By Chris Haffenden | Editor | email@example.com
In a week where stable markets came unstuck after comments from unstable geniuses; regulators tried to finally regulate the off-grid and self-declared unregulatable on systemic concerns – causing uncertainty and instability; politicians fumbled their messaging, as amber gamblers bet on stop/go covid policies – yet more uncertainty and instability - it was tough to concentrate on LevFin credit.
Competing for our attention were a flood of earnings releases on Thursday for a number of zombie companies, stressed and post restructuring credits, with conference call clashes aplenty that afternoon. Surely, lead managers can get companies to coordinate their scheduling of earnings calls? Cue plenty of requests for earnings replays and transcripts.
I miss the live experience of hearing management fumble when an analyst grills them on their working capital evolution and cash burn.
Minor rant over, it’s time to concentrate, close my charts, and get some thoughts onto the page.
It’s been a tough week for airlines and travel businesses, with odds on bets for a lucrative summer drifting in the betting market. Arguably, it could have been worse, many thought the UK would delay Stage 3 reopening on Monday (17 May) for at least a couple of weeks given increased concerns over the spread of the Indian variant.
Politicians have since urged caution, creating confusion on whether it is still safe to arrange drinks and a meal inside a pub, or contemplate jetting off to France or Spain – the Amber Gamblers. Many travel and hospitality firms were geared up for this date and are likely to see lower take-up than expected. EasyJet’s CEO yesterday was livid, saying that “it was never the case that under the traffic-light system an amber designation meant people should not travel there.” Amber has turned to red.
My Amber Gamble - a Pint for Friday Workout Readers who can guess where I will be tonight for my first 2021 indoor drink
Latest news is mixed, the variant may be less transmissible than previously thought – but that was due to most coming from abroad - our world-beating track and trace once again giving the variant a two week head start. The odds are no better than evens on a June 21 full reopening.
BTW Traffic lights system analogy is wrong. In the Highway Code a red and amber light together means stop, only a flashing amber means go, and only if you believe it's safe to do so.
But enough of my pedantry, markets are seeing amber, and it’s unclear whether it means proceed with caution or it's about to be accompanied by a red light and the brakes will be slammed on.
Many investors jumped the lights, racing into travel business’ debt and equity prior to reopening.
The success of Carnival’s debt raises, the ability of TUI and Lufthansa to raise subordinated debt in recent months is testament that there is little, or no premium attached to reopening risk. Dufry is a great example, the Swiss travel retailer got its B1/B+ rated notes away at 3.375% in April. This week its bonds dipped to 98-98.5 on the latest financials, but with covenants waived and with further headroom, and refinancing of loan maturities until 2024, it has plenty of runway (pun intended).
But not all skies are so friendly. Frequent flier to LevFin funding Deutsche Lufthansayesterday (20 May) suspended interest on its 4.382% hybrid bonds due 2075. The German Airline caught investors by surprise, it said that payments would violate state aid rules. At one point the bonds dropped to just 90-bid, from 97, before recovering later in the day to 95. Lufthansa received €6bn from the German State last June, including a €3bn government guaranteed loan.
Those who piled into TAP Air bonds last November after they dropped into the mid-50’s and saw a sharp ascent into the low 80’s by January may become nervous fliers if still in their seats. Ryanair’s court victory earlier this week means that TAP and KLM may be forced to return state-aid payments made last summer. It also calls into doubt a further tranche to the Portuguese carrier. However, the judges said that no repayments needed to be made, until the European Commission had made a new decision on the loans. Despite posting a record $990m loss earlier in the week, Ryanair managed to raise €1.2bn of five-year bonds at 0.875% the day after the ruling. It retains a BBB-rating. It’s reliance on new Boeing 737 aircraft and ambitious expansion plans are a leveraged bet on air travel bounce.
Amigo Binary Options
There are plenty of gamblers in Amigo Loans equity. Since the announcement last December that the guarantor lender would use a Scheme of Arrangement to deal with redress claims that threatened its solvency, the shares tripled by 10 May, a market cap of £140m, but a long way off its £1.5bn peak.
The shares fell 38% on 10 May, when its regulator the FCA said it would oppose the Scheme at the sanction hearing. Amigo decided to suspend its shares on the morning of the hearing, concerned about the asymmetry of information, with limited space on the Microsoft Teams meeting for the remote hearing. This wasn’t helped when one shareholder posted the link on a message board.
