The high yield market broke its fast for bond deals this week with Mercer International’s unsecured bond offering, which is getting more favorable buyside reception than the last crop of high yield deals following a turbulent month for markets, according to five sources following the transaction.
Though Mercer operates in the volatile paper pulp sector, the bond deal backing its acquisition of peer pulp mill operator Daishowa-Marubeni International (DMI) should benefit from an expanded pro forma operating footprint and strong free cash flow as pulp prices ride a cyclical uptick, the sources continued.
Led by Credit Suisse, the Canada-based borrower’s Ba3/BB- USD 350m senior unsecured bond marks the first new high yield offering for nearly two weeks, according to Debtwire data. Official price talk for the deal is in the 7.25% area as of Thursday morning, with books closing at 12.30pm ET, multiple sources said.
Recent high yield issuers have struggled — Atlantica Yield pulled its unsecured notes offering last week, while Avation priced its add-on at a discount and HC2 was forced to restructure its deal multiple times, eventually pricing a convertible bond and a downsized senior secured note.
Volatility has rocked markets over recent weeks, driving investor outflows from equities, high yield, and even leveraged loans. However, Fed chair Jay Powell’s comments in a speech Wednesday reassured investors over the pace of interest rate rises, sparking a rally.
Thanks to this more supportive backdrop and the fact that it is seen as a solid credit compared to most recent high yield issues, Mercer is expected to fare better.
Along with cash on hand, Mercer plans to use the proceeds from the bond to finance its USD 359.2m acquisition of DMI. The acquisition, announced last month, is expected to close in 4Q18, pending regulatory approval.
“It’s a good strategic acquisition, the credit metrics look strong, they have decent cash flow and the rating is up there, so they’ll be able to get it done,” one of the sources said.
Pro forma the deal, the company is 2.4x levered, based on USD 453.93m of combined operating EBITDA and USD 1.089bn total debt.
The rest of the company’s capital structure includes USD 100m 7.75% senior unsecured notes due 2022, USD 250m 6.5% senior unsecured notes due 2024, USD 300m 5.5% senior unsecured notes due 2026 and USD 30.73m in capital leases.
Based on USD 454m of EBITDA, roughly USD 74m of interest expense, USD 126m of capex and USD 33m of dividends, free cash flow comes to roughly USD 221m, or 20% of total debt, according to deal documents. Accounting for USD 65m of tax provisions, that drops to USD 156m.
Liquidity stands at USD 375.6m pro forma for the deal, with USD 220.2m of cash and USD 155.4m of revolver availability.
Mercer’s business can be split into two segments: pulp (89% of pro forma LTM revenue) and wood products (11% of pro forma LTM revenue).
The company expects the DMI acquisition to increase its annual production capacity for pulp by about 41% and surplus energy by about 8%, according to deal documents.
The deal will also add northern bleached hardwood kraft (NBHK) pulp to Mercer’s product mix and expand the company into Asia. The company anticipates USD 15m-20m of synergies per year due to a greater number of mills, primarily within 12 months of closing the transaction, according to deal documents.
Northern bleached softwood kraft pulp prices have been rising in recent years and should continue to drive topline and EBITDA growth for the company going forward, sources said. In 3Q18, the company’s pulp prices increased by roughly 34% to USD 852 per air-dried metric tonne (ADMT) from USD 638 per ADMT in the same period last year.
One source ran a much more conservative cash flow model based on higher capex and lower EBITDA to account for declining pulp prices, but still came up with FCF of USD 70m-80m (roughly 7% total debt).
Another source expressed concerns around cyclicality in the pulp and forest products space, but said Mercer was probably the best credit to own given those concerns.
“There are not a lot of other credits in the space I would want to own given the cyclicality of the forest products and tissue markets,” he said. “Capacity for turning trees into pulp and paper tends to come on in chunks, usually at the top of the cycle.”
At current price talk, the deal offers good compensation for concern around peak corporate earnings, one of the main drivers of the recent market volatility, one of the analysts said.
Mercer’s own USD 300m 5.5% senior unsecured notes due 2026 traded on Wednesday at 94 to yield 6.566%, down four points from 98 in early October, when the acquisition was announced, according to MarketAxess.
While the company has few direct comps, sources cited Brazilian pulp and paper company Fibria Celulose and Canadian packaging and tissue product company Cascades.
Fibria’s Ba1/BBB- USD 600m 4% senior unsecured notes due 2025 last traded on 2 November at 94.5 to yield 5.045%, according to MarketAxess. Cascade’s Ba3/BB- USD 200m 5.75% senior unsecured notes due 2023 traded yesterday (28 November) at 98 to yield 6.253%.
Mercer did not respond to request for comment. CS declined to comment.