Borrowing for Growth
Last year, Richmond, Virginia-based Douglas Publications bought Briefings Publishing Group and its nine business-management newsletters from Wicks Business Information in an estimated $15 million deal. Commerce Bank contributed an undisclosed amount of senior debt, and BIA Digital Partners, a mezzanine lender, committed $5.8 million toward the transaction in senior subordinated debt with warrants. That allowed Alan Douglas, CEO of Douglas Publications, to avoid having to raise a large amount of outside equity and possibly cede control of the company.
The transaction was small compared to the massive scope of deals like the sale of Hanley Wood last year, but it was significant in that it represents an example of a capital source that is booming in the magazine industry. With the economy coming around even for lagging businesses like print media, magazine publishers are looking for opportunities for growth. The M&A climate;the most direct indicator of how bullish strategic and financial investors perceive the industry;was hotter in 2005 than any year since 1999-2000. But it's not just M&A that is fueling growth, it's organic business development too. New consumer magazine launches have been setting records in recent years. Advertising pages are up. E-media has been growing fast. It's not surprising, then, that publishers are exploring how they can finance acquisitions and new initiatives alike.
While the availability of private-equity money has never been greater, debt-based financing has been hot too. It's easy to understand why: There couldn't be a better time for publishers to borrow money, thanks to low interest rates and willing lenders holding an abundance of debt capital. "2005 was a banner year for debt financing," says Thomas L. Kemp, managing director and a specialist in business-to-business media at Veronis Suhler Stevenson, a private equity and mezzanine-capital investment firm. Kemp is also a former CEO of Penton Media, Inc. "And the use of debt correlates closely to the overall transaction volume and total dollar volume. A rough estimate would be that about 50 percent of the total transaction dollar volume;or enterprise value;would be debt."
Adds David Harrington, senior vice president and publishing leader at G.E. Global Media & Communication, "It's an advantageous time to be a borrower." Harrington should know. Within his group's $6.3 billion portfolio, publishing is one of the largest and fastest growing segments, accounting for nearly one-fifth of the total. Last year, it closed $400 million worth of deals and loans in the business-to-business industry. G.E. Global Media & Communication specializes in senior debt;that is, loans that are secured by a company's assets and stock, and repaid over a period of five to seven years. And another senior-debt lender, Bank of Montreal Harris Nesbitt's media, communications and technology group, recently ran a tombstone ad listing 12 media-company deals from the last year-and-a-half worth an aggregated $1.3 billion in senior-debt lending. The deals ranged in size from $22 million to $377 million.
Among the forms of debt, senior facilities are the most attractive form of borrowing, because the interest rates are lowest, about 6 percent to 8 percent. So publishers looking to borrow for growth are wise to borrow as much senior debt as they can, but G.E., Harris Nesbitt and other senior debt lenders like Bank of New York have their limits. Typically, half of the principal winds up including equity or subordinated debt. "It's rare you see a transaction of 100 percent debt instruments," says Hank G. Kush, managing director in charge of the media finance group at Commerce Bank, another senior debt lender. G.E., for example, works in conjunction with private-equity firms.
Senior debt is like a mortgage on a house: It's the most secure, because the lender is first in line to get its money back if the company is sold or fails to repay a loan. The advantage for the borrower is that the interest is the cheapest, but lenders require their customers to abide by financial covenants guaranteeing a certain level of profitability: A leverage ratio, an interest cover ratio, a fixed-cost ratio and other targets that are tracked by quarterly reporting of financial statements. A leverage ratio simply means that you can only borrow up to a certain percentage of the value of the business. An interest-cover ratio means that interest can only make up a certain portion of EBITDA.
A Look at Subordinated Debt
Beyond senior debt there are two types of subordinated debt. One, second-lien debt, also has financial covenants associated with it, but interest costs are higher. Instead of senior, or first-lien's 300 basis points above LIBOR, the London Inter Bank Offering Rate, which is about 4.25 percent, second-lien money may have a spread of 500 to 600 basis points, for a total of 10.25 percent interest, obviously significantly higher than senior debt.
The second type of subordinated debt is mezzanine. This is a more flexible option for publishers because less is required in covenants. And unlike second lien, interest accrues on mezzanine debt and is repaid at the end of the term. In some cases, borrowers can reduce interest payments by offering warrants or an equity portion of their company;usually a minority stake of 5 percent or so.
Both forms of subordinated debt do not require borrowers to repay the principal until the end of the term, when a "balloon" payment is due. "Mezzanine is usually used along with senior debt. It allows you to get more debt on the company than you would on senior debt alone," VSS' Kemp says. "It will allow for more leverage ratios, and less current cash pay in the short term. There are pros and cons to all these debt instruments."
