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In a narrative now rich with irony, Trader Corp., the parent company of used-car publication Auto Trader, is grappling with a debt downgrade under the ownership of another private equity company.
This week, rating agency Moody's Investors Service downgraded Trader Corp. after Thoma Bravo acquired the company for $1.6-billion from fellow private equity player Apax Partners in early July. Because so much leverage was used in the acquisition, Trader Corp.'s debt will soar to more than eight times its earnings before interest, taxes, depreciation and amortization, prompting Moody's to lower the corporate family rating to B3.
That Trader Corp. must endure this heavy debt burden is a flashback. Yellow Media unloaded the company in a fire sale in 2011 – all because Yellow Media, best known for publishing phone books, was drowning in debt. The former owner had purchased the assets comprising Trader Corp. in deals totalling $1.2-billion, but sold them for $745-million.
This time around, there is hope Trader Corp. can survive the new debt levels because Apax has already slapped on a mountain of debt, which amounted to more than 10 times earnings before interest, taxes, depreciation and amortization (EBITDA) in 2012, and still found a way to make it work. At the time of the sale, the debt burden had fallen to just 4.5 times EBITDA, because operating earnings are now more than $100-million annually.
Apax also tacked on its debt at what was arguably an even riskier time for Trader Corp., because no one knew then if the Auto Trader properties could survive the transition to a digital-first business model. Today there is much more certainty that there will be a secure future.
Apax was able to turn Trader Corp. around because it had experience transforming Auto Trader U.K. – which it owned in a separate company – to a digital-first business. The private equity firm also installed Sebastian Baldwin as Trader Corp.'s new chief executive, and he had experience in a digital world. The difference was that Apax added debt believing there was extra profit to be made. Because it had a business plan to turn things around, the buyer had a way to earn its way out of extra debt. And it worked rather magnificently: When it first took took over, Trader Corp.'s EBITDA margin, or EBITDA to total revenue, was in the mid-20s; today, it's 43 per cent.
For Thoma Bravo, it isn't as clear what can be done to boost earnings or margins – and yet new debt is still being added. "While it is possible that Trader's next level of growth after its successful transition to digital from print will come from acquisitions, the high leverage leaves no room … for leveraging transactions," Moody's wrote in its report. Thoma Bravo could not be reached for comment.
It is entirely possible the new debt burden won't prove to be too big of a problem. Standard & Poor's also rates Trader Corp., and it did not downgrade the company this week. Moody's also acknowledged that Trader Corp. has a lot going for it. The AutoTrader brand name is incredibly strong in Canada, and the earnings margins are healthy.
Amid the debate, there is one thing no one can deny: Apax benefited from the original deal. In 2011, former Yellow Media CEO Marc Tellier swore the Trader Corp. divestment wasn't a fire sale, despite selling it for less than the purchase price in the face of a potential debt-rating downgrade. "Let's be very, very clear about one thing: No one had a gun to my head to sell this asset," he told The Globe and Mail.
What Apax bought for $745-million, which included an equity cheque of $363-million, has now been sold for $1.6-billion. It is tricky to determine exactly how much Apax made, because debt levels cloud the picture and details on any dividends Trader Corp. paid to Apax over the years aren't publicly available. But it was a profitable trade for the private equity firm.