The concept of the one-stop shop may sound simple, but in reality it has more turns than a Rubik's Cube. In the context of a leveraged buyout (LBO), the idea of just one law firm advising one or two investment banks on the structuring of senior and high-yield debt appears to be truly inspired. After all, the structuring of an LBO is just a means to an end, with the main goal as securing the debt to purchase a company. Or so advocates of the one-stop shop theory would have us believe.
To delve deeper, however, is to uncover a veritable hornet's nest of unanswered questions. Are the investment banks really driving this? Is there actually a demand for firms to provide such a service? Are UK firms even capable of acting as all things to all banks, or is it a clever piece of spin doctoring intended to create an illusion of resource?
And underlying all this is the most important question: is every party involved in the LBO market – including the senior lenders, bond investors and the private equity houses – happy that investment banks use just a single law firm on transactions of mind-blowing complexity? Does the issue of conflicts figure anywhere in this equation? On current reckoning, it would appear not. And finance lawyers are exceptionally reluctant to address these issues on the record.
Most of the law firms in the UK that count themselves as leading lights in this area – Allen & Overy (A&O), Ashurst Morris Crisp, Cahill Gordon & Reindel, Clifford Chance, Latham & Watkins, Milbank Tweed Hadley & McCloy, Shearman & Sterling, and Weil Gotshal & Manges – have been given to much posturing about just how many deals the firm has “one-stop shopped” on.
But the fact that some firms have been rushing to secure a dual role on these deals has inspired some comment among bond buyers. “A dog chewing on a bone cannot see that it might have something tomorrow,” says one, colourfully. “So it just gorges itself until it is absolutely full, chucks up there and then and will deal with it tomorrow.”
And while both UK and US lawyers appear to be throwing themselves at the mercy of the investment banks in a quest for high-yield work with senior debt – as they did in the heady days of 1999 and 2000 when leveraged finance was the darling of the corporate world – the irony of the situation is the paucity of one-stop shop deals. “[The one-stop shop] is a product more talked about than done,” admits one senior lawyer.
There is scant evidence to suggest that this Holy Grail of acquisition finance actually does exist. For instance, Tim Grell, managing director of European leveraged finance at Merrill Lynch Europe, has had little experience of lawyers acting in a dual capacity. “The only first-hand knowledge I have is when I came over here in 1997 when there was one firm acting on senior debt and mezzanine,” he says.
One of the very few examples around is Shearmans' role on the LBO of Irish packaging and printing group Clondalkin, which was taken private by Candover in September 1999. Led by Shearmans' former head of European acquisition finance Stephen Mostyn-Williams, the firm acted for the lead arranger on euro300m (£189.8m) worth of senior debt for Warburg Dillon Reed and Allied Irish Banks, and high-yield debt underwriter Lehman Brothers on the euro120m (£75.9m) mezzanine bridge and the bond takeout. Clifford Chance, led by corporate partner Adam Signy, represented Candover on the deal.
It would seem, however, that some firms find defining the concept of providing a one-stop shop role on an LBO with high-yield a little more difficult; and this is where the spindoctoring starts. One area of particular confusion is where a firm acts on the “bridge”. This is a tranche of debt which is put in place within the LBO structure to aid completion of the deal. In simple terms, bridges are implemented because putting together the high-yield debt is a long and laborious process.
The bonds, which are funded from investors such as pension funds, are sold to the market through a US-style roadshow, where the issuer, ie the company selling the debt, will visit a high number of prospective buyers. A US-style prospectus is also produced, which requires hefty documentation. “It takes a hell of a long time and places a huge demand on manpower,” says one finance lawyer.
Mezzanine debt is often used in bridge financing. Because it is a product derived from privately held funds, it is much quicker to put together and is a convenient short-term alternative. But acting on senior debt and a bridge does not a one-stop shop make. Take, for example, the various interpretations of which roles law firms provided on the LBO of UK bookrunner Coral.
In December 1998, Ladbroke Group sold off Coral for £390m to Morgan Grenfell Private Equity, represented by A&O. Asked about his experience of one-stop shopping, head of banking at Ashurst Morris Crisp Nigel Ward says: “We acted for Lehman Brothers on the senior loan and structuring of the high-yield debt. Latham & Watkins acted on the documentation and the implementation of the high-yield. With a US firm it was thought at that stage we had greater experience of structuring a deal in Europe than they had.”
However, Mark Stegemoeller, a corporate partner at Lathams, interprets the deal in a different way. He says: “Ashursts acted on senior and mezzanine. It was the one to close the deal in February 1999 with the mezzanine which was then taken out by the [£80m] bond. Ashursts was involved in negotiating on subordination terms of the senior debt – but against us.”
