Synlab, the Germany-headquartered lab group, is tempting loan and bond investors with an attractive yield for a market leader in a stable industry. While relative value against its peers is a strength, the deal suffers from aggressive documentation and the uncertainty created by owner Cinven’s efforts to take full control of the company, according to six loan and bond buysiders.

The company is marketing a EUR 550m senior secured 2031 note that, alongside a EUR 900m term loan B, are earmarked to fund Synlab’s take-private by Cinven and repay its existing term loan A due 2026. There is also a EUR 500m PIK note that has been preplaced with direct lenders and sits outside of the restricted group. The bonds and the loans are pari passu and are set to have a B2/B+/B+ rating. 

Price talk is out on the bond in the 8.25% area and also on the loan at Euribor+ 475bps-500bps and 98 OID. The deal is expected to price tomorrow (12 December) with books closing on the bond at 10am UK time and commitments due on the loan at midday.

Deutsche Bank is the joint global coordinator and sole physical bookrunner, while Barclays, BNP Paribas, Citi, CACIB, Mizuho, Natixis, Goldman Sachs, HSBC, ING, RBI, Santander, SMBC, Standard Chartered, and UniCredit are the joint global coordinators and joint bookrunners.

Investors polled by Debtwire considered the pricing attractive given the size and diversification of the business, strong management and the stability of the industry. However investors also pointed out the high leverage and aggressive documentation on the loans.

While a minnow compared to giant American groups such as LabCorp, Synlab is the biggest fish in Europe with around a quarter more revenue than its largest competitor last year. It has 27,000 employees operating across 450 labs and 1,800 blood collection points in 33 countries. Its core markets are France, Germany, Italy and the UK. But its network now spreads far from its German roots to Latin America, Africa and the Middle East.

“I am hoping for a few loan documentation amendments,” the first buysider said. “Currently it’s very aggressive for incurring more debt and high watermarking.”

“The docs are terrible,” a second buysider added. “I’m just hoping they won’t bulldoze it through and loan investors push back. There is a lot of leeway to pay down the junior piece for example.”

Based on the marketed EUR 456m LTM 3Q23 run-rate adjusted EBITDA, the company has 4.8x total senior net leverage. Add on the PIK notes and that climbs to almost 5.9x.

“It’s not really a material deleveraging story,” the first buysider said. “Prior to COVID and the most recent French tariff cuts, labs used to be valued at 12x EBITDA but now everyone is assuming an 8x multiple. Some of the cost efficiency addbacks could be inflated, but they have a good track record in cost synergies so I’m not doubting them much. Still you have to give little bit of a haircut on the structuring EBITDA.”

There is added complexity due to the fact sponsor Cinven is not guaranteed to gain 100% control of the company. Should Cinven not succeed in squeezing out minority shareholders, it will spend the spare cash on paying off the existing EUR 385m 2027 TLB. This would cut total net leverage to 4x.

Cinven merged Synlab with its French lab group Labco in 2015. It then continued to grow the combined business before launching an IPO in 2021. However, the share price has been underperforming, making it difficult for the sponsor to exit its continued 43% stake.

That led Cinven to launch a takeover offer in September at EUR 10 per share. It now has more than 85% of the voting rights, which while insufficient to squeeze out minority shareholders, gives the sponsor control of the company. It is considering delisting the stock.

The activist firm Elliott, which alongside Synlab’s board thinks the price is too cheap, has built a stake of almost 7% in the company, according to press reports from last month. In the investor presentation, the company itself said that as a sector leader it should trade in 9-12x bracket.

“I’m trying to figure out what the Elliott stake means and whether they can still put in place the same capital structure with the same leverage,” the third buysider said. “I am concerned about what guarantees lenders will have on the subordinating risk.”

However, the first buysider said that it was unlikely to present any material issues and there was a precedent in the market from German pharma company Stada.

“In each individual lab the doctor needs to have some kind of stake themselves,” the first buysider said. “So, trying to implement asset coverage from the lender perspective is not the way to look at it. Therefore, it doesn’t make much difference if Cinven owns 85% or all.”

Diagnosis: yieldy 

The marketed EUR 456m EBITDA figure has more than 10 adjustment line items taking you from the EUR 419m management adjustment figure. The largest are a EUR 20m legal provision, EUR 9m related to building a new lab in Southeast London and EUR 12m in costs from being a public company that would not reoccur.

Liquidity will come from a EUR 500m RCF and an estimated EUR 200m in cash that Synlab will have on its balance sheet come the closing of the transaction in 1Q24.

The company is forecasting EUR 2.7bn in revenue and 16%-18% adjusted EBITDA margins for 2023. Long-term, it wants to get back to margins of around 23%. The company expects margins to increase by around 1% just by delisting the stock. It also has a cost-savings and efficiency programme focused on centralising labs and optimising logistics and staffing. SALIX, as the programme is known, has generated EUR 30m in savings year-to-date.

Synlab is unlikely to generate much free cash flow at its current EBITDA. The company has spent around EUR 163m in net capex and EUR 161m in lease expenses over the LTM 3Q23 period, although around EUR 50m of the capex went on a lab its building in Southeast London, which is an extraordinary cost.

