Wall Street finds a new way to finance unprofitable tech companies
No gains? No problem. Investors are funneling money to unprofitable software companies through a new type of debt deal.
Non-bank lenders like Golub Capital, AllianceBernstein Holdings LP and Owl Rock Capital Partners LP have issued asset-backed bonds to help fund around $ 2 billion in loans to these companies since November, according to data from Kroll Bond Rating Agency. Inc. and S&P Global Market Intelligence. Most of the loans go to fast growing but still unprofitable software companies.
The eruption of recent transactions is the latest indicator that large investors have resumed their hunt for high yield debt to offset low interest rates on safer government and corporate bonds. It also highlights the growing reach of private debt funds, which have replaced banks in many transactions and resisted Covid-19 despite fears of suffering from a surge in defaults.
Loans backed by complex bonds – called asset-backed securitizations or ABS – can be modest, like the $ 25 million Golub provided to software delivery specialist CloudBees Inc. Other deals run in the hundreds of millions of dollars, as the $ 300 million Rock Owl loaned to support the leveraged buyout of software security firm Checkmarx by private equity firm Hellman & Friedman LLC. Golub has been lending since 2013 and has had zero defaults, even during the pandemic-induced economic downturn last year, according to a credit rating report.
Companies often take out loans to fuel growth without resorting to additional stock sales that dilute existing shareholders. If borrowers are having a hard time, they can cut costs to generate cash and cover their debts, which protects buyers of ABS bonds, those involved in the transactions said.
Yet some fund managers argue that the new deals pile debt on debt, ignoring the risk of default of relatively immature companies.
Demand for ABS backed by classic business loans known as secured loan bonds, or CLOs, surged late last year as markets recovered from the pandemic liquidation. But, the new deals are so unorthodox that major credit rating firms Moody’s Investors Service and Standard & Poor’s Global Ratings don’t rate most of them, those involved said.
Instead, most deals obtained ratings from the Kroll Bond Rating Agency, one of the three smaller companies competing with Moody’s and S&P for credit rating business.
“We try to be thoughtful in our approach,” said George Lyons, senior manager of Kroll. “It’s a new form of securitization but we are able to create a probability of opinion by default.”
Bonds amplify the amount that the companies that issue them can lend. Private debt funds provide loans to dozens of companies, using their own capital and the money raised by issuing ABS bonds. Cash flow from pooled loans pays interest and principal to holders of ABS bonds, with any excess going to the funds and their customers.
A single investment bank, MUFG Securities Americas Inc., arranged all transactions for the lenders, selling them primarily to US investors specializing in ABS, the sources said. Spokesperson for MUFG, a subsidiary of Japan’s largest bank, Mitsubishi UFJ Financial Group Inc.
declined to comment.
“These are healthy businesses funded in a totally inappropriate way,” said Dan Zwirn, founder of Arena Investors LP, who helped create direct loans through his former company, DB Zwirn & Co. The rise valuations in the tech sector and increased competition among lenders allow companies to borrow excessively, he said.
Supporters of the deals say they are structured more conservatively than traditional business loan securitizations, with about two dollars borrowed for every dollar loaned, compared to the roughly 9-to-1 ratio common in conventional CLOs. At least a quarter of the loans pooled in the ABS deals were more conventional business loans and Owl Rock’s deal has a minimum 60% allocation to these traditional loans, which allowed it to achieve a unique credit rating. A from S&P. Lenders have also developed new analytical tools to measure risk in transactions.
Debt funds providing sub-investment grade corporate loans have historically lent to companies bought by private equity firms. Lenders used the debt-to-earnings ratio, often referred to as leverage, to analyze whether target companies could bear the debt borrowed to acquire them.
As tech companies became a bigger part of the U.S. economy, private equity firms also began to buy them, starting with established, profitable companies before moving to more speculative ones that traditionally relied on the market. venture capital to obtain liquidity.
Debt investors have traditionally been reluctant to lend to companies with little or no profit because they cannot get the spectacular returns from equity investors if a company is successful, but can still incur large losses if it fails. This attitude has changed in recent years, with investors increasingly convinced that these companies will not fail, thanks to their own belief in companies and the committed support of private equity firms who have paid a high price for them. companies.
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Companies like Golub have focused on software-as-a-service, or SaaS, vendors that license their technology to companies ranging from hospitals to hair salons on long-term contracts. Fund managers began to provide loans secured by recurring contract income, believing that cash flow was predictable enough to repay debts as end users of the software become heavily dependent on it.
“We started doing recurring income loans in 2013,” said Craig Benton, head of structured products at Golub. As the business grew, the business began borrowing money from banks to increase the amount it could lend and increase its returns.
Golub began exploring the use of ABS to further develop its software lending business about three years ago and raised $ 209 million in debt with its first deal in October 2019. The financial fallout from the coronavirus has resulted in the halt of riskier ABS sales for most of 2020, but MUFG arranged new financing for Golub and Owl Rock in November and has closed three more deals since.
The average credit quality of loans is equivalent to debt with a single B or triple C rating, two of the lowest rungs on the credit rating scale, according to a Kroll study. If borrowers default, it’s unclear how much lenders will get back. “It’s a relatively new asset class with limited recovery data,” Kroll said in a report.
With the fall in interest rates, investors have been willing to accept lower yields on ABS bonds. The interest rate on the one Golub issued on April 6 was 3.2%, compared to the 4.722% he had agreed to pay in his first transaction.
Write to Matt Wirz at [email protected]
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