Friday Workout

Future Perfect, Prescient and Correct, Clause and Effect

By Chris Haffenden | Editor |

A couple of things irked us this week at 9fin - apologies in advance for any venting – but sometimes it’s better to let it out. 

First up, is the two-year free pass given to stressed borrowers (Douglas and CGG) by the ratings agencies on their refinancing, thus avoiding triple-hook which would have limited demand and raised borrowing costs. This is not withstanding highly distorted metrics for EBITDA, via add-backs or excessive capitalisation of capex, and highly optimistic business assumptions. 

Secondly, was the flak we got for our review on the Foncia documents – contrary to messages sent around by sell-side desks - we stand by it and are not issuing any kind of correction, as our tweet below outlines. 

Future Perfect

Irked by the willingness of ratings agencies to take optimistic management turnaround projections at face value, and rate on 2023 projections (without haircuts), I posted this earlier in the week: 

“Is anyone else frustrated by agencies rating stressed refinancing B- while at the same time saying: “we consider the leverage profile high for the rating and sector and more commensurate with a CCC level.” They say "FCCR is 1.0x and will improve to 1.5x by FY23” Why give them an 18-month pass?

Responses were mixed, some said agencies looked through a five-year cycle, with the refinancing removing the immediate risk of payment default and triggers, automatically leading to an upgrade. 

Indeed, S&P says that “An obligation rated 'CCC' is currently vulnerable to non-payment and is dependent upon favourable business, financial, and economic conditions for the obligor to meet its financial commitments on the obligation. 

Others are less accommodating, “The rating agencies in HY constantly using the DeLorean time machine’” said one. “Rating agencies have become momentum investors, rather than looking at the facts,” said another. 

The future perfect state agencies are working from became even more clear when our analysts took a closer look at Douglas’ earnings breakdown. The refinancing is based on Management Adjusted EBITDA of €395m, compared to pre-IFRS16 reported EBITDA of just €111.9m. It says management adjusted EBITDA was calculated to illustrate the recovery potential of the group as well as the ‘new normal’ post Covid-19. Rather than using LTM figures for run-rate calculations, Douglas says that these will be based on net-sales recovery rates based in June 2020 to October 2020 last year, when most of its stores were open. 

In total, there are management adjustments of €138.3m (of which: €21.4m are consulting fees, €13.3m restructuring costs and severance payments, €8.3m PPA, -€2.5m inventory write downs, €74.9m Covid-19 effects, and €7.8m other adjustments). For one of their 5 measures of EBITDA, so called “Adjusted EBITDA (as reported)” the German Beauty products retailer even adds-back its annual credit card fees to EBITDA – surely a cost of goods sold, and non-exceptional. 

In total, the management adjusted EBITDA is even higher than the €347m achieved for LTM December 2019, and significantly above LTM figures as at end December 2020. 

Douglas is a business that we know well, producing a deep-dive analysis in December. 

The €2.75bn refinancing includes a €220m equity cheque from sponsor CVC to fund the turnaround plan and includes a €300m HoldCo PIK syndicated alongside a senior secured bonds and loans package.

S&P has preliminary assigned a B- rating to the new senior-secured notes. But most of its report reads as if for a CCC-rated business and the agency admits: “we see very limited headroom under the likely 'B-' rating upon completion of the transaction,” It goes on to say: “The execution risk associated with the group's transformation plan, coupled with the uncertain macroeconomic environment and the very high leverage post transaction, would likely translate into a negative outlook upon closing of the transaction.” 

So why not rate CCC with a positive outlook?

The big winner on the refinancing was the €335m SUNs due July 2023, which traded as low as 35 last June, and had started 2021 in the low 60’s. These will be repaid at par and are arguably replaced in the capital structure by the new HoldCo PIK (we are interested in speaking to potential PIK investors on their pricing thoughts). It will be interesting to see how close Douglas can get to the old 6.25% coupon on the new senior secured. The new €1.08bn Term Loan B is guided at E+ 500bps. 

Optically, CGG, the France-based geoscience business is much lower levered, being marketed off net leverage of just 2.7x. But this is based on adjusted segment EBITDA of $402.3m (EBITDA is $291.5m). The figure includes earnings before amortised costs for multi-client surveys, with the heavy capex costs for that division capitalised as investments. Moody’s expenses rather than capitalises them – raising leverage to an eye-watering 16.5x. 

