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Will Caiger-Smith

A quick glance at fund flows and recent CLO issuance suggests that leveraged loans are this year’s hot ticket among investors, and that is being reflected in recent primary deals: among the beneficiaries this week were Tropicana, Griffon Corp, Addison Group and Vaco Holdings.

Those borrowers all ended up with loans that priced tight to talk, many of them ahead of schedule. Some of them raised more debt than they had planned—Vaco, for example, upsized its dividend recap, following the blueprint laid out by Golden Nugget last week.

Against this kind of backdrop, buysiders who push back on terms can’t always expect it to lead to much in the way of changes. So when the sellside does offer sweeteners (however marginal they might appear) they’re worth examination. 

In absolute terms, Quest Software’s buyout financing was a successful syndication. After some minor changes—a new CSA, a $100m shift from the second lien to the first, a removed coupon stepdown—both tranches priced within talk, although at the wide end.

But it wasn’t exactly a blowout; sources told 9fin the book was slower to build than other recent deals, especially in the second lien. “In a market where deals are accelerating and tightening, it’s notable that this one was behind the pack,” said one source.

Most of the buysiders that 9fin canvassed about the deal cited high leverage (around 7x through total debt) as a major sticking point. And while that's been a fairly evergreen complaint about new LBOs for some time, it carries extra weight in the case of Quest. 

The main issue is around where growth is going to come from. Clearlake, the incoming sponsor, is buying Quest at a roughly 11x EBITDA multiple, implying a 6.5x return for former owner Francisco Partners after five years at the helm, according to the Wall Street Journal.

That's a tough act to follow. Quest appears to have stabilized its sales strategy following its separation from Dell back in 2016, but several buysiders said they felt uncomfortable about the company’s recent pivot towards acquisitions to drive growth, especially given the high opening leverage.

“First lien lenders don’t need much growth, but the second lien does—and growth is very M&A dependent,” said the first source. Goldman Sachs and Morgan Stanley, which led the deal, declined to comment, while Quest and Clearlake didn’t respond to emails seeking comment.

Given these concerns, the prospect of debt-funded acquisitions raising leverage even further—potentially in the not too distant future—is uncomfortable for some.

“It’s already aggressive leverage for a B3 credit, and it's based on highly adjusted metrics” said a second source. “Free cash flow is pretty minimal, and they need acquisitions to grow." 

Acquired growth could also take some time to bear fruit, if the company’s recent purchases are anything to go by. S&P mentioned margin improvement as a challenge in its rating report (as well as noting that dividends were likely as soon as leverage improves):

“Ongoing progress in improving EBITDA margins will slow…the acquired businesses have generally been dilutive to profitability and [we] expect Quest will have to undertake material restructuring costs to bring the new assets up to the firm's current margin levels.”

The deal didn’t require a major overhaul to get over the finish line, but more extensive changes might have been necessary if the market were less frenzied. This syndication could end up being instructive for other highly levered borrowers in the coming weeks.

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Quest Software — a bull market laggard, but you’d barely know it

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