Stronghold solutions provide patient capital as debt, low cost, use as mezzanine financing, no requirement to retain equity, and access to the world’s largest pools of capital.
For general terms and overview please see: Project Financing. A discussion of Middle Market acquisitions follows.
Middle Market
A strategy to rebuild & relaunch a critical US economic sector
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Overview
Many US Middle Market businesses entered the current economic downturn piled high with unsustainable debt.
The sector stands uniquely positioned for acquisition, debt restructuring, recapitalization, and relaunch made possible by Stronghold designed instruments:
Senior fully secured debt instruments of an insurance company delivering an enhanced yield over the return on 30 year US Treasuries.
The instrument's value to institutional & qualified investors positions Stronghold programs to operate at significant scale.
Stronghold’s programs stand as efficient alternatives to private equity financing, IPOs, and SPACs while providing access to larger pools of institutional investment capital.
Market Profile
200,000+ U.S. Middle Market companies
30 million employees
$10 trillion of the $30 trillion in annual U.S. private sector gross receipts.
Private equity ownership has driven these companies to focus on short-term financial results rather than product/service value, improving manufacturing processes, or developing new products and technologies.
Private equity owned U.S. companies hold 60% of the $2.5 trillion outstanding in highly leveraged loans due between 2022 and 2025.
While high yield debt markets, have recovered since essentially closing in March 2020, concerns remain:
First, the gains come as a rising share of companies miss debt payments. Consumer services companies, which have been hit especially hard by pandemic-related shutdowns, have been defaulting at the quickest pace since 2002, according to S&P Ratings.
Overall, there were 54 corporate defaults in the second quarter, the most in any quarter since 2009, according to Moody’s. The firm expects defaults will rise further from here to peak in the first quarter of 2021, in part because it rates a record amount of debt in the lowest four tiers before default.
Second, the performance of distressed bonds—debt of companies that are either in or close to default—has lagged far behind the rest of the market. They are down 27% so far this year, ICE data show, while the broader high-yield market is down just 0.2%.
That underperformance is unusual for historical economic recoveries, Bank of America says. In the first half of 2009, when the stock-market troughed and rebounded from the financial crisis, the ICE Bank of America Distressed High Yield Index returned 48%, outperforming the broader high-yield market.
Bonds rated in the lowest three tiers before default (CCC+, CCC, CCC-) have lagged behind higher-rated bonds as well, probably because of their perceived default risk. The main question is whether the financing floodgates soon open for those low-rated and stressed companies.
“Investors will either begin providing new funding to these issuers soon or face the risk that they will default,” wrote the Bank of America strategists. “There seems to be no other viable solution, in our view.”
— Barrons (3 August 2020)
Concerns about a recession affecting this market sector began emerging in 2019:
“Any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses”
— Federal Reserve’s Financial Stability Report (May 2019)
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“The proliferation of ... PE-owned companies with high leverage, small scale, niche business models, and fragile balance sheets will exacerbate the next, more prolonged default cycle.”
— Moody’s (2019)
Current events have weakened economic activity to a degree the Federal Reserve and Moody’s could never have anticipated in 2019.
Plan
Stronghold designs and directs programs implemented by its insurance company partner, Pendragon Insurance Company SPC, Ltd.
For each acquisition program, the insurance company:
Establishes a dedicated protect cell,
Issues a bond,
Sets up reserves (in trust) to cover the its embedded credit insurance guarantee to repay principal,
Finances the acquisition,
Purchases outstanding debt, and
Recapitalize the identified businesses.
Such a program can purchase the acquisition target's debt at face value.
Typical terms for investments in the Middle Market companies:
Secured loan,
Interest payments of 15%-16% on a look-back-make whole basis,
Management earn-out,
Companies provide an equity kicker directly to the bond buyers as incentive to purchase the bonds.
Value proposition for the companies:
Solution provides patient capital at terms these companies can meet.
Over a 5-10 year period, well supported professional management, unencumbered by private equity financialization, can rebuild, grow their businesses, and go forward owning their businesses and controlling the companies' destinies.
This approach:
Brings together the best characteristics of an equity investment and debt financing for these companies and
Provides compelling returns to the institutional bond buyers.
Scale
Programs can operate for individual acquisitions or as a blind-pool to pursue a diversified portfolio of acquisitions.
Institutional Roles
Investment banks:
Originating/vetting qualified Middle Market companies,
Negotiating prices for the assets,
Negotiating the purchase of the outstanding debt, and
Placing Stronghold designed instruments with institutional investors to support the acquisitions.
Commercial banks:
Senior debt financing to companies, where a Stronghold program provided mezzanine debt.
Securities lending to bond buyers interested in leveraging the instruments and
Bridge financing to an acquisition team (repaid upon bond issuance) to facilitate acquisition timing.
Institutional & qualified investors:
Purchase Stronghold designed bonds and
Recommend Middle Market companies in which they have interests or synergies.
Fixed Income Market
The NAIC has withdrawn favorable treatment on many “enhanced yield" structured products.
Stronghold instruments stand as debt securities of an insurance company — not structured products.
These developments have throttled institutional fixed income return prospects (especially for insurance companies).
Why Now?
Stronghold has designed a solution to affect structural change across these vital Middle Market companies.
The current economic conditions provide motivated buyers for the Stronghold designed bonds and motivated sellers of these assets.