But Moody’s has confirmed their B3 rating with a stable outlook. Despite a 35% drop in sales in 2020, and the likelihood that spending from E&P customers will be depressed for the next 12-18 months, with leverage still around 6x by the end of 2022. S&P Global is less optimistic, however, downgrading to CCC+ on elevated debt and weak cash flows. The proposed refinancing helps liquidity but doesn’t do anything to address the overburdened capital structure, it notes. 

We suspect that the triple-hook from S&P led to the company securing a first-time B- rating from Fitch Ratings (not to be confused with Fish Ratings), with a positive outlook to boot, with the agency saying their rating is supported by the asset-light business model! On a more positive note, there is a significant equity cushion (€801.5m) – which raises the question why they haven’t tapped shareholders. However most significant holders are hedge funds from the last restructuring in 2017.

But the current red-hot HY market and the appetite for risk led to decent demand for the new bonds. The new senior secured six-year non-call three notes were set at: €585m at 7.75% and $500m at 8.75%, both at the lower end of IPTs, but slightly above the coupons on the debt they refinance.

More Back to the Future (receivables) this week from the Greensill Saga. 

It emerged this week in court documents that Greensill allowed some of its customers even more latitude to predict and travel into the future. It even allows them to borrow against project business from counterparties that they had never met and dealt with before. These prospective buyers were categorised as account debtors. 

Coal producer Bluestone Resources is suing the supply-chain lender for withdrawing a $785m receivables purchase agreement which it says was provided as long-term funding. In their complaint Bluestone said “Greensill Capital – from the start – agreed to finance Bluestone based not on the existence and collectability of Bluestone’s then-existing receivables, but rather based on Bluestone’s long-term business prospects.” 

Greensill would automatically roll the short-term supply chain loans, with Bluestone paying interest. Matt Levine nails it in his Bloomberg Opinion blog “Greensill basically gave Bluestone a payday loan for a job Bluestone hadn’t yet applied for.” 

Almost inevitably, Greensill introduced Bluestone to the steel group GFG Alliance, its largest exposure. But its first cargo (from a June 2020 sale) was not paid for in December 2020. Bluestone was urged by Greensill management to continue to deal with GFG, despite Greensill failing to step in on the missed payment. But Bluestone was subsequently asked to make further payments to Credit Suisse (its loans were parcelled into CS funds) as Greensill was unable to make the payment itself. 

Prescient and correct

We at 9fin like to think we are fairly commercial in our covenant analysis. We eschew the liberal use of CAPS, bolding and exclamation marks in getting our message across!!! If it is a good credit with mitigating circumstances, we give sponsors and lawyers drafting the docs the benefit of the doubt. 

But less than a week after seeing the docs for Ahlstrom – which appeared to use boilerplate Thyssen Krupp Elevators language with a couple of novel concepts thrown in – Foncia appeared. This arguably took documentation to a new low for 2021 and at time of going to press most aspects appear to have remained, despite some pushback. COVENANT EMPTOR! 

Our QuickTake has the full charge sheet for the accused (non-subs please ask for a copy), but here are few (reproduced from our social media posts on the day the deal emerged):

  • Make Restricted Payments (dividends or investments capacity) while in default or Event of Default, with no requirement to meet the most basic financial health test of 2.0x interest cover

  • Sell assets (incl. collateral with no requirement to apply the proceeds to repay secured debt (or in some instances any debt at all).

  • Pretend that your RCF is drawn to inflate your debt capacity under your ‘no worse’ tests

  • Layer/prime your existing secured bondholders using non-guarantor subsidiaries, or by granting security over assets not covered by the deal’s ‘soft security’ package.

  • Covert your restricted payments capacity into secured debt capacity – diluting existing bondholder's value coverage

  • Re-lever the business above day 1 leverage, pay a dividend to yourself as part of a change of control and port the capital structure without a 101 put offer

  • Juice up EBITDA with unlimited add backs, subject to no time limit, and use them to calculate whether you comply with covenants at a time of your choosing

Clause and Effect 

We highlighted the presence of a clause in Permitted Investments which looks remarkably similar to the J Crew Trapdoor. In Foncia, however, it is drafted to exclude Investments in Unrestricted Subsidiaries and requires the ‘cash or other assets’ to originate from outside the ‘Group.’ 

In spite of some discussion around what the word ‘originate’ actually covers, we said that these tweaks remove most of the teeth from the clause – but in that case why is it there? 

One interpretation is that it might allow a mechanism for sponsor injections, but surely the incredibly loose docs, will already allow this, and why take the risk of further irking investors?