When the hearing finally got away, the gamble management took on settling the redress claims for just around 10% of their value, which looked increasingly risky. The company claims that if the Scheme is not approved it will go into administration, with Grant Thornton lined up.
Early in the hearing, Justice Miles was unconvinced about the binary option facing claimants:
“No evidence had been provided why the company would be immediately put into administration, that is in the short-term. Why is insolvency automatic and inevitable, absent a cash flow or balance sheet event…There is a Sword of Damocles element about this, creditors are being told if you don’t approve the company it would go into insolvency [and receive nothing].” The court is entitled to explore the objective facts. There is some existing value to the shares, with no cash crunch and it can pay its debts as they come due, noted Miles.
Prior to lunch break, Justice Miles set the company some homework - to explain a graph on a dedicated website used to outline the cash available for payouts to redress claims.
Robin Dicker QC, acting for the company, explained that the assumptions are based on the lack of any future lending, with the graph illustrating cash flows out to 2024 when the bonds are due. This supports Amigo’s claim that only £15m is available in the pot for redress claims.
Justice Miles said that the way the information was presented appears illogical. “The premise of the graph should be what the business looks like if the scheme is approved.” Your point that the upfront cash payment [£15m] contribution is the most that can be paid ignores the fact that more money can be earned on the resumption of lending, he suggested.
Tom Smith acting for the FCA pointed out that Amigo has £180m of cash on its balance sheet. If Amigo has ample cash and has stopped lending, what are the triggers [for insolvency], said Smith. “In restructuring parlance, there is no burning platform.” There is no imminent cash flow or liquidity crisis evidenced. The timing is missing on why they need to file now. “One is searching in vain for any indication of this.”
The company indicated that value breaks in the secured debt, and it is a matter of law that redress claims are ahead of the shareholders, said Smith. The treatment of shareholders is much better than the redress claimants, with the equity staying unimpaired, save giving away just 15% of profits for four years, compared to just a 10% payout for redress claims.
“We estimate that the claims of redress creditors to be written-off as £540m out of total claims of £600m. On any view, this is very substantial indeed.”
The tripling of the shares since the Scheme was announced shows what the market thinks of future equity value, continued Smith. “There is no justification why shareholders should retain their equity. Why is none going to the redress creditors?”
Before Robin Dicker could respond, others on the call were offered the chance to speak. For the next 20 minutes a number of disgruntled Amigo shareholders spoke, most critical of the FCA, both on its oversight on the guarantor lender in the past year, leading to a surge in customer complaints, and it's late decision to oppose the scheme.
At one point Justice Miles had to point out that they were not there to cross-examine the FCA, much to the clear relief of Tom Smith QC. The Judgment is likely next week, nervous holders may be hoping the suspension is lifted before then.
Zombie epoch or eclipse
According to Bank of America we may have reached the epoch of Zombie company numbers.
EuroStoxx 600 companies with interest cover of less than 1x is 11.3%, down from 13.6% last year. Still higher than the post-GFC Zombie high of 10.3% in Dec 2009. While Investment Grade firms are back to profitability many are still raising significant amounts of debt, and 60% are still cutting capex. The anticipated investment boom may not arrive.
In High Yield and Leveraged Loans a significant portion of deals remain highly levered. The prevailing argument is that this will be temporary, and leverage will normalise as we recover. Cost savings, and working capital improvements and management discipline gained during 2020, mean that we don’t need to hit 2019 earnings heights to meaningfully deleverage.
Reopening will improve metrics in coming quarters, but for some leverage is unlikely to improve much on a LTM basis until the fourth quarter at least, given the Q3 comps. We also need to factor in surges in raw material costs, supply chain issues, and pre-covid structural changes in some industries.
In primary, many deals are priced off 2019 figures, or issued at historically high leverage with adjusted EBITDA baking in synergies, benefits and covid-adjustments, often 40% or more higher than actual EBITDA. More concerningly, many deals are projected to produce little or no FOCF in the next couple of years, even on their optimistic assumptions. The expansion of deal EV multiples and higher equity cushions mitigates somewhat, but the re-rating cannot go on forever. Zombies could re-emerge.
One zombie that refuses to die is Yell.
Directories businesses were the darlings of LevFin prior to the GFC (like Healthcare today), given their strong cash generation and virtual monopolies in their jurisdictions. Older LevFin heads will remember their fall, the structural shift to digital and their inability to compete. It’s a real horror story. But Yellis still there, albeit substantially smaller than in its heyday.
"Sales performance continues to improve steadily, our customer churn rate is now