Opinion: Ralph Waters' train smash and Ironbridge's pyrrhic victory highlight the downside of heavily leveraged acquisitions

By Gareth Vaughan

Back in August 2006, when few of us knew much about US subprime mortgages or collateralised debt obligations, I set off to Fletcher Building's headquarters in the industrial Auckland suburb of Penrose.

With photographer in tow for my gig that day, as a Fairfax business reporter, was an interview with Fletcher Building CEO Ralph Waters, who was in the last days of a highly successful five-year reign at the helm of the building materials manufacturer and distributor.

From a journalist's perspective Ralph Waters was gold because he always had something interesting, forthright and very newsworthy to say. My previous experience with him included him telling me in 2005 of his disgust with the shoddy building standards and materials that caused the leaky home problem after he had forked out nearly NZ$400,000 fixing his own 13-year-old leaky Auckland home, and criticising opposition party leader Don Brash for suggesting New Zealand was spiralling into a recession, which Waters felt risked becoming a self fulfilling prophecy.

And that day proved no exception.

Waters gave both barrels to the voracious overseas - mostly Australian - private equity raiders who at the time were snapping up New Zealand businesses in predominantly debt-funded acquisitions at what then looked to be very high prices and now look mind boggingly stupid prices.

In particular his ire was directed at Australia's Catalyst Investment Managers, which had recently acquired Auckland-based firm Metropolitan Glass (now Metro GlassTech). Catalyst, whose name now seems rather unfortunate given what was to come, bought Metro GlassTech for NZ$366.2 million after outbidding Fletcher, which as Waters pointed out had synergies or cost savings available to it through the deal the private equity player didn't have, by about NZ$100 million.

Waters said we were living days of private equity "irrational exuberance" as cheap credit flooded the world. Although some private equity firms banked huge profits, they couldn't defy economic gravity.

"It's going to end in some train smashes for some of them... a highly geared balance sheet doesn't leave you much room to move," Waters said back then.

It's all over now

Last week we saw the last rites of his "train smash" as an Overseas Investment Office approval confirmed Metro GlassTech had been taken over by lenders led by another Aussie private equity fund, Crescent Capital Partners, in a deal it valued at just NZ$181.5 million. That's less than half what the business sold for less than six years ago. For any investor, or lender, that may indeed feel like a train crash.

The original banking syndicate comprised of underwriter BOS International, Sumitomo Mitsui Banking Corporation, ANZ, ASB's parent Commonwealth Bank of Australia (CBA), WestLB and Oversea-Chinese Banking Corporation, saw the writing on the wall some time ago with most selling out at about 60 cents in the dollar last year with hedge funds among the buyers.

The haircuts were sizable. Metro GlassTech, which was founded by Andrew Smith, John Bedogni and Cameron Gregory in 1987, had bank borrowings of NZ$288.7 million, according to its first financial statements filed with the Companies Office after the 2006 deal. In the eight months to March 31, 2007 it also had revenue of NZ$101.159 million, and preference shares (read more debt) of NZ$62.477 million. The company paid NZ$19.344 million of bank loan interest and NZ$5.307 million of preference share interest and had NZ$30.952 million of equity as of March 31, 2007.

In a directors' report in parent NZ Glass Holding Company's latest and last annual financial statements, directors note Metro GlassTech's sale for an enterprise value, which includes debt, of NZ$180 million. They say the sale and capital restructure was necessitated by a continuation of the downturn in the residential building market which has run since mid-2008, becoming the worst on record in New Zealand. On top of this, they say, the devastating Christchurch earthquakes have compounded this downturn, rendering the company's capital structure unsustainable with a drop of 40% in Metro GlassTech's core business market of glass for new residential buildings over the past three years.

Now, the decline in residential building consents to record lows and the tragic events in Christchurch have undoubtedly contributed to the company's financial woes. Certainly no one foresaw the latter and few probably predicted just how weak the residential building market would get. But the core of Metro GlassTech's problem can be traced back to its private equity owners setting it up with an unsustainable debt burden in the first place.

