April 12, 2012
Interviewed by: David Snow
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Stories of Sale-Leaseback Success

Most private equity professionals are aware of sale-leasebacks as an option for creative finance, but not everyone has entered into such a transaction. Privcap’s unique discussion series features three experts who have executed sale-leaseback deals and who share their experiences in compelling detail.

Most private equity professionals are aware of sale-leasebacks as an option for creative finance, but not everyone has entered into such a transaction. Privcap’s unique discussion series features three experts who have executed sale-leaseback deals and who share their experiences in compelling detail.

David Snow, Privcap: We’re joined today by Christian Oberbeck of Saratoga Partners, Kenneth Clay of Corinthian Capital Group, and Gino Sabatini of W. P. Carey. Gentlemen, thank you for joining Privcap Today. Welcome.

So today we’re talking about creative finance. But specifically, I’d like to hear your stories about how different kinds of creative finance were applied to private equity deals, how it worked and what the outcome was, and whether or not it was successful. So Gino, as someone who has worked on many, many sale-leaseback finances with private equity firms, can you think of one recently that was very illustrative of that form of financing really solving a problem or helping to add value to the deal?

Gino Sabatini, W. P. Carey: Sure. I’ll talk about one that we did a few years ago with a private equity firm called Sorenson Capital, because I think it does represent quite well what we do for the lower and middle market sized deals. They were buying a company called LifePort, which was a refurbisher of helicopters. They converted a helicopter into a medivac copter or search and rescue copter. So they called us, and they said, the seller, this individual, has these two facilities which he owns, and we would like to buy the facilities from him at closing, use the proceeds to help buy the company.

Total size of the deal was relatively small. For us, it was under $10 million for both buildings. They contacted us early on in the process. We closed as part of the acquisition financing.

The reason I wanted to use this example is 18 months down the road, they decided one of the facilities was doing very well and they needed to expand it. So they called us up, and they said, “We’d like to put another $2 million into this facility. Is that something you’d like to do?” The company was doing very well and we said, sure. So we expanded the building for them. It allowed them to expand their business and the company’s doing very well. I think it’s a good example of how we partner up with private equity firms.

Snow: Why wouldn’t Sorenson Capital have just gotten a loan or some other form of financing to expand their facility?

Sabatini: Well, when they did the initial acquisition, the sale-leaseback provided them with the highest level of proceeds. Once we did the sale-leaseback, we were the owners of the facility. So they came to us and asked us to put more money into the facility to expand it.

Snow: Ken, any interesting stories recently from your investment activities, where you were able to do something creative to help the company along?

Kenneth Clay, Corinthian Capital Group: Sure. We have a portfolio company that has been growing very rapidly and we were expanding. We built a new facility out of the profits of the business. But we had been very successful in doing an earlier financing, which was committed right prior to the credit crisis and then closed afterwards. So we had a very, very favorable piece of financing and fairly high leverage, about five times for a middle market business.

So we were kind of victims of our prior success. We didn’t want to upset this very favorable financing. But there was no additional leverage available in the market. And we had a company that was growing, and growing fairly rapidly. We quickly maxed out our revolver and we had assets, we had availability, we were performing in all material respects. But we needed some additional capital.

So we did a sale-leaseback with W. P. Carey, where we wrapped up the new facility, as well as a couple of the existing facilities that were acquired assets. Use of proceeds was not a problem for us, we just gave that over to the lenders, but primarily to pay down the revolver, a little bit against the term, and generated a lot of additional availability within that existing financing package to continue to grow the business.

It was a very tough time in the market. This was during the thick of the credit crisis and so this creative financing really enabled us to continue to execute on our plan.

Snow: How about you, Chris? Your firm often gets involved in complex investment situations and so you make full use of a whole set of financing techniques. Are there any that stand out recently as being very interesting examples of the use of creative finance to drive value?

Christian Oberbeck, Saratoga Partners: Well, in our own company, we had an instance where we had a subsidiary of one of our investments and they had some Defense Department work. We had an inquiry from one of the large defense contractors that they wanted to acquire that subsidiary. So we developed that inquiry and it was only for part of the business. Then we formalized a little process around it.

As we developed, the defense interest wasn’t sufficiently large, because it was the commercial side of the business, which they weren’t interested in. The other people that became involved and looked at it didn’t value it quite where we valued it.

But then we actually looked, and we had a building, an important building for the business. We were able to structure a sale-leaseback facility that was a higher value than we were offered for the whole business by the various parties. So we were able to, in effect, use a sale-leaseback to get what that limited market at the time– substantially more than the market would have gotten if it sold the entity. We got to keep the entity and develop it. So that was a very favorable outcome from a sale-leaseback financing.

To your other question on restructurings, I think creative financing, generally, necessity is the mother of invention. Often, the most creative elements come out of restructurings, because you’re pressed against things and conventional financing gets pretty much topped out.

I recall one deal I was in quite admiration of. GE is generally pretty good at alternative financing. Collins and Aikman, I don’t know if you remember, they had a lot of problems. They were on the verge of bankruptcy.

Snow: Right, this is an automotive company.

