May 8, 2006

Third-Party Banks Providing Financing for Stapled Bids

From “Stapled finance has become a favorite product for investment banks auctioning companies. By offering prepackaged financing, they hope to encourage bids and collect a second layer of fees on the deal.

But in a twist, Bally Total Fitness Holding Corp. has turned to Deutsche Bank AG to provide ready-made debt financing in Bally’s auction, sources close to the bank and company said, not J.P. Morgan Chase & Co. and Blackstone Group LP, the banks running the sale of the fitness chain.

Deutsche is offering about $700 million in financing, sources said, made up of senior bank debt and subordinated debt. The choice of an independent debt source was made by a special strategic alternatives committee of Bally’s board comprising management-backed directors plus Don Kornstein, who was installed on Bally’s board by hedge fund Pardus Capital Management LP after a proxy contest at Bally’s annual meeting in January.

Investment banking sources close to the company said that outside counsel to the committee, Robert Wall of Winston & Strawn LLP, recommended finding a third bank to provide the debt financing to avoid the potential impression of a conflict of interest. Wall declined to comment.

Stapled financing emerged as a result of the slump in financing markets in 2001, when financial sponsors found it hard to obtain the debt financing they needed for LBOs. With a stapled package on offer, bidders know going in that they will be able to obtain financing, and at what price. Even if they choose other lenders, the stapled package could serve as a floor when negotiating alternatives.

There are potential conflicts, however. Some bidders fear the bankers handling a sale may have an incentive to favor a bidder that will take advantage of their bank’s financing. And some bidders are wary of working with a lender whose bankers may share information about the bidder with the bankers handling the sale.

Lining up stapled financing from an independent bank is not unheard of, but is not common, says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, but it makes sense, he adds. ‘These days the more free from conflict one can be in these situations the better. From a shareholder perspective, you want the highest possible price.'”