Carrying the near NZ$289 million of debt (as at March 31, 2011), and having to pay the NZ$33.310 million worth of annual interest payments on it, was going to be a tough ask for a company in a static economy, let alone a weakening one. And history teaches us that boom and bubble times, ultimately, always end. Ultimately, Metro GlassTech was left with an equity deficit of NZ$288.893 million.

Ironbridge's pyrrhic victory?

In another twist in the world of highly leveraged, top of the market, private equity deals last week another Australian firm, Ironbridge Capital, declared victory, through a press release issued to selected media and MediaWorks staff, in its stoush with the much bigger TPG over control of TV3's parent MediaWorks.

In the second recapitalisation since its about NZ$790 million leveraged buyout of MediaWorks in 2007, Ironbridge says the plan sees new "funds" of over NZ$50 million committed alongside a restructure of the existing interest rate swaps to reduce funding costs, repayment of its Crown spectrum loan (for the renewal of radio licences for the 20 years to 2031) in full, which was originally worth NZ$43 million, "meaningful" additional investment in programming, promotion and sales, and "material" reduction in debt.

In late 2009 NZ$70 million was tipped in via the first MediaWorks capital restructure post Ironbridge's takeover.

TPG, formerly known as Texas Pacific Group, bought MediaWorks debt with a face value of NZ$70 million in December from CBA, apparently for about 60 cents in the dollar. That gave TPG about 18% of MediaWorks' senior debt that has a face value of NZ$387.7 million, according to the company's last publicly available financial statements. The other holders of the senior debt are lead banker BNZ, Westpac, Lloyds Banking Group, the Royal Bank of Scotland, Rabobank and JP Morgan. See more on the senior lenders here.

TPG, which led a move on Australia's Alinta Energy that culminated in its shareholders handing control over to lenders and retrieving just A10 cents in the dollar after a near three-year battle, has made no secret of its similar long-term ambitions for MediaWorks which may yet bare fruit if other senior debt holders get on board with TPG's plan and help force through a debt-for-equity swap.

Up in smoke

The new Ironbridge capital restructure plan confirms some NZ$96.8 million of subordinated debt, held by Lloyds, Royal Bank of Scotland and Ironbridge has gone up in smoke. Gone with it is a NZ$24.3 million so-called payment in kind debt facility held by Goldman Sachs. However, the plan includes no haircut on the senior debt, whose maturity has been extended a year to 2015, and somehow leaves Ironbridge with equity in MediaWorks. In theory this might mean the TPG stake has increased in value by 40% in just two months.

It will be interesting to see what auditor PwC says, if indeed this is how the deal is ultimately structured, when MediaWorks' next annual accounts are lodged with the Companies Office.

Ironbridge people will tell you MediaWorks has faced an unprecedented advertising downturn since 2007 and, again like the Metro GlassTech industry problems, this is true. But once again the fundamental problems can be traced back to the fact Ironbridge loaded an unsustainable level of debt onto MediaWorks' balance sheet. By dumping the money it borrowed to buy the business on the media company's balance sheet and using this to pay interest on the debt, as soon as earnings started to fall little money was left for anything else. Finance costs in MediaWorks' last publicly available annual results - for the year to August 31, 2010 - were NZ$49.957 million and the company had a NZ$50.945 million equity deficit.

One thing that seems unlikely is that TPG will just walk away from MediaWorks given it clearly sees an opportunity, has a foothold, appears happy to bide its time, has media experience notably through US Spanish language media company Univision Communications, and ex-MediaWorks CEO Brent Impey is helping TPG out as a consultant.

Extend and pretend

Meanwhile it would be interesting to ask bankers from BNZ, which is the lead banker in both the MediaWorks and Yellow Pages lender groups, just how the two situations differ. Remember that Yellow Pages' lenders crystallised NZ$1.05 billion of losses early last year after the NZ$2.24 billion 2007 purchase of Yellow Pages from Telecom by Hong Kong-based private equity group Unitas Capital and the private investment arm of Canada's Ontario Teachers' Pension Plan. That particular leveraged buyout included about NZ$1.5 billion of debt.

If the banks were prepared to take a haircut on the senior debt there why aren't they on MediaWorks? And will they be forced to anyway say six, 12, or 18 months down the line? My guess would be yes.

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