Oberbeck: Automotive supplier. For a whole bunch of reasons, they were on the verge of bankruptcy several years back. They needed $100 million to push off the bankruptcy. There was no way to get it from all the different facilities. And they found out– they actually did a sale-leaseback of their Mexican production facilities that was an exclusive supplier to Ford. And they did $100 million financing in the really most complicated situation.

The company eventually went bankrupt. But the way they structured the sale-leaseback financing was outside of the credit facilities. So they actually owned that facility in Mexico outright and the contracts with Ford. They provided the financing. The company actually ultimately went bankrupt. But then it was viewed as a necessary asset and then the company kept paying the lease payments throughout the bankruptcy and rolled the whole thing forward, because it was essential for the value of the whole enterprise.

So in restructurings, you often find things that maybe you weren’t as aware of before because you have to, just to make things go.

Sabatini: It’s so funny you used Collins and Aikman as your downside example, because I was going to use the same company. We did a $50 million sale-leaseback with them in 2002.

As part of our underwriting, there’s really three things we look at– the value of the real estate, the ability of the tenant to pay the rent– in other words, the credit– and then the criticality. It was very important to us that we got critical facilities so that, in the event they had problems, they would be leases that got affirmed. Basically, that’s what happened and we came out of that deal without losing too much money. And we were very happy about that.

Snow: So anyone joining the conversation table, walk us through when sale-leasebacks don’t work. What tend to be the common themes? Is it, as you said, the criticality, the fact that the seller of the assets not only can no longer pay, but actually can afford to go without the usage of the real estate?

Sabatini: Sure. If they don’t need that real estate, and they’re obligated to leases which they have to pay rent, they’re going to get rid of them. Kmart’s a perfect example. That company went bankrupt, primarily to rid itself of underperforming leases. That’s why most retailers go bankrupt, quite frankly. So yeah, if you’re doing a sale-leaseback, you want to make sure you have critical important real estate at a reasonable basis.

Snow: Since we’re talking about creative financing gone awry, or creative financing that actually ends up challenging the performance of a company, does anyone have any stories, without necessarily naming names, of times when creative financing took you on a roller coaster ride?

Clay: I’ve got a couple, actually, typically involving structured financings and seller notes. I think they’re great to get deals done. They can be the difference between getting a deal done and not getting a deal done. But if you have to go back and revisit it, then it is often another painful negotiation.

We have a couple of portfolio companies that sort of involved such discussions. One was a company that we bought, in retrospect, at kind of the peak of a cycle. And we had a seller note that ranked senior to our equity. And we ended up putting some additional equity in.

But then you have a discussion about, is the senior note impaired? If so, by how much? What does the senior note holder– I’m sorry, the seller note holder– have to do to modify or extinguish that note in order for the new equity to come in? Do they participate in that if they’re stockholders?

In this particular case, we had a pretty good outcome, we’re both we and the seller note holder put in some additional equity and the business is performing much better. We’ve rejiggered the balance sheet in ways that make sense for the company. But when you have to go back and revisit those things, it’s tough when they rank ahead of your equity, as they often do.

We had another situation with a seller note, where the seller was able to get his price by, in part, taking back some paper on a business that was performing. It was performing sufficiently well that we could do a dividend recap. His note was set to accelerate and be paid off under those terms.

But it was large enough, as a percentage of the prospective proceeds, that it kind of rendered the transaction not worth doing. In this particular case, he owned a fairly significant minority share of the business and stood to benefit from the dividend recap, versus us not doing it at all. So we had to go back and revisit those terms, rate, maturity, and have a partial paydown to get something done.

So it would have been easier to be able to keep that note in. But that just wasn’t the way that it played out. So we got our transaction done, and it worked out well for us. But the lesson is that if you have to go back and revisit those things under circumstances that are different than what you envisioned, whether they’re better or worse, then you have a whole other round of negotiations, which can be cumbersome, but still, in the end, usually worthwhile.

Snow: Do you agree, Chris?

Oberbeck: Well, your question earlier was about how you call it, a roller coaster. We had the transaction, a company we were acquiring in Germany from a much larger company. The company wasn’t performing well. We were paying a fairly low purchase price. They made glass, specialty glass, among other things and they had a glass furnace.

We had the deal kind of negotiated based on cash flows, asset values, and the like. There was just one line item in the accounting report that just said, metals lease. And it was, 700,000 euro a year or something like that.

So we get it right away in documentation for the deal. Then we just assumed it was just another lease. It turned out that that was a sale-leaseback of platinum and rhodium metals from a German banking institution that was loaned to this parent company that was not levered, was doing very well.

They wouldn’t let that lease– we didn’t even know what it was. No one explained it to us until we found out. We didn’t even know that there happened to be, like, 19 million euro worth of platinum in this furnace. They didn’t explain it or anything. So that caused a little bit of a breakdown in the communication around the deal for a while. We had to figure out what to do with that.

We ultimately worked out, effectively, a seller sale-leaseback. So we did a sale-leaseback with the seller of that plat.  So they took it on to their books. Actually, they were able to keep it back-to-back financed,  but it caused a several month delay in the deal and almost broke over that.