What's it all mean for publishers? The Douglas Publications example is one way that the different types of debt are used together. Scott Chappell, a partner at BIA Digital Partners who leads its information and publishing services arm and was involved in the Douglas package, emphasizes the flexibility, compared to senior debt lenders, that mezzanine lending gives publishers. "We give them a wider berth to operate," he says. With mezzanine debt, a publisher trying to launch a series of new titles could benefit from not having to repay the capital until the end of the term, which includes an extra, sixth year. "If you're going to take a little longer to be profitable, that's okay," he says.
Transactions in the magazine industry are usually based on multiples of cash flow or EBITDA, or earnings before interest, taxes, depreciation and amortization. On top of interest and principal payments, the financial covenants required by senior lenders mean that borrowers also have to maintain an interest cover ratio that could be two to one. That means if annual interest expense is $5 million, minimum EBITDA would have to be $10 million. Another covenant could be four times trailing cashflow; if cashflow is $10 million, then EBITDA must be $40 million.
If a company doesn't meet those targets, the lender could call the loan, but that doesn't usually happen. "Normally they'll negotiate with you to set new terms," says Kemp. "Usually it costs you money," since the interest rate is increased and the borrower is charged a fee for a new amendment to the loan.
As for when publishers should select one type of debt rather than another, Kemp draws a comparison to buying a house, when borrowers might have a mortgage and a home-equity loan on top of that with a lower interest rate. "Generally, you get a better return if you maximize your down payment," he says. "Senior bank debt is probably the first thing you want to do, but that will only go so far." A company making an acquisition for eight to 10 times EBITDA, for example, may only get three or four times EBITDA from a senior debt lender.
There is another form of lending;fixed-rate public debt or high-yield bonds;but it is available to just a minority of publishers, because the minimum deal size is $100 million and usually more like $150 million to $200 million. Advanstar Communications Inc. and Penton both have high-yield debt.
When to Say When
One big concern about debt is knowing when to say when. "If the house is too expensive for your means, don't buy it," Kemp says. Within the publishing industry, the accepted level of risk is a leverage ratio of five times a company's trailing EBITDA. "If you're doing $10 million of EBITDA and debt is $50 million or less, that's comfortable."
Commerce Bank's Kush puts it another way: "A good rule of thumb is debt should not be more than 65 percent of your capitalization structure."
BIA's Chappell warns of the excesses of the last downturn. "Ask lenders and investors how the years 2000 to 2002 treated them and you will hear them say for the most part that they lent and invested too heavily to the industry and got burned in the advertising downturn," he says.
And there's one unique aspect to lending to publishers, G.E.'s Harrington points out. Unlike manufacturers, for instance, media companies don't own many assets beyond their computers, which means that lenders take an interest in intangible assets, like lists of advertisers and subscribers and the names of the publications. "The value of that is a judgment," he says.
The Value of Borrowing:
The various debt facilities offer an array of options and you cede no control of your company. But lenders get paid first, and require strict financial covenants.
The Characteristics Of Debt as a Capital Source:
Amount typically loaned
Three or four-times leverage;meaning to the trailing EBITDA. Generally, this is tied to LIBOR plus spread of 2.5 to 3.5 times over LIBOR. (LIBOR is the London Interbank Offered Rate Index, an average of the interest rates that major international banks charge each other to borrow US dollars in the London money market.)
Senior debt is the cheapest because it has the first call on assets.
Depending on the lender you might start paying back principal sooner. Term length is usually five-to-seven years. Payment is smoother but scales up. More principal is paid earlier in the term.
Amount typically loaned
This option will take you up to 4 or 5 times trailing EBITDA.
Second-lien debt is more expensive. It may be LIBOR plus 500 to 700 basis points.
Cash payments on interest. It doesn't accrue;the borrower makes quarterly payments. Usually the term length is the same as senior debt. Principal payment is modest at first with a big balloon at the end. Up to the last year the publisher may have only paid 14-20 percent.
Higher leverage. This might be 10.5 to 11.5 in annual percent interest rates. Because it is subordinated further, the interest rate is much higher. But there are more flexible terms.
You may have the option of paying interest or letting it accrue, or offering warrants on the equity. Term length is typically five-to-seven years. You work with the lender on what works best.
Amount typically loaned
This financing is only available on large transactions. The minimum size is $100 million.
Cash-pay interest with a fixed rate. Fixed rate. The borrower pays interest twice per year and no principal until it matures.
The term length can be seven-to-ten years or more. There are limitations on ability to pay back early;if the borrower choose to do that, a premium must be paid. But there are no covenants with bonds.
Source: Thomas L. Kemp, VSS