Loan Market Tempts Affiliated Computer

It's ripe enough to fund a $3 billion-plus debt refinancing.
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In a move that shows just how hot the syndicated loan market has become,

Affiliated Computer

(ACS)

is tapping it for more than $3 billion that it will use to replace nearly half its equity capitalization with debt.

The unusual financing was a hit Friday with shareholders, who bid up the stock to an all-time high of $63.43 intraday. The price eclipsed the previous zenith of $62.05, reached in early January as reports swirled that Affiliated was on the verge of a leveraged buyout by a group of private equity companies.

Affiliated, which sells technology outsourcing services, will buy back up to 55.5 million shares in a Dutch auction at between $56 and $63 per share, depending on demand. The deal suggests it will spend more than $3 billion for about 45% of its outstanding stock.

Robust high-yield debt markets have opened the door to record private equity and privatization activity over the past year. While cynics argue that managers are leveraging companies to dangerously high levels, debt investors are signaling the opposite.

"The market itself is in very good shape right now. In general, the demand for loans is very strong, and new issuances of high-yield and investment-grade loans continues to grow," said one senior investment banker who asked not to be named because of his involvement in the current transaction.

Because of the reliable cash flow created by their long-lived contracts, Affiliated Computer and another tech outsourcer,

Computer Sciences

(CSC)

, have attracted private equity scrutiny. No deals have materialized, however, with the talks reportedly breaking down over price.

Thursday's financing by Affiliated has hallmarks of a leveraged buyout, with the main difference being that the company will maintain a significant presence in the stock market. The Dutch auction meets the goals of an LBO halfway, infusing a big chuck of debt onto the balance sheet while boosting the stock price with leverage.

The boost was something the stock has needed since 2002. For almost four years, the share price has been relatively stagnant, trading between $50 and $60. By issuing debt and buying back stock, the company has won stock market plaudits by enhancing the earnings participation of shareholders who stick with it.

Both UBS and Stifel Nicolaus raised their Affiliated ratings on Friday. The "announcement is a significant (positive) surprise and a key element of our upgrade of ACS shares," said William R Loomis of Stifel Nicolaus in a report this morning.

Debt markets were less impressed, with Moody's and Standard & Poor's both cutting their rating on Affiliated's outstanding debt. The agencies cited the massive debt levels due to the share repurchase as the reason. Affiliated is bringing its leverage up almost five times its previous level, raising the debt-to-EBITDA ratio -- the standard metric used by the ratings agencies -- from 1 to almost 5.

In a syndicated loan financing, a lead bank commits money to a company at a preset interest rate that reflects its debt rating and loans to companies with similar debt profiles. The investment bank then sells off pieces of that loan to other interested parties. The pieces then trade in a secondary market, where they act similarly to bonds.

Citigroup wil lead Affiliated's loan and has even offered to upsize the deal to $5 billion if the transaction sells well. Right now, at $3.5 billion, the company has leverage generally in line with its competitors. But a bigger deal could potentially drop the company into junk status, said John More, senior analyst at Moody's Investors Services, who assigned the original rating to the company.

Still, given the current demand in the debt markets, the deal could be executed without a hiccup.

"As the debt market gets more bullish, people are willing to stretch on leverage. Investors are willing to pay more for debt as a percentage of the capital structure," said the investment banker.

A company can't make decisions to change capital structure on a whim; debt markets need to be ripe. They are now.

"As the markets increase its bullishness and liquidity, there has been an easier ability to finance higher leverage levels," said the investment banker.

However, deciding the appropriate debt-to-equity ratio for the company requires more than just a demand consideration. Investors also consider just how much debt a company can support.

In Affiliated's case, the company first tried to shop itself to the private market, asking between $62 and $65 per share to take the entire company private. That transaction, which would have almost doubled the amount of debt the company is now incurring, must have left private equity investors uncomfortable. After months of negotiations with Blackstone, the company abandoned its private equity alternative.

Now, big investors who wanted to sell an LBO have the current deal to facilitate a higher price.

While these transactions are almost always good for a stock investor, UBS analyst Adam B Frisch cautions that too much leverage could ultimately stunt Affiliated's ability invest in growth over the next few years. "A self-imposed junk rating could ... slow ACS' aggressive M&A strategy, which has driven most all of its recent growth," he said in a report.

Still, because of the fury of activity in the leveraged loan markets, the debt will likely be refinanced at cheaper levels sometime in the near future, according to Frisch.