Medallia Inc. broke new ground with buyout debt financing backing Thoma Bravo's acquisition of the company.
The company's $1.8 billion recurring-revenue unitranche loan was the largest loan of this structure, market sources said. The financing included a $100 million revolver and closed Oct. 29. Medallia is a software-as-a-service platform that uses machine learning technology for experience management.
Blackstone Credit, funds managed by affiliates of Apollo Capital Management LP, KKR Credit, Thoma Bravo Credit and Antares Capital are the lenders. Ally provided the revolver.
Loans like Medallia's are based on the borrower's recurring revenue stream rather than EBITDA. The structure is particularly useful for borrowers in a growth phase. These loans typically have covenants and are unrated.
Most of the recent recurring-revenue jumbo borrowers have been software companies.
The Medallia financing tops a recurring revenue loan issued by Pluralsight. In April, Pluralsight received a $1.175 billion recurring revenue term loan, alongside a $100 million revolver, backing the take-private acquisition of the workforce development company by Vista Equity. Owl Rock was administrative agent. Owl Rock and Ares Capital were joint lead arrangers and bookrunners.
New frontier
As credit investors clamor for returns in a low-rate environment, private debt providers have been willing to move into this area of lending, which Wells Fargo analyst Finian O'Shea called a "new frontier."
"Without question, one of the biggest stories in private credit remains the industry's step into a new void: making more and larger private/direct sponsor-backed loans, based not on EBITDA but rather the borrower's revenue," O'Shea said in an Oct. 25 research report.
The willingness of lenders to provide recurring revenue structures, opening the door to alternative financial metrics, has likely led to some erosion of the syndicated loan market in favor of private debt.
In the case of the Pluralsight (L+800, 1% floor) loan, covenants are based on recurring revenue through December 2023, switching to EBITDA-based covenants thereafter, Wells Fargo said. This structure allows for greater financial flexibility for the borrower for roughly three years.
The Wells Fargo research argued that due to this changeover in the covenants, the flexibility is not overly excessive for the borrower.
"EBITDA itself has been a lightning rod for criticism, especially as defined in credit agreements, where add-backs and adjustments are often so deep that 'covenant-wide' has come to describe the asset class. We have wondered if highly adjusted EBITDA is really that different from recurring revenue in the first place," O'Shea said.
The Wells Fargo research said recurring revenue loans are becoming more widely accepted as collateral, citing Golub Capital late-stage loans which are, in essence, recurring revenue loans, as well as Owl Rock Technology Finance middle-market CLOs that allow for up to 40% of collateral value to be invested in recurring revenue loans.
O'Shea expects recurring revenue loans to become more normalized in the market. Notably, the structure fits with relationship-based lending that occurs between private credit providers and borrower companies.
"One thing that recurring revenue lenders on a big Vista Equity or Thoma Bravo buyout have in common with one another is that they have all participated in a big Vista or Thoma deal before," O'Shea said.
"While it's easy to view revenue-based lending as a sign of excess and stretching during a frothy market, we believe that view looks past some important nuance. We understand sponsors are not eager to overpay for leverage, but we believe that known execution and incumbency do matter, and billion-dollar recurring revenue loans seem to us to be closer to 'by invitation only' than a BWIC where every creditor under the sun is invited."