The Refinancing Window at Kestrel Foods
Kestrel Foods is an unlisted UK manufacturer with EBITDA of £48m and net debt of £210m (4.4x). Its £200m term loan matures in 14 months at a floating rate of SONIA + 375bp; SONIA is 4.1%. Covenants require net debt/EBITDA below 4.0x tested on the next 12-month forecast, so the company is already in a technical breach risk. Management wants to fund a £60m automation project that would add £14m of EBITDA by year two. The board is weighing: (a) a 7-year fixed-rate bond at 7.9% issued now, (b) waiting 12 months for markets to improve, or (c) a £90m equity raise from a private equity investor at an implied 9x EBITDA multiple. The CFO notes the fixed bond would carry a 2% arrangement fee and require a 3.5x leverage covenant.
1. Advise the board on which financing route best balances covenant headroom, cost and strategic flexibility. Justify with numbers.
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Current position. Net debt/EBITDA = 210/48 = 4.4x, already above the 4.0x covenant test. Any new debt taken on today pushes leverage higher before the automation benefit arrives, so route (a) must be sized carefully.
Route (a) fixed bond. Refinancing £200m at 7.9% costs £15.8m interest vs current £200m × (4.1%+3.75%) = £15.7m - broadly neutral on cost but converts floating to fixed (removes rate risk). The 2% fee = £4m, capitalised or expensed. Post-issue leverage stays ~4.4x, breaching the 3.5x bond covenant immediately unless the £60m project is deferred. Verdict: only viable if the automation spend is postponed or part-funded by equity.
Route (b) wait 12 months. Leaves the company exposed to a refinancing cliff (14-month maturity) and floating-rate risk; if SONIA rises 100bp, interest cost rises £2m pa. High execution risk.
Route (c) equity raise. £90m at 9x EBITDA implies equity value 9 × 48 = £432m. New investor takes 90/(432+90) = 17.2% of enlarged equity. Proceeds clear £60m capex and £30m debt paydown, cutting net debt to £180m and leverage to 3.75x pre-benefit, falling to 180/(48+14)=2.9x once automation delivers. Best covenant headroom and funds growth, but dilutes existing owners and is the most expensive in expected return terms.
Recommendation. Pursue (c) or a hybrid: a smaller fixed bond (£140m) plus £60m equity to keep leverage under 3.5x while funding automation. Pure (a) is unworkable on covenants; (b) is too risky given the maturity cliff.
2. The PE investor demands a 22% IRR over five years and an exit at 10x EBITDA. What exit EBITDA is required to meet that return, and is it credible?
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Required exit value. Investment £90m for 17.2% stake; to earn 22% IRR over 5 years, the stake must be worth 90 × 1.22^5 = 90 × 2.703 = £243m at exit.
Implied total equity value at exit = 243/0.172 = £1,413m. At 10x EBITDA, required exit EBITDA = £141m.
Credibility check. Current EBITDA £48m; automation adds £14m → £62m. To reach £141m requires an additional £79m of EBITDA - a 2.3x increase on the post-project base - which cannot come from the stated plan alone. It would need aggressive bolt-on acquisitions or margin expansion well beyond management's projections.
Conclusion. The 22% IRR target at a 10x exit is not credible on the current plan. Either the investor's return expectation must fall (e.g. 15% IRR requires exit stake value 90 × 2.011 = £181m → equity £1,052m → EBITDA £105m, still demanding), or a lower entry multiple/structured preference shares must be negotiated. Flag this as a key term to renegotiate before signing.