Without taking into account the PIK notes outside the restricted group, the company could face interest costs of around EUR 155m including roughly EUR 110m on its loans and another EUR 45m on the bonds. Then there are income taxes of EUR 43m.

“By my calculations there is some free cashflow, enough to keep it ticking over anyway so long as they put the brakes on the M&A,” the fourth buysider said.

Management said on the global investor call (GIC) that there will be no dividends and leverage will “almost certainly” decrease from its starting point.

In the past, the company has been highly acquisitive. However, on last week’s investor call CEO Sami Badarani said that around EUR 100m would be a reasonable figure to expect for M&A expenditure next year. The company does not plan to enter new markets, but rather hopes to increase the density of its existing network. What matters in the lab industry, the executive said, is to have dominant positions in specific regions where you can build out a hub-and-spoke model. Synlab will continue to trim around the edges of its portfolio with some swap deals and disposals, he added.

“We passed on this as at a macro level we are pretty full on lab names and the deal feels a bit too aggressive for us,” a fifth buysider said.

Test-tube credit

The lab diagnostics industry is stable and defensive. Demographics are fuelling its growth as European populations grow older and face increased chronic diseases. The pressure on public health budgets is also driving outsourcing to the private sector, where private equity-backed chains have been consolidating the fragmented industry.

The business model is 60% B2B with hospitals, physicians and other labs purchasing tests. The rest is B2C or direct-to-consumer in the case, for example, of wellness tests. Routine tests make up around two-thirds of revenue with a third each coming from specialty testing and other diagnostics such as imaging or genetic tests.

“I’m agnostic on diversification,” the second buysider said. “You can divide up your eggs, but the French market has been fairly benign aside from the latest triennial process – it’s Germany where tariffs have been harsh.”

The boom created by COVID-19 testing has now passed with testing for the virus down to around 2%-3% of the market in Western Europe from around 16%-18% in 2021. But public health authorities have been unable to resist picking the pocket of the lab industry by cutting tariffs. In France, for example, the public payor finalised a new deal with the industry in the summer.

S&P estimates the reduction in core testing tariffs at 5%. France’s total budget will increase by only 0.4% per year until the end of 2026, notwithstanding an expected higher increased volume of tests, the ratings agency said. Therefore to grow faster than 0.4%, Synlab must gain market share or increase volumes in specialty tests not covered by the agreement.

“I think you can say with confidence that they are still coming down from the COVID-19 boost and need to get comfortable and believe that they can raise profitability and mimic pre-pandemic margins,” the third buysider said. “Beyond that it’s a highly regulated market, so the price from various government insurance markets is stable and they operate with some visibility. They will be fine if the efficiency programs continue; that is the biggest comfort since they have been able to do that in the past.”

Saints & Synlabs

Investors could look at rival lab players Cerba and Biogroup for comparable value. Cerba, which is Luxembourg-based but operating across Europe, has a B2/B- rated EUR 720m 3.5% senior secured 2028 note that trades at 81.44-mid with an 8.6% yield today, according to Markit.

In a client note, RBC pointed out that Cerba’s note “has close to 3yr shorter duration, but the company has higher 6.5x secured leverage and has been experiencing more earnings pressure vs Synlab”.

Biogroup has a B2/B-/B+ rated EUR 1.15bn 3.375% senior secured 2028 note that trades at 86.62-mid with a 7.17% yield-to-worst.

S&P has cut its credit rating on Biogroup’s senior secured and unsecured notes to B- and CCC, respectively. Inflationary pressures have been higher than anticipated in the lab industry due to the high levels of full-time employees, partly a legacy of the pandemic, the agency said. Payroll expenditure at Synlab, for instance, has ballooned to 42% of revenue in 3Q23 LTM from 30% in FY21.

“I think it’s a bit of a cleaner story than Cerba and Biogroup with a bit less leverage by a turn or two,” the fourth buysider said. “The others are more concentrated in France. Cerba has bigger problems given it really seems to have been impacted by the COVID run-off and doesn’t have a clear CEO. In that sense, though this has slightly more tenor, I still think if it priced wider it would look good value.”

Earlier in the year, high yield investors were taking another look at Cerba and Biogroup’s bonds as the French labs groups’ credit metrics deteriorated with the pandemic is over. With earnings plummeting, leverage piling up and regulatory headwinds also in play, the defensive reputation of the industry was under review, despite demographic tailwinds and gradual private equity-backed consolidation.

“My view is that the docs are horrible and there is a risk of cash leakage further down the line,” a sixth buysider said. “The market is full of lab names and FY24 will have further headwinds due to tariff cuts. Also, Synlab might be more diversified, but they also have much lower margins.”

RBC’s client note also looked at Cheplapharm. The German pharmaceutical company has a B2/B+ rated EUR 725m 7.5% senior secured 2030 note that is indicated at 104.80 yielding 6.24% to worst. The bank points out that it offers “a little under 1yr less duration, with -1.1x less leverage and stronger margin/FCF. This would still make a 9% area on the new Synlab SSN seem decent.”

Deutsche Bank declined to comment.