Or there is the LBO involving Swedish-based CB Bus, where Adam Kupitz, a high-yield debt specialist who joined A&O from Sullivan & Cromwell's New York office (The Lawyer, 10 July), claims that A&O provided one-stop shop advice. However, Tony Keal, head of acquisition finance at A&O, says that the firm acted for Goldman Sachs, which initially underwrote the senior debt and the mezzanine bridge. Its work also included acting for the investment bank on the bond. It was the developments with the senior debt layer, however, that prevented A&O laying claim to a true one-stop shop service. The bankers on the deal decided that they wished to fund the senior debt through separate banks in Sweden, with local firm Mannheimer Swartling providing advice.
Despite the best efforts of law firms, there just does not appear to be huge demand from the investment banks for one-stop shops. Despite this, some law firms' strategies have been driven by a perceived client demand. In March last year, Milbank Tweed recruited Kevin Muzilla, a former senior lawyer from Cahills in New York, to capitalise on his relationship with a number of investment banks, in particular Deutsche Bank.
Equally, A&O's decision last summer to recruit Kupitz from the US was driven by Goldman Sachs, which recommended that it increased its capability in this area. However, three sources who are in a position to know say that Goldman Sachs' policy on legal one-stop shopping can vary wildly on both sides of the Atlantic. In fact, the sources say that in the US Goldmans is vehemently opposed to such a notion.
Other investment bankers are lukewarm at best towards the prospect of a bank-bond combination. Malcolm Stuart, co-head of leveraged finance at Schroder Salomon Smith Barney, says: “It's our view that there is no law firm in the City that is really good at it.” Although Stuart adds that he would seek out Clifford Chance or A&O for senior debt expertise, since they have experience of this market, he nevertheless says: “In the past we used one UK firm on high-yield in the early 1990s. It was like inventing the wheel – a three-minute decision would take days.”
Lok Lee, head of high-yield syndication at JP Morgan, which was taken over in September by Chase Manhattan for $36bn (£24bn), says: “The law firm I have on high-yield is not necessarily the best on senior debt. In the LBO market there's a limited number of really good banking lawyers, and you often find that they're conflicted.”
Steve Conway, managing director at JP Morgan, who says that he personally is inclined to use one firm, nevertheless admits that the bank itself has a more conservative approach to the issue.
Meanwhile, a source close to Deutsche Bank is equivocal. He says: “It really depends. There is no particular way – there are kinds of adjustments that can be made. The attitude is that they feel it may be a maturity issue in the US; they took the decision some years ago and they haven't got around to addressing it. While they're trying to sell senior bank debt, they don't want investors to think that they didn't subordinate the high-yield debt.”
And herein lies the crux of the matter. There is huge reticence on the part of lawyers concerning potential conflicts that could arise between the senior debt providers and high-yield investors. There are two ways that an LBO with high-yield debt can be structured: it can be subordinated or contractually subordinated. It boils down to this: what rights do the investors and lenders have should the company fold, and therefore become unable to repay its debts?
A&O's Kupitz admits that there are potential conflicts in working out what rights high-yield investors have in recovering their assets, since they are inevitably subordinated to the senior debt providers. “There is a conflict technically when representing the high and senior debt,” he says. “The issues are well known, but what it comes down to is a commercial issue, in that will the bank be able to get the senior of the high-yield off?” Kupitz adds that the firm deals with any potential conflict by having different teams working on different tranches with firm Chinese walls in place.
Bronwen Still, head of department in the professional ethics division at the Law Society, says: “With a situation like this, if it has been fully disclosed to the client I don't think we'd have a problem with that.”
But is everyone, especially those high-yield investors, being treated fairly in the structural makeup of an LBO as the lawyers chase the dream of the one-stop shop? Grell for one is not so sanguine on the issue. Merrill Lynch prefers to use two different firms on senior and high-yield, and will instruct a third practice should the structure also include a layer of mezzanine debt – as the bank did in the Vantico deal.
In June this year, Ciba Speciality Chemicals spun off its performance polymers division Vantico, and Merrill Lynch used a plethora of firms. On senior debt, underwritten by Credit Suisse First Boston and Merrill Lynch Europe, Clifford Chance advised. On high-yield debt, also underwritten by the two banks, Cravath Swaine & Moore acted. On the mezzanine, Shearmans was counsel, while on the sponsor side Morgan Stanley Development Capital used A&O.
Grell explains: “Primarily it's because in the UK we prefer to have two firms representing two classes of debt providers. We don't want to have a public bid view that the bond was structured the way it was because of our relationship with the senior side.”
One bond investor says he is cynical about how lawyers deal with the structural issue of guarantees, arguing that there is a natural bias to secure the commitment of the banks lending on the senior debt at the expense of the bond investor's rights. “When you sit and listen to a lawyer saying that they're going to put guarantees in place, they can give various rights to get down to the assets,” he says. “That's all well and good in giving you those rights, but don't play 'now you see it, now you don't' security.”
So while senior lenders are undecided on the merits of a one-stop shop, bond buyers are clearly prone to cynicism about the issue. One such buyer says: “The client of the lawyer is the investment bank – it might not get the senior debt work if it doesn't get the compromises on the high-yield.”
For the moment, most finance firms are adamant that a one-stop shop is what the clients want. But there are an awful lot of clients out there who need convincing.