Leveraged Buy-out of Kinetic Concepts Inc. by Apax Partners led consortium

This note deals with one of the famous deals of the year- acquisition of Kinetic Concepts Inc., (KCI or Company or Target), a Delaware corporation, a leading global technology company in the area of high-technology therapies and products for wound care, tissue regeneration and therapeutic support system markets by investment funds advised by Apax Partners (Apax Partners) and controlled affiliates of Canada Pension Plan Investment Board (CPPIB) and Public Sector Pension Investment Board (PSPIB) (KCI, Apax Partners, CPPIB and PSPIB are collectively referred as Parties and Apax Partners, CPPIB and PSPIB and their affiliates are collectively referred as Sponsors) and discusses in brief (a) the structure employed by the Parties for the acquisition and (b) the ‘financing clause’ under the merger agreement (Merger Agreement) signed between the Company and the entities controlled by the Sponsors.  

What in my view makes this acquisition deal interesting is that (a) the management was not very much interesting in running the Company, and (b) this happens to be a classic leveraged buy-out (LBO) transaction involving the issue of junk bonds for debt financing, which the US markets have seen in recent times.

Structure of the LBO transaction

Under the Merger Agreement executed on 12 July, 2011 between KCI, Chiron Holdings, Inc., (Chiron Holdings or Parent), a Delaware corporation, and Chiron Merger Sub Inc., (Chiron Merger Sub or Merger Sub), a Texas corporation and a wholly owned subsidiary (WoS) of Chiron Holdings, Chiron Merger Sub will merge with and into KCI (Merger) under the Texas Business Organizations Code and KCI will become WoS of Chiron Holdings, an entity owned by a consortium comprised of investment fund advised by Apax Partners and controlled affiliates of CPPIB and PSPIB (Chiron Holdings, Chiron Merger Sub, Apax Partners, CPPIB and PSPIB are collectively referred as Acquirers).  If the Merger is completed, shareholder of KCI will receive $68.50 per share in cash from the Acquirers (estimating the transaction value of KCI acquisition upto $6.1 billion) and the Company would be delisted from the New York Stock Exchange (NYSE) and made private.

 Financing clauses under the Merger Agreement

Among other things, the most important clauses of the Merger Agreement are ‘section 4.7’ and ‘section 6.15’ concerning with ‘Financing’ of the Merger transaction (Financing Clauses).  Under the Financing Clauses, the Merger/ acquisition would be funded by (a) equity financing up to $1.75 billion to be provided by the Sponsors to the Parent and Merger Sub (Equity Financing) and (b) borrowing of up to $2.6 billion under a senior secured term loan facility and $2.15 billion in aggregate principal amount of senior notes (or, to the extent those are not issued at or prior to the closing of the Merger, $900 million in senior unsecured bridge loans and $1.25 billion in senior secured second lien bridge loan) (Debt Financing).

               (a)   Equity Financing

Pursuant to equity commitment letter dated 12 July, 2011 the Sponsors (Apax Europe VII-A, L.P., Apax Europe VII-B, L.P., Apax Europe VII-1, L.P., Apax US VII, L.P., Port-aux-Choix Private Investments Inc. and CPP Investment Board (USRE V) Inc.) have committed to provide an aggregate equity contribution in the amount of approx. $1.75 billion to Chiron Holdings for the purpose of funding the equity portion for the financing contemplated under the Merger Agreement.

(b)   Debt Financing 

Pursuant to the debt commitment letter dated 12 July, 2011, Bank of America, N.A., Credit Suisse AG, Cayman Islands Branch, Morgan Stanley Senior Funding, Inc., Royal Bank of Canada and UBS Loan Finance LLC (Lenders) have committed to provide Merger Sub borrowings of up to $2.8 billion under senior secured loan term and revolving facilities and $2.15 billion in aggregate principal amount of senior notes (or, to the extent those are not issued at or prior to the closing of the Merger, $900 million in senior unsecured bridge loans and $1.25 billion in senior secured second lien bridge loans), on the terms and subject to the conditions set forth in the debt commitment letter.

