Tuesday, April 25, 2006

EuroMoney Article on PBT

EXECUTIVE VICE-PRESIDENT Guy Spanos was considering the prospects for his company, Pay By Touch Solutions. Set up in 2002, its payments technology using finger scans had taken off and was being used in more than 100 (now 2200) stores across the US. Pay By Touch had also made a series of fruitful acquisitions. Now, three years on, Spanos and founder, chairman and CEO John Rogers wanted to refinance their balance sheet and rapidly expand the business at home and abroad.

Spanos was clear about how he wanted to raise capital. Earlier in his career he had worked in the capital markets and knew that this time he wanted financing from hedge funds. Using UBS as a prime broker, Pay By Touch secured $130 million – $75 million of which was raised in senior secured notes from five hedge funds.

An increasing number of companies are taking the same path. As Pay by Touch shows, companies with healthy balance sheets and good growth prospects are discovering that hedge funds can offer an alternative and, perhaps, preferrable source of financing, be it through private equity-type arrangements, private placements, leveraged loans, commercial loans or asset-based lending.

It’s a suitable marriage. Some $80 billion is expected to flow into hedge funds this year, and it needs to be put to work. And for companies, growth is back on agenda, with flexible and tailored financing offered by hedge funds providing a solution. That’s the way Spanos saw it. “Not being a long-established company with an established cashflow, we knew that the traditional banks would not provide a loan,” he says. “At the same time, we didn’t want to use private-equity firms as we didn’t want to dilute our share price or give up control in the company. We wanted flexibility to structure the financing predominantly in the form of debt, and we wanted smart capital, so we went to the hedge fund community knowing we’d find a solution.”

Competitive advantage

Hedge funds have a clear competitive advantage over their traditional private-equity peers. They have bigger pools of capital and their return requirements are lower. “Hedge funds take fees upfront and revalue the assets on a continued basis. Private-equity houses, however, only take their fees out on exit,” explains one lawyer. As a result, hedge funds are able to pay more for companies, leading, private-equity houses lament, to higher purchase prices.

The lack of restriction enjoyed by hedge funds also allows them an edge over traditional private-equity players. At a recent presentation at the University of Pennsylvania’s Wharton School, Och-Ziff’s Dan Och discussed a life insurance investment where his hedge fund was able to offer advantages because of the flexibility of its approach to management control. “Some private-equity firms needed a board seat,” he says. All Och-Ziff required was a one-page legal document declaring that it had the same rights as all the other large capital providers.

For Pay By Touch, the flexibility of the structures was crucial. “It was a highly unusual loan, providing security on the debt from our patent portfolio with a component of equity,” says Spanos. “ A traditional bank would not have provided it. We didn’t have any concerns. Hedge funds are as diligent as private-equity companies and banks. They aren’t quick to pull the trigger, and we liaised with them with the help of UBS throughout the structuring process.”

This new source of financing, however, is putting pressure on other providers. More than half the private-equity professionals surveyed by ACG/Thomson in June complained about the hedge funds’ involvement in their space. With good cause.

Hedge funds were able to offer a more suitable alternative to private equity in the case of Pay By Touch; elsewhere they are acting as pure private-equity houses. In the US in 2004, 23 private-equity deals totalling $30 billion were conducted by hedge funds, and in Europe hedge fund involvement in private equity is growing, with a series of high-profile deals this year.

In the reverse takeover of insurer Britannic Life by Resolution Life, hedge funds were the sole providers of equity. In April, Och-Ziff Capital Management bid in the £1.2 billion ($2.1 billion) auction for Yellow Brick Road, a pan-European directories business; in September, a consortium of six hedge funds, including Och-Ziff, Perry Capital and Citadel, entered talks to take over discount retailer Peacock Group.