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Kat Hidalgo

Brookfield has rolled on to the scene with a debt-heavy deal, though buysiders feel DexKo can tow the extra weight of leverage. Strong cash flow, a flexible cost base and diversified end markets hold up here. What’s stuck in the rut are the docs on this deal. Aggressive step-downs, unlimited capital leases/purchase money debt and more than flexible restricted payments capacity have driven buysiders to push back on a number of points, and with such aggressive step downs, pricing has also become a concern.

The first buysider said: “The credit is marmite. Some people love it, some people hate it, but we’re okay, subject to pricing.” A second buysider agreed, saying pricing was at the top of their list of concerns.

The third buysider said: "We're comfortable with the credit, but it's docs-dependent on whether we go with it."

Brookfield agreed to buy the Michigan-headquartered business in July 2021 for an EV of $3.7bn, around 10x “normalised” EBITDA. This includes the purchase price of Brink, a Dutch tow bar manufacturer, of $279m.

A sizable TLB of $2.21bn-equivalent, alongside $665m worth of SUNs, will finance an LBO of the business. The TLB will be divided between an $800m TLB and a €950m TLB and delayed-draw term loans of $160m and €100m, available for two years after closing, according to S&P. The company will take out a $200m RCF and a $150m ABL facility that will each remain undrawn at closing.

Price talk on the euro and dollar loans currently sits at E+425 bps and L+400-425 bps, respectively. The business is rated B2, with B1 ratings for the first lien and Caa1 for the SUNs.

DexKo sells auto parts such as axles and chassis for recreational and industrial vehicles in North America, Europe and Australia. It employs 6,000 people in 50 production facilities and 50 distribution centers around the world. Around 20% of the company’s revenues is generated from after-market services. The North American-focused DexKo acquired German business Al-Ko in 2016 and various acquisitions fit under either of these two brand names.

The transaction will leave the business with around $700m in extra debt, with all of its existing debt repaid. Previous TLBs included a €180m TLB paying E+400 issued by Al-Ko in 2019 and a €349m TLB issued by DexKo in 2018 paying E+375 bps.

The business is being marketed off of an EBITDA of $380m. An equity cheque of $1.167bn leaves marketed net senior leverage at 5x and total leverage at 6.75x. The first buysider admitted: “This is probably quite high for a cyclical name, and some people will look at it and say that’s much too high for an auto name.” 9fin estimates that with a fully drawn ABL facility and DDTLs, this would add around 0.9x of leverage.

However, there are minimal adjustments to EBITDA, putting actual leverage at close to marketed leverage. DexKo’s LTM to June 2021 EBITDA is less than $10m away from the company’s marketed EBITDA, according to one buysider, with the difference being from earnings from acquired businesses. LTM to June 2021 revenue was $2bn, according to Moody’s.

Ratings agencies and buysiders alike appreciate the business’ dominant position in its markets. The first buysider said: “It holds more than 50% market share in its core markets and it's roughly 5x larger than its closest North American peer and 3x larger than its closest European peer so that’s comforting.”

While both Moody’s and S&P mention the cyclical nature of the business, the first buysider stressed this was not your typical auto parts manufacturer. “The business is diversified across a wide range of applications, not just autos, but parts that you need for industrial applications, construction and oil and gas,” they said.

“It should be treated more like a diversified industrials supplier,” they continued. “They’re very large, but they sell to small customers and buy from small suppliers so they have good bargaining power as opposed to auto suppliers selling to major multinational car manufacturers. It’s much more defensive.”

Despite bullishness on the company, the first buysider did note there were risks associated with some of these end markets. “The business is doing very well post-pandemic. It’s enjoying tail winds such as a surge in camper van purchases where people were unable to go abroad, and high construction activity, which has also done well during the pandemic. There’s a question around whether these trends are sustainable.”

An omnipresent issue for manufacturers in 2021, raw materials pricing could be a concern for DexKo, but the first buysider wasn’t worried. “Raw materials volatility was there in Q2, but when you have a fragmented customer base, it’s easier to pass through price changes. There was no problem passing through changes and it didn’t affect their Q2 performance.” The buysider also noted the business’ flexible cost base.

Steel typically makes up 80% of the composition of automobiles, including chassis, according to Steelite. Shanghai Steel futures reached a record CNY 6,198 per tonne in May 2021, not dropping far below that since then, according to Trading Economics. On 17 September the price stood at CNY 5,709 per tonne.

Buysiders were unanimous in their dislike for the business’ weak documentation, with the first buysider calling them “worst in class” and the third agreeing they were “horrible.” The second buysider, went a bit more easy on the company, calling the docs “pretty bad.”