In any event, guarantor coverage for Foncia is already weak (at 54.3% of consolidated EBITDA) with no cap on non-guarantor debt. Worse still, this sits alongside a dividend recap paying a €475m dividend to sponsor Partners Group. According to Moody’s this adds a further three turns of leverage to the French Real Estate services provider, which if you strip out the liberal use of add backs for future savings, puts leverage at 9x, very toppy considering the sector it operates in. 

From a personal point of view, I wonder what the motivations are for such documentation. Why is this type of language needed? 

Is the company considering corporate actions to take advantage?

I also wonder who is driving the innovation, are lawyers being too clever by half, or is it the greed of sponsors? 

Discount Factor

Takko, the German discount retailer, has led a charmed life. For most of the past decade it was on restructuring advisor’s watchlists, with bonds often plunging into the 30s and 40s on poor earnings, but each time, it managed to avoid a restructuring. In 2017 on the back of a strong rebound in earnings it managed to price dual tranche fixed and floating 2023 notes at 5.375%. 

But last summer, when it suspended coupon payments and appointed PJT Partners as its financial advisor, many thought a full-blown restructuring was inevitable. Liquidity was tight, with forecasts that liquidity in March would turn negative. Last week, it announced that talks over a €60m German State backed support loan from KfW had failed. But this week, it said that it had reached agreement for a €54m bridge loan to meet a liquidity shortfall, without giving a breakdown. 

The owner, Apax Partners, investors, and the financing banks are supporting the discounter and providing additional funds, said Karl-Heinz Holland, the interim CEO. He added, “because of our sustainably successful business model, we are confident that we will soon be able to pay back these funds.” 

In brief

Yesterday, Mr Justice Andrew Johnson approved Obrascon Huarte Lain (OHL) application to hold a single-class creditor meeting on 9 April. The court has jurisdiction as the notes are under English Law. To implement the planned restructuring a Scheme Attorney will be appointed to execute contractual documents on behalf of scheme creditors, with a Restructuring Implementation Deed being the key document, according to the company Skeleton. Under the restructuring plan for the Spanish concessions and construction group there is €105m of debt reduction on day one, with around €500m of planned disposals to deleverage further. In addition, there is a capital increase of up to €71m. 

Premier Oil’s Scottish Scheme of arrangement was sanctioned today. The deal for the UK-based oil & gas operator is a combination of debt restructuring and reverse takeover. The plan provides an exit route for creditors via cash plus listed equity with two options funded by a new USD 4.5bn borrowing base facility:

  • Cash plus equity equating to 61c in the dollar in cash plus 18c of MergedCo equity; 

  • Cash alternative at 72 cents (limited to $175m, scaled back if more is subscribed). 

Following closing, Premier’s stakeholders will own 23%, with Harbour (Parent of Chrysaor) and other Chrysaor shareholders owning the remaining 77% (Harbour 39%). In total $2.7bn of gross debt will be repaid with creditors to receive $1.23bn in cash and other liabilities. Assuming cash take-up in full, existing premier shareholders will get 5.5% of MergedCo, with Premier’s creditors receiving 10.6%. 

Naviera Armas has announced that it has entered into lock-up agreements with key stakeholders to facilitate its restructuring, whose headline terms were originally outlined on 30 December. Bondholders had agreed to provide €100m (€40m initially, with €60m after long-form docs agreed) of the €140m of fresh liquidity (€40m coming from existing shareholders). Holders who wish to subscribe to the bridge facility have until 7 April to instruct the clearing systems, ahead of 21 April funding date. No further details were given with regards to the debt/equity swap and its implementation. 

Provident Financial appears to be going down the same route as Amigo Loans, using a scheme of arrangement to deal with compensation claims. It’s shares fell 30% this week on news that the FCA has opened an enforcement investigation – focusing on affordability and sustainability of lending and an FOS decision on a complaint handling process. 

Aryzta’s sale of its US business for $850m has alleviated investor concerns about short-term performance, after the release of its 2021 interim report. Leverage has ticked up to 4.1x (excluding hybrids), but the key for shareholders will be how it deals with its €926m of hybrid notes – which prohibit the bakery business from paying dividends to shareholders if it defers coupons - which has been the case for the past three years. Management has previously said it would engage with the holders once it gets the business through the pandemic. 

Last week we asked whether shipping companies would avoid mistakes of the past, and not content with super-profits might be tempted to increase capacity. CMA CGMappears to have blinked first, signing letters of intent to order up to 20 wide-bean panamax container ships worth $1.2bn

What we are reading this week