Using the Commercial Paper market to cover the bridge financing of an acquisition can provide buyers with substantial savings. However, the strategy does require a bit of foresight and vigilance on a number of points, as Matthieu Guillot, senior director at Redbridge, explains.
The classic case of acquisition financing is based on setting up a bridge loan before refinancing the transaction over the medium-to-long term through a bank loan, bonds or equities.
Such bridge loans are expensive for the borrower since they are seldom used in full. In most cases, the buyer manages to complete the refinancing transaction before the seller is paid off. However, the buyer will have paid fees on two occasions to the brokers charged with securing the financing of its acquisition. From this standpoint, a bridge loan for these acquiring corporate entities is similar to an insurance cost, which can be avoided with a minimum level of foresight.
The three main commercial paper (CP) markets are deep enough to easily meet the occasional liquidity needs of a corporate entity. The size of the corporate compartment of the Negotiable European Commercial Paper (NEU CP) market is approximately EUR 50-60 billion, as is the Euro CP market. Thus, a company like French SEB was able to raise more than EUR 900 million on its NEU CP program to bridge the financing gap of its acquisition of German group WMF.
The benefits of this strategy are significant for the buyer. In fact, in contrast to the banking market, investors in the NEU CP market do not impose a “floor” in the definition of the interest base rate in the financing agreement. This allows issuers to benefit from negative short-term rates. Additionally, issuers are funded at a lower margin than in the banking market due to the short-term nature of CP financing. Ultimately, a strong investment grade issuer that would pay a product margin (with utilization commission) of 60 basis points in the banking market may well end up at -20 basis points on the NEU CP market. This represents a saving of 80 basis points!
The majority of issuers are financed at negative rates, with some even borrowing at rates below the EURIBOR.
Use of the CP market lends itself to bolt-on acquisitions, generally up to the amount of the buyer’s revolving credit facility (RCF). The strategy is harder to imagine in the context of a transforming operation. In the context of the takeover of a group of identical size, or one even larger than the buyer’s group, conventional bank bridge financing remains essential.
Anticipate three months in advance
The strategy of using the CP market to obtain bridge loans for acquisitions does require a minimum degree of preparation and foresight. It takes two months to set up a commercial paper program, and another month to become known to the investment community via underwriting agents.
Arbitrages on the path to the market
Eligibility for the NEU CP market means being rated or having financial instruments (equity or debt) listed on a regulated market (“whose securities are listed for trading on a regulated market in the European Economic Area, or in a market outside the European Economic Area recognized as equivalent by the European Commission”). As a last resort, a corporate entity may also opt to obtain a bank guarantee in order to access the market.
The arbitrage conditions for rating, listing or bank guarantee to gain access to the NEU CP market were revised slightly with the advent of the new ratings agencies. In addition to the traditional agencies of S&P, Moody’s and Fitch, corporate entities today can work with new players such as Spread Research (France) or Scope Ratings (Germany). Scope Ratings has developed a short-term ratings approach.
The decision of whether to work with these new agencies must be based both on the cost of rating and the price impact of access to a larger pool of liquidity, since the reputation of the three historical ratings agencies is more established.
In addition, running a CP program requires the backing of a confirmed medium-term resource, such as a five-year revolving credit facility (RCF). The aim is to avoid any liquidity problems for the group should it prove impossible to renew a maturity on the CP market.
In such an event, the implementation of a swingline is strongly recommended. To recap, a swingline allows a credit facility to be drawn on the value date. In effect, the three-day period stipulated in conventional loan documents means that it is not possible to deal with any difficulties in renewing the NEU CP outstanding amount, which occurs on D-2. If there proves to be no appetite in the market, and the outstanding amount must be (partially) repaid, in the absence of provisions, a liquidity crisis can be averted by using a swingline. This option of drawdown on the value date is without cost, but does mean that the RCF must be appropriately arranged, as necessary.
Finally, the CP program gives a corporate entity time to set up the medium-term refinancing of its acquisition. However, beyond acquisitions, which are by nature periodic, it is essential to ensure that lines are maintained with investors. Once in place, the NEU CP program can be used to finance Working Capital Requirement (WCR) under favorable conditions. It is worth remembering that this is the main reason for the existence and utilization of the CP market.