Snow: Gino, you mentioned the three gates, or the three screens, that your firm looks at in order to do a deal. How often do you say, no, thank you? And what is the most common reason why you would choose to pass on providing financing for a deal?

Sabatini: We usually don’t pass. We usually do most deals. No, in all seriousness, if we have no leg to stand on, if we have a terrible piece of real estate– and by that, I mean a nonfunctional, older building in the middle of nowhere– and we have a credit that we do not think will be able to pay the rent, well, that’s going to be tough deal for anybody to get done.

On the other hand, you can have a terrible building, and we will pay very high dollar per foot for it if there’s a good credit that we really have very little doubt will be able to pay us the rent for 20 years. As Jason said in one of the earlier sessions, we will pay a little bit more than the property is worth, because we’re relying on that cash flow stream more than anything else.

Snow: Any top lessons learned from your years of being creative?

Oberbeck: Well, I guess there’s different stages. Obviously, when you’re doing the acquisition on the front end, I think one thing you want to be very careful about is pushing the creative envelope into a situation that can’t get executed. You’re dealing with people that sometimes represent things that basically don’t happen. You get shot down at credit committee, or the market’s not there, or something like that.

So I think you need to be appropriately conservative about what is really going to get done to win the deal on the front end. I think you just want to be careful not to take little flights of fancy as to what can happen to make things great, and really be more “middle of the fairway,” I think, in getting hold of a deal if it’s competitive.

Now, at other points in time, like in restructurings– your own, or if you try to enter someone else’s restructuring– one lesson is that there’s always something there, always. There’s always a loophole. There’s always a gap in a document. There’s always an asset. There’s always something creative that can be done. You just have to find it.

And sometimes, you don’t find it till late in the game. Or sometimes, you find it early in the game. But there’s always a way to do something a little differently. Sometimes, you need consents of people. But there’s a deal to be had if you can generate incremental liquidity, especially in a restructuring type of environment. Because new money is usually the toughest thing to find. But if you have some way to do that– and there always is a way. There’s always something that can be done. That was one of our lessons.

Snow: Gino, what kind of advice do you find yourself giving to GPs again and again, or rather, giving to GPs most frequently, who get in touch with you and say, hey, we’re thinking about doing a deal with you? What do you find yourself explaining most often?

Sabatini: Well, I mentioned in the last session, the criticalities is really the most important thing that a GP should think about. It is a long-term relationship. We would love it if they wanted to do buildings, which were important to them. But they should think down the road, because this is a long-term situation. And they have to think through their exit, how the sale-leaseback is going to work with that. That’s the most typical conversation.

Expert Q&A With Jason Fox, Co-Head of Domestic Investments, Managing Director, W. P. Carey

From a private equity perspective, how does a sale-leaseback work?

Jason Fox: A sale-leaseback is a relatively straightforward transaction. A corporate owner-user who has a long-term need for the sale-leaseback but wants to unlock the value and the equity tied up into that real estate will choose to sell their real estate to an investor like us, W.P. Carey. In turn, they’ll get 100% of the market value of the real estate. We, in turn, will execute a lease with that company and get a long-term income stream that our investors are looking for.

Are sale-leasebacks only executed at the outset of a private equity deal?

Jason Fox: These sale-leasebacks can happen at any point in time with a company. When we work with private equity firms, there’s really a number of reasons why they would do these. First and foremost, it is an illiquid asset. For them, they’re able to unlock equity by doing a sale-leaseback at this point in time, whether it’s initial financing of the transaction when they buy a company. They can capitalize their investment with your typical sources of equity and debt, but also some alternative financing such as a sale-leaseback. It adds leverage to the equity. It also decreases the cost of capital.

What is ‘cap-rate arbitrage’?

Jason Fox: When a private equity firm does a sale-leaseback, there is this cap-rate or multiple arbitrage that occurs, especially when they’re buying industrial companies that tend to trade at lower multiples. For instance, an industrial company that they may be buying for six times cash flow that owns its manufacturing plants, its corporate headquarters, maybe some distribution plants. We can do a sale-leaseback on that and current pricing in the sale-leaseback market, based on cap-rates or capitalization rates, are typically in the 7% to 10% range, which is effectively equal to a 10 to 14 times multiple for those cash flows. So the simple math is, if they’re buying companies for six time cash flows and selling a portion of those cash flows in the term of rent to us at 10 to 14 times, it’s immediately accretive to their equity.

Where in the world does W. P. Carey operate?

Jason Fox: Well, W.P. Carey’s truly a global firm. We currently own assets in 18 different countries. We can do cross-border transactions. We’ve done a number of deals in which, certainly in North America, are more common. We have a company that has distribution facilities across Canada, the United States, and Mexico where we’ll do those seamlessly.

In fact, a big part of our business is doing follow-on investments with private equity firms. We tend to follow our tenants, our partners in the private equity firms, to other countries. As they buy new portfolio companies, whether it’s in emerging markets such as Brazil or in established markets in Europe, we’re able to do sale-leasebacks with them. After you do your first transaction, each follow-on tends to be even more seamless.

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