No bank deals in the UK? Try a slice of Turkey

Times are tough in the private equity arena. According to some, the world is now facing the very real prospect of financial meltdown and, in the mainstream markets at least, liquidity is nowhere to be had.

Sovereign wealth funds, as detailed in this column earlier this month (The Lawyer, 10 March), have to some extent stepped into the breach, buying stakes in all manner of businesses, providing much-needed cash injections to Western banks such as Citi, and even pumping $4bn (£2bn) into a vehicle for ailing financial institutions set up by private equity house JC Flowers.

However, the role of sovereign wealth to date has been largely to provide equity. For private equity houses, which were unarguably at the forefront of the erstwhile M&A boom, investments require debt. The problem is that debt is now incredibly difficult to access.

Although lawyers across the City are adamant that they still have strong pipelines of work, evidence of this is scant. As Ashurst private equity partner Stephen Lloyd admits, there is not really much of a market for debt-backed transactions at the moment.

But of course ‘not really’ does not translate to ‘not at all’ – and while bulge bracket banks may be loath to lend, local banks are getting a piece of some private equity action that might otherwise have passed them by. Turkey is a case in point.

The timing of the first major private equity transaction in the country could not have been more perfect from the local banks’ point of view. When Kohlberg Kravis Roberts (KKR) announced its acquisition of Turkish shipping company UN Ro-Ro on 9 October 2007, credit squeeze fever was at its hottest. Debt finance for the acquisition was therefore arranged by local banks Garanti Bankasi and Turkiye Is Bankasi under advice from Clifford Chance partner Raymond O’Connor. The magic circle firm had done some work in Turkey before, but gaining this instruction could yet prove crucial – already the firm has won an instruction on another high-profile Turkish buyout.

Clifford ;Chance ;banking partner Charles Cochrane advised GarantiBank, IsBank and VakifBank as financiers on BC Partners’ acquisition of a controlling stake in the Migros supermarket chain. (At £818.84m, the transaction is unlikely to set too many pulses racing, but the fact that Migros was owned by the influential Koc family, which owns numerous companies and banks across Turkey, is significant.)

From Cochrane’s point of view, these local banks in Turkey have been the beneficiaries of low liquidity in mainstream banks.

“Turkish banks haven’t really been affected by the credit crunch and the liquidity from the private equity houses’ established banking links wasn’t around,” he says in regard to the Migros deal. “KKR and BC Partners didn’t have historic connections with these banks, but when a private equity house is looking to execute a deal fairly quickly and they want liquidity there’s a real opportunity for these banks.”

The Turkish banks’ instruction on the KKR deal could largely be put down to fate. While the local knowledge of domestic banks is useful on any transaction, had it not been for the credit crunch the private equity house would almost certainly have wanted its main relationship banks to be involved.

That said, the fact that KKR had already worked with local financiers gave BC Partners the confidence to also use local players.

“BC Partners took a huge amount of comfort from the fact that KKR had already done a deal with these guys,” says Cochrane.

The implication must surely be that the way has been well and truly paved for more Turkish deals to be debt-financed on the ground.

But can Clifford Chance stake the future of its private equity finance practice on this? Almost certainly not. As Cochrane points out, while the Turkish banks are building up solid execution records and gaining a real understanding of where Western sponsors are coming from, their appetite is purely local. These banks will not be stepping in to finance multinational transactions any time soon.

Besides, while these recent transactions have generated a lot of interest in the legal community and beyond, in fact they are barely groundbreaking or, indeed, innovative.

When the bull market was raging in April 2006, Cleary Gottlieb Steen & Hamilton partner Simon Jay represented Texas Pacific Group (TPG) on its $900m (£449.96m today) acquisition of Turkish spirits producer Mey Alcoholic Beverages. The financing was led and syndicated locally.

Cleary finance partner Andrew Shutter says: “The financing by local banks has been going on for a long time. It’s a function of who’s been looking to do what investment. In 2006, when financing the Mey deal, it was led by a local bank and syndicated locally because all the funds buying the paper had some rules that prevented them going outside the EU – the normal source of finance wasn’t available because of where the target was.

“The big divide is whether you’re looking at an EU or non-EU country,” he adds, pointing out that, before the Czech Republic joined the EU, local banks would have ;provided ;the ;bulk ;of financing on local transactions. The volume of transactions being done in the Czech Republic at that time is, of course, debatable.

That said, Shutter acknowledges that imaginative ways of financing private equity deals are required amid current market conditions, and points out that vendor finance, which was a feature of the previous downturn, is set to make a comeback.

The markets have undeniably changed. And while the future remains almost totally unpredictable, deals are still being done – and done in interesting ways.

That is not to say it is business as usual for all the transactional lawyers out there – far from it. Credit has been squeezed and prices are beginning to feel the pinch too. Surely it is only a matter of time before that begins feeding through to fee structures.

The rise of vendor finance

Previously, a private equity house would finance a deal using a small equity stake, with the remainder of the cash coming via bank loans. In the absence of such debt it can be in the seller’s best interest to provide the finance rather than accept a knockdown price, with the private equity house paying off the debt out of cashflow over a period of around three years.

In 2002 TPG, Bain Capital Partners and Goldman Sachs Capital Partners, advised by Cleary’s New York office, used this facility to buy the Burger King Corporation from Sullivan & Cromwell client Diageo for $2.26bn (£1.13bn today) ‘in cash’.

Of course, vendor finance might not be necessary, as sellers are coming around to the reality that high asking prices are simply not sustainable. In some instances prices are being slashed by as much as 30-40 per cent.

Ashurst’s Lloyd explains: “There have been some deals with savage price cuts with reference to the market. In the past the sponsor would say they’d found something horrible in the due diligence and ask for a price-cut. Now the sponsor just says they don’t want to pay that price and the seller says okay.

“Most people are saying that the reason there’s not a market is that vendors haven’t changed their price expectations to cope with the lack of funding, but there are some signs of it now.”

Buyers’ ;hands ;could ;be strengthened even further by the fact that, for smaller transactions at least, there is still some bank funding available – although with the lending criteria seriously tightened the levels of debt being taken on have dropped.

The problem this creates from private equity’s point of view is that cash buyers could come in and trump those that need to saddle themselves with masses of debt.