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Private equity companies are known for keeping a keen eye on costs, even when times are good. Collapsing software and gaming valuations, though, must be providing an extra frisson for the buyers of Electronic Arts.
Silver Lake, Saudi Arabia’s Public Investment Fund and Affinity Partners agreed to buy the video game maker for $55bn in September. Since then, gaming shares have taken a tumble: rival Take-Two Interactive, for example, is down by a fifth. That may help explain why the incoming owners of EA, known for its football and NFL games, are taking a robust approach to dealing with its bondholders.
Typically in a leveraged buyout, holders of the target’s outstanding public debt receive a payout equivalent to 101 cents for every dollar of face value, under the so-called “change of control” provision. But EA’s owners have invoked a “defeasance” clause in the bond documentation. Instead of buying back the bonds, they will buy a pile of US treasuries, place them in a trust, and use the income they generate and the securities themselves to cover all future interest and principal payments. EA’s notes, due in 2031 and 2051, in effect become treasury-backed instruments.
For EA, that’s good capital management. Its 2051 bond, issued in a low-rate environment, yields 2.9 per cent while 30-year US treasuries yield about 4.6 per cent. That means the company can spend less on treasuries to make up the same interest payments. Instead of the roughly $1.5bn they would have spent paying everyone back at 101 cents, they only spend about $1.1bn buying treasuries, Lex calculates. Sure, that’s a tiny sliver of the private equity companies’ total equity investment, but every little helps.
Some bondholders, however, are displeased. From a net present value perspective, they are no worse off. They receive identical cash flows to those their bonds promised, now backed by the US government. But these quasi treasuries will be hard to trade, and anyone who tries to sell may have to accept less than their face value.
In recognition of this, EA has offered to buy them back at a treasury-equivalent price of roughly 73 cents on the dollar for the 2051 notes. That might be attractive to long-term holders. But event-driven funds that piled in after the M&A announcement and drove up the price from about 60 to 95 cents on the dollar will be left nursing losses, and are pushing back at the company’s offer.
Defeasance clauses — the name literally means “to make null” — are widespread in corporate bond contracts. But incoming investors might have underestimated the likelihood that they are invoked. With treasury yields now much higher than yields on debt issued in 2020 and 2021, and many private equity buyouts facing lower valuations, EA may not be the last LBO to seek to take advantage of this contractual quirk.
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