Mezzanine Debt to Get the Deal Done
by Thomas J. Buono, BIA Financial Network
As most newspaper owners realize, it is a seller's market. The number of newspapers is limited and the demand exceeds the supply. You must compete with other local owners, group owners, publicly-traded companies and possibly other media for that key acquisition. It is an environment in which daily papers often trade for between 9 times and 15 times EBITDA. It is an environment in which banks prefer to lend between 4.5 and 5.5 times EBITDA. Consequently, buyers must put up more equity, settle for a lower return on equity or employ a different capital structure in order to get the deal done.
One financial vehicle being used more frequently in communications deals today is mezzanine financing. This junior capital can take the form of subordinated debt with current and/or non-current interest, subordinated debt with warrants or even some type of junior preferred equity. This funding is subordinated to the senior debt and has a priority to the common equity, hence the name mezzanine. It is more risky than the senior debt and less risky than the equity, and its cost typically falls in between these alternatives. It is not uncommon for private mezzanine debt to have an all in rate of return in the high teens to low 20% range. However, this funding has greater flexibility when it comes to length of term, current interest, deferred rates and other terms. Unlike outside equity, mezzanine’s ownership stake (through warrants) in the company is nominal, if at all.
To illustrate how mezzanine debt can be beneficial for acquisitions, consider the following example:
You learn of an adjacent market newspaper that is for sale. It has EBITDA of $3 million, has been under-managed and has strong potential when combined with your existing papers. You have unused bank lending capacity of $10 million on your existing company and your lender is willing to lend 5 times EBITDA for this acquisition.
Scenario 1: Sales Price $36 million $25 million Senior Debt $11 million Equity =$36 million Purchase Price
If the sale were to happen at $36 million, you could use the senior debt for $25 million ($10 million plus 5 times EBITDA) and employ $11 million of equity to get the deal done, assuming it was readily available. Alternatively, if financially constrained, you could use mezzanine debt to close the gap. However, other potential buyers are interested in this property and they bid up the price to $42 million. Now a deal that you could do at 12 times EBITDA is only available to you at 14 times EBITDA.
Scenario 2: Sales Price $42 million $25 million Senior Debt $ 6 million Mezzanine $11 million Equity =$42 million Purchase Price
Your due diligence indicates that you can grow EBITDA at a double digit annual rate. Rather than pass on this deal, you can employ mezzanine funding to help bridge the gap, without giving up a significant ownership stake in the company. Additionally, given the growth potential of this strategic buy, the resulting return on equity might even be enhanced due to such a capital structure.
There are many such situations in which mezzanine funding can help you conserve equity, and in some cases improve your overall returns. More importantly, in this competitive acquisition environment, mezzanine can help you get the deal done.