In the pending buyout of Angelica (AGL) shareholders have not just the usual worry about the debt funding, but in an odd twist the equity portion could also be at risk. The financing consists of equity from an entity affiliated with stressed Lehman (LEH), while most of the debt is provided by struggling Regions Bank (RF), with some help from Apollo Investment Corporation (AINV) .
After a multi-year battle with activist funds Pirate Capital and Steel Partners, Angelica announced a sale for $21/share in late May. Pirate valued Angelica much higher at between $31 and $35 per share, according to its 13D filings. It started buying Angelica shares in early 2005 at prices between $25 and $30. The Angelica investment is yet another disaster for Pirate in a string of mishaps that has seen its assets under management dwindle from $1.8 billion to a reported $400 million. Other failed investments by Pirate include Massey Energy, which rallied just after Pirate had liquidated its holdings, and Gencorp, still in the doldrums. Steel Partners fared a little better, acquiring its first Angelica shares in early 2003 for less than $17.
The buyer is Lehman Brothers Merchant Banking Partners IV, a $3.3 private equity fund managed and backed by Lehman with $500 million of its own capital and that of its employees. One third of the commitments comes from European and Middle Eastern investors, and the balance from other investors such as the State of New Mexico or school teachers' pension funds of Illinois and Pennsylvania. The $135 million equity commitment for the Angelica acquisition hardly makes a dent in that fund, but the problem is that unlike hedge funds or mutual fund, private equity funds only receive capital commitments at the time they are raised, but not yet the cash. Limited partners make only commitments that are drawn on when the fund needs the money. The question is whether Lehman will be able to pony up its commitment at a time when it is facing a run on the bank.
So unlike the many buyouts that collapsed when the debt funding was pulled, Angelica's buyout could collapse if the equity funding isn't coming through.
This is not to say that the debt funding is necessarily any more solid. Regions Bank provides $133 million in senior debt, and we have the feeling that about the last thing that Region's management wants to add to its balance sheet is a loan on a leveraged buyout, albeit a not overly leveraged one.
Ironically, the most solid portion of the financing are payment in kind notes. We though that PIK notes had been banished for good by the credit crunch, but they are making a surprise rebound here. Apollo Investment Corporation acquires these $90 million subordinated notes with a 15% coupon, 3% of which can be paid in kind.
It will be interesting to see what excuse Region's can come up with to withhold funding. In that case, Lehman's fund can provide temporary financing. The PPM provides for the possibility of making investments in excess of $225 million if the additional amount is bridge financing. The best bet for investors is that Lehman follows through on its proposal to take itself private, and fund the deal outright through the investment bank.
Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which owns shares of Angelica.