The third buysider was shocked at the inclusion of unlimited capital leases/purchase money debt. They said: "The docs were absolutely horrible on this, but what can you do? We've made doc changes suggestions and I'm hoping a few of the terms involved are typos."

Points of particular frustration for the first buysider included the “huge amount” of restricted payments flexibility. “The ratios are set too wide in terms of debt incurrence,” they said.

Two margin step-downs are currently present in the docs, representing 25 bps reductions where the closing date first-lien net leverage on the loans decrease by 0.5x and 1x, according to LPC.

The first buysider said: “The two step-downs aren’t ideal. People will probably push back on those, but at the same time, the market is also very hot right now. Also if a turn of deleveraging is delivered, you’d probably feel more comfortable in the business.”

The first buysider didn’t look kindly on the DDTL, as only ticking fees could be earned here. Ticking fees associated with these facilities will start off at 50% of the margin for both loans from day 61 after transaction close. This will increase to 100% of the margin on day 181, according to LPC.

DexKo has already undergone several stints of institutional investor ownership. Its vendor, KPS Capital Partners, acquired the business from The Sterling Group in 2017. It has made 26 acquisitions since 2021.

KPS invested more than $600m throughout its holding period, and the business made 15 acquisitions under its ownership alone, according to a press release.

The first buysider said: “The business has done very well under KPS and the existing management team. They have grown organically, increased margins and successfully consolidated acquired businesses. Brookfield’s strategy looks fairly similar to KPS.’”

Indeed, as CEO Cyrus Madon said on Brookfield’s Q2 2021 earnings call, the firm plans “to support opportunities to both enhance margins and accelerate growth.” When pushed by analysts on specifics of the plan going forward, he said: “We have an on-boarding plan. We will develop a detailed plan of how we're going to hit the ground running over the first few months, put in place our capital allocation strategy, look for growth opportunities and look for productivity improvement opportunities, all of which we identified before we bought DexKo, but we'll refine those strategies and start executing.”

With such a successful session of PE ownership already under its belt, one could question if Brookfield will generate significant value at DexKo. This had no truck with a fourth buysider though. They said: “This argument frustrates me. The sponsor can make whatever decisions they like. I’m looking at the deal from a credit perspective: Can they pay their interest?”

Moody’s expects a free cash flow to adjusted debt ratio of at least 5% in 2022, while S&P estimates annual free cash flow of $150-200m, on an S&P-adjusted basis.

The first buysider said: “They’re a big cash generator, and they have been over time.”

Cash Flow appears to be a focus for the sponsor as well. As Cyrus Madon said on a recent earnings call: “Like many of our operations, DexKo’s business has durable cash flows due to its strong competitive position and flexible cost structure.”

While cashflow does look promising, buysiders and ratings agencies alike expect the business to continue making smaller acquisitions in this fragmented market, likely using its DDLTs.

The firm will contribute $400m to a somewhat anemic equity cheque of $1.1bn, the remainder of which will come from institutional partners of Brookfield’s. The firm also reserves the right to syndicate some of its commitment to its partners, it wrote in a press release.

This is a common strategy for the firm. It also acquired modular building leasing services business Modulaire Group this year, taking a 30% stake of the business for $500m at a price of 9.5x EBITDA.

Such little skin in the game places more attention on the sponsor.

Opinions on Brookfield ranged from having little experience with the firm, to being positive on it. The first buysider said: “They’re a strong, large, blue-chip sponsor. They did a great job on Clarios.”

A battery manufacturer acquired by Brookfield in November 2018, Clarios was last in the market in February 2021 to reprice its debt. The business ended up allocating a $3.972bn TLB at L+325 bps.

Clarios also paid down its debt by $100m. The business’ most recent lender presentation shows it has also deleveraged from 6.8x in Q3 of its FY2020 to 5.2x in the same quarter in 2021. EBITDA is also up by 26%, from $309m to $389m and revenue is up 31% from $1.52bn to $1.99bn in the same period.

On the other hand, the company has also been accused of being “highly secretive, seemingly obsessed with control and susceptible to family squabbles that have few parallels among its Wall Street peers,” according to a report by the Financial Times.

Credit Suisse is the lead-left bookrunner and administrative agent for both loans.

Deutsche Bank, BMO, Bank of America, Barclays, BNP Paribas, CIBC, Goldman Sachs, RBC and TD are bookrunners.

Credit Suisse and Brookfied declined to comment, while DexKo did not respond to requests for comment.

DexKo is mostly a go for investors, but Docs are so so

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DexKo is mostly a go for investors, but Docs are so so

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