The market material adverse change clause, or "market MAC," gives banks the ability to walk away from their obligation to syndicate or hold debt if further deterioration of the credit markets takes place. Market observers have seen a return of the once-typical clause, but they say it has yet to establish staying power.
The burger wars begin today with bids due on Wendy's and three potential buyers expected to make offers. One buyout group is led by former Carl's Jr. and Hardee's Chairman and CEO William Foley and includes buyout firms Ares Management, Oaktree Capital Management and Thomas H. Lee Partners; the second group is led by Cedar Enterprise president and Wendy's franchise owner David Karam and includes buyout firms Kelso & Co. and Oak Hill Capital Partners; and the third interested party is Nelson Peltz, who is seeking to buy Wendy's through holding company and restaurant franchise operator Triarc Companies. All either declined to comment or did not return calls and e-mails.
Financing for the Dublin, Ohio-based fast food chain promises to be a sticking point for the buyers, in part because JPMorgan and Lehman Brothers have attached a market MAC to the financing agreement. A source familiar with the deal confirmed that the market MAC was still in the staple financing agreement as of last week, and that the financing package would largely be based on securitizing fees that franchisees pay to the company, with a backstop loan supporting the securitization. The financing package is expected to spur the buyout groups to submit bids that were lower than previously expected for the company. While Triarc valued the company at between $3.2 billion and $3.6 billion, one franchisee reportedly valued the company at approximately $2.5 billion.
The market MAC is in some ways a relic that is seeing a revival in the face of current troubles in the credit markets, after disappearing during the feverish days of the buyout boom.
"One of the most immediate reactions to the credit crunch in August was banks turning back and putting back into commitment letters the market MAC, which was a provision that was fairly common two to three years ago," said a New York-based attorney. He added that market MAC clauses were one of the first things to go as the leverage buyout boom reached stellar heights and sellers and sponsors demanded tighter commitments from banks.
But, he adds, while the market MAC clause has shown up in many more financing agreements put forth by banks, its staying power has not been strong. What banks are doing, said the New York attorney, is putting the market MAC provisions in their financing agreements in order to negotiate it away in exchange for greater market flex.
Market flex is a bank's ability to make changes to the pricing and/or structure of a buyout or acquisition if it runs into trouble syndicating the debt. The majority of the hung equity bridges that have saddled investment banks were deals that had feeble market flex controls for the banks.
"Banks have definitely been more successful in getting better market flex," said the attorney. "That's the one change that has stuck. Market flex terms are significantly broader than they were prior to August. That's the thing that sponsors understand; that's the price they pay now to get the commitment." And LBO firms and acquiring companies have been insistent on getting those commitments. "A commitment with a market MAC is not a meaningful commitment in an LBO," the attorney said, adding that he has not seen a market MAC survive in a financing agreement in any significant deals valued at over $100 million.
Underwriting banks have lost significantly in the wake of the current credit market crisis. Heated competition to underwrite large LBO deals left banks with funding commitments on their books that quickly became a tough sell once the markets turned. Thus, the banks would greatly benefit from being excused from holding the debt under such clauses, or would need greater flexibility in tweaking future deals to enable them to syndicate buyout and acquisition debt.
Banks are usually in the same boat as LBO firms, though, especially since the MAC clauses governing both buyouts and debt underwriting became more identical as the buyout boom progressed. One advantage banks have in some deals, however, is that some MAC clauses list the bank as the entity that decides if a MAC has occurred.
Market observers and sources familiar with the deal emphasize that the market MAC clause is not the only reason for prices to come down on the Wendy's buyout bids, or even the most compelling one. Many of the company's franchisees have publicly complained about Wendy's mismanagement, poor ad campaign and what they see as a vacuum in leadership in the years since the death of founder Dave Thomas. Rivals McDonald's and Burger King have gained significant ground on Wendy's in areas such as expanding their breakfast businesses and fostering growth overseas.
But the company is improving. "They've recently had better results," said Diane Shand, a primary credit analyst with Standard & Poor's. "They're up against formidable competitors, and the U.S. market is mature. They seem to be getting some franchisees internationally, but it remains to be seen if they'll be successful internationally. Their product pipeline has gotten better, but their product pipeline had been weak, and they had a poor advertising campaign."
Not Flame Broiled, Down In Flames
And Wendy's is not the only buyout recently affected by investment-bank reaction to the credit market downturn. In fact, the same two banks, JPMorgan and Lehman, threw General Electric's buyout of mortgage lending and vehicle fleet management service provider PHH into doubt. The banks informed The Blackstone Group, which planned to buy the company's mortgage business from GE, that it had "revised interpretations as to the availability of debt financing under the debt commitment letter." The revised interpretation left a $750 million shortfall in the financing of the $1.8 billion buyout deal. PHH shareholders voted to approve the buyout, but for the deal to have gone through, Blackstone would have had to double its $750 million equity commitment, and it has said it will not do that. JPMorgan declined to comment. Lehman Brothers did not return calls by press time. - MS
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