon exhibited by Rank Group in the past year.

Since October, the New Zealand based firm has built a global packaging empire with three multi-billion-dollar acquisitions funded almost exclusively through leveraged loans and corporate bonds. The latest of the deals – Reynolds Group’s USD 6bn takeover of Pactiv – shocked debt investors with the miniscule equity cheque contributed by Rank.

Rank Group will put up just USD 500m of equity to support its takeover of Pactiv, valuing the group at USD 6bn. Given that USD 300m of that injection comes in the form of contributed assets, the private equity firm is paying less than 5% of the USD 4.6bn purchase price to Pactiv shareholders in cash.

“This is completely outrageous,” one owner of Reynolds’ bonds told Debtwire. “They are effectively managing to [execute] this transaction with almost no equity. A typical LBO deal requires sponsors to put in around 25% equity.”

The sponsor launched its packaging blitzkrieg in October last year when portfolio company SIG bought the much larger Reynolds Packaging and Closure Systems International for USD 3bn. Rank put up a EUR 500m (USD 630m) equity cheque representing roughly 10% of the deal, which boosted group revenues to EUR 2.8bn from EUR 1.26bn for SIG alone.

Rank’s owner Graeme Hart then set out levering Reynolds further to buy new assets and pay himself out in the process. In April, Reynolds bought New Zealand-based Evergreen Packaging Group and Whakatane Mill from another Rank portfolio company, Carter Holt Harvey, in an all-debt USD 1.75bn deal.

The budding conglomerate put the icing on the cake this month with its buyout of US specialist food packaging group Pactiv, which will boost combined revenues to a combined USD 7bn annually.

“This is a repeat acquirer, that tends not to do deals on the cheap but offers small equity cheques,” a second investor commented. “Its bonds warrant a discount.”

But, countered an analyst at a London-based investment bank, the sponsor has a strong track record in deleveraging the group. Following Rank’s acquisition of SIG in early 2007, the company reduced leverage to 3.8x in 2Q09 from 6.1x at the end of 1Q07. And after releveraging following the acquisition of the Reynolds’ business last year, leverage for the combined group dropped to 4.3x at the end of 2009 from 5.1x pro forma as of 2Q09.

Reynolds Group did not return calls seeking comment. Rank Group could not be reached.

From triple Bs to triple hooks overnight

But a more immediate and bigger concern for existing Reynolds debt holders is the USD 5bn of new financing and USD 500m-USD 750m of inherited bonds that will be layered into the capital structure as a result of the Pactiv deal. Roughly USD 2bn-USD 3bn of the buyout debt will rank senior secured, priming all outstanding bonds, said investors and analysts.

Pro-forma the new debt and a projected USD 200m of synergy-related EBITDA, Reynolds’ leverage would rise slightly to 5.5x from 5.1x. But excluding anticipated efficiencies, run-rate EBITDA of the respective businesses implies a 6.1x leverage figure.

The biggest losers from the debt holder perspective could be on the Pactiv side. “These [Pactiv investors] went on holiday in August as holders of BBB rated bonds, and will come back as investors in CCC rated bonds,” the first investor commented.

US consumer and foodservice packaging group Pactiv (Baa2/BBB) will become a subsidiary of the Reynolds group and jointly guarantee new senior secured debt issued by the parent. Under the new structure, unsecured Pactiv debt will rank pari passu with Reynolds’ unsecured bonds, the investors and analysts noted. Reynolds plans to leave up to half of Pactiv’s roughly USD 1.5bn of debt in place.

Standard & Poor’s and Moody’s both placed Reynolds on review for potential downgrades as a result of the deal, which they note will pressure its financial metrics. S&P has Reynolds unsecured debt on a B- rating and Moody’s on Caa1.

Credit Suisse, HSBC and Australia New Zealand Bank have committed debt financing for the deal. Reynolds plans to issue a mix of loans, senior secured bonds and unsecured bonds that will likely include euro-denominated debt, management said on a conference call this week (18 August).

Amendments and adjustments

Reynolds’ existing credit agreement permits the group to issue up to USD 750m of loans, which means it would need to obtain an amendment from its syndicate in order to increase the limit. The group expects to be able to remain in compliance with its 3.5x senior secured and 5.5x total leverage debt incurrence covenants but that depends heavily on the realization of projected efficiencies.

The company based its calculations on a combined pro forma EBITDA of USD 2.1bn, using USD 1.1bn equivalent for Reynolds and USD 750m for Pactiv plus USD 200m of synergies. Rank will contribute another USD 50m from Reynolds Foods Services business, currently independent from Reynolds.

The consolidated business would carry USD 11.5bn of combined total net debt, including roughly USD 5.5bn equivalent from Reynolds, USD 5bn of new debt and around USD 500m-USD 750m of Pactiv debt.

But the synergies will take 12 -18 months to realise and will incur a USD 100m cash cost. “However, you have to give them credit for having always achieved their previous savings targets,” a third investor commented.

Creative equity accounting

The Reynolds Food Service business, which currently sits outside of the group structure, will form part of the sponsor’s equity injection. It is valued at USD 300m, i.e. 6x its USD 50m EBITDA. The remaining USD 200m of the equity injection will be in cash.

The size of the deal also rankled investors after being told by Reynolds’ management on the 1Q10 earnings call that the group was only considering bolt-on acquisitions. “This is clearly transformational,” the first investor noted.

The group may have been somewhat disingenuous with its presentation of the leverage figures and financing of the transaction, but the deal itself makes a lot of sense, a second analyst noted. “There are many reasons for bondholders to be [angry], but on the face of it, it’s a good deal,” he added. “Pactiv has very strong relationships in the US, and it provides the group with significant scale and diversity.”

Reynolds’ bonds have recovered some of their initial losses following the announcement of the acquisition, when the secured bonds dropped two points and the unsecured bonds three points. Its euro-denominated senior secured 7.75% 2016s regained a point at 102.75/103.75, while its 8% 2016s clawed back half a point at 96/97. The 9.5% 2017s are unchanged at 96/97, according to the second investor.


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