| NEW YORK
NEW YORK Data center operator Cyxtera is the first leveraged loan issuer to try to protect itself from moves by the US government to cut tax deductibility on interest payments that would make buyout financing more expensive.
The proposed changes will penalize heavily indebted companies, including many private equity-owned firms, which have benefitted to date from effectively being able to subsidize debt interest payments.
A US$1.3bn leveraged loan that backs Cyxtera’s buyout by BC Partners, Medina Capital Advisors and Longview Asset Management is the first deal to try to limit increased costs if tax deductibility ceases. Citigroup is leading the deal.
The financing, which includes an US$815m first-lien loan, a US$310m second-lien term loan and a US$150m revolving credit facility, also offers call protection, a standard feature that helps investors to keep assets by making it more expensive for companies to repay loans early.
The company is asking lenders to allow it to ‘call’ or repay its more expensive second-lien loans at a lower price than it would otherwise have to pay, if the tax changes come into effect.
Cyxtera, the data center business of telecommunications company CenturyLink, was bought by the private equity consortium for US$2.8bn in a deal announced last November.
The company’s first-lien loan is being sold with traditional six months call protection at 101 cents on the dollar and its second-lien debt has a higher penalty of 102 for the first year and 101 for the second year.
Cyxtera is, however, asking lenders for permission to buy back the second-lien loan at the lower price of 101 in the first year if the US government shuts the tax deductibility loophole for interest payments.
The prospect of higher debt interest payments is making companies and private equity firms think twice about lining up expensive loans – or come up with ways of getting out of steeper interest payments if tax deductibility disappears, particularly on large leveraged loans.
“I would not be surprised to see this springing up more often, especially in the large cap deals and cov-lite deals, which tend to include more bond-like terms and provide maximum flexibility for sponsors and borrowers to pursue growth initiatives and incur additional debt,” said Samantha Koplik, partner at Dechert LLP.
Covenant-lite loan issuance is expected to break a quarterly record volume this year after intense repricing and refinancing activity in the first quarter, according to Thomson Reuters LPC.
The language is expected to crop up more often on second-lien loans, several lawyers said. Second-lien debt is also rising with US$4.2bn of volume so far this year, more than double last year’s first quarter total. Fourth quarter was even stronger at US$8.6bn.
Higher costs could also prompt companies to use debt more carefully and focus on rapid repayment and deleveraging during the life of a term loan instead of constantly refinancing loans.
“It may mark the beginning of a swing back to a model where companies are really looking to de-lever over the course of a term loan facility,” Koplik said.
Cyxtera’s request to refinance its second-lien loan in the first year with a lower prepayment penalty if the tax changes are passed is anticipating a significant shift in the cost of debt that could alter the entire capital structure, Koplik said.
Lenders are being asked to agree to provide this repayment flexibility at closing, which allows borrowers to avoid having to negotiate later when the outcome and impact of the tax changes are clear.
Investors are considering Cyxtera’s request before a commitment deadline of March 14 and are open to similar requests - as long as they are compensated.
“It’s something that we would consider,” said Joe Mayo, managing director and head of investment research at asset manager Conning.
Investors that bought the loan in the secondary market above the level that it could be called could be impacted. This is more of an issue for bonds than loans, which typically do not trade higher than 101.
“If you’re going into it with full knowledge, and you’re buying in the new-issue market, you’re aware of that potential risk and you’re not going to be facing a significant downside if it does get called away from you,” Mayo added.
Some investors and leveraged loan lawyers are wondering what other concessions private equity firms may demand if Cyxtera’s request is passed as they seek to recoup higher costs and whether they will be limited to the year of any tax change or the full maturity of the loan.
“Is there going to be pressure from companies, or private equity sponsors to push the redemption price down to par?” a lawyer said.
BC Partners declined to comment. Medina, Longview and Citigroup did not return request for comment.
(Reporting by Jonathan Schwarzberg and Lynn Adler; Editing By Tessa Walsh)