Among other things, the obligations of the Lenders to provide debt financing under the debt commitment letter are subject to a following conditions:

•   consummation of the Merger in accordance with the Merger Agreement;
• execution and delivery of the definitive credit agreements and delivery of customary closing documents and legal opinions, including a solvency certificate;
• delivery of an offering document for use in a Rule 144A offering involving senior secured and senior unsecured notes, the proceeds of which would be used to complete the Merger and related transactions, and other data and information for use in such offering;
• expiration of a 20 consecutive business day marketing period  with customary blackout periods to seek placement of the notes with qualified purchasers 
• As a matter of market practice, the debt commitment letter was not subject to due diligence or a “market out” condition, which would allow the Lenders not to fund their respective commitments if the financial markets are materially adversely affected.

Further, under section 6.15 (c), prior to the closing, the Company shall and shall cause its subsidiaries to, and shall use its reasonable best efforts to provide to Parent and Merger Sub, at Parent’s sole expense, all reasonable cooperation reasonably requested by Parent necessary in connection with the financing, including:

• furnishing Parent and Merger Sub and their Financing sources required in registration statements on Form S-1 by Regulation S-X and Regulation S-K under the Securities Act, 1933 (Securities Act) and of a type and form customarily included in private placements pursuant to Rule 144A under the Securities Act;
• participating in a reasonable number of meetings, presentations, road shows, due diligence sessions, drafting sessions and sessions with rating agencies in connection with the financing;
• assisting with the preparation of customary materials for rating agency presentations, bank information memoranda, offering documents, private placement memoranda and similar documents required in connection with the financing;
• using reasonable best efforts to obtain accountants’ comfort letters and legal opinions as reasonably requested by Parent and facilitate the pledging of collateral in connection with the financing, including, executing and delivering any customary pledge and security documents (including security documents to be filed with the United States Copyright Office and the United States Patent and Trademark Office to register copyrights, patents and trademarks, as applicable, of the Company and its subsidiaries to the extent required in connection with the Financing), currency or interest hedging arrangements or other definitive financing documents or other certificates, legal opinions, surveys, title insurance and documents as may be reasonably requested by Parent (including a certificate of the chief financial officer of the Company with respect to solvency matters as of the Closing, on a pro forma basis); and
• assisting Parent in connection with its amendment of any of the Company’s or its subsidiaries’ hedging, swap or derivative arrangements on terms satisfactory to Parent.

 
Under the Form 8-K filed with the US Securities and Exchange Commission (SEC) on 11 October,    2011 the Company, KCI USA Inc., and investment funds advised by the Sponsors announced that Chiron Merger Sub, intends to commence an offering on or about 11 October, 2011, of $1,650 million in aggregate principal amount of second lien senior secured notes due 2019, comprised of a Dollar tranche and a Euro tranche, and $900 million in aggregate principal amount of senior notes due 2019 (collectively, the Senior Notes).  Upon consummation of the acquisition, the Company and KCI USA, Inc. will assume all of the obligations of Merger Sub under the Senior Notes and will become the co-issuers of the Senior Notes. 

Further, according to the Form 8-K filed with the SEC on 4 November, 2011, the Merger/acquisition was completed (consummation of acquisition) and it was announced- ‘In connection with the consummation of the acquisition, KCI and KCI USA obtained approximately $2,500 million of senior secured financing under new credit facilities and issued $1,750 million aggregate principal amount of second lien senior secured notes due 2018 and $750 million aggregate principal amount of senior notes due 2019.  The new credit facilities and the second lien senior secured notes will be guaranteed by certain of KCI’s and KCI USA’s parents and subsidiaries and will be secured by substantially all of the assets of KCI, KCI USA and certain of their parents and subsidiaries.  The senior notes will be senior obligations of KCI and KCI USA and will be guaranteed on a senior basis by certain of their parents and subsidiaries.  KCI used the net proceeds from the new credit facilities and the notes offerings to pay the consideration under the merger agreement and related transactions, to refinance existing debt and to pay certain costs and expenses of the transactions. 
 
It is pertinent to note that the total debt raised by KCI post-Merger/ acquisition by Sponsors is equal to 7550 million, which is much more than as required under the debt commitment letter provided by the Lenders.  Now, the balance-sheet of KCI is highly leveraged and now it is upto the performance of Sponsors how they run the Company and repay the debt and exit out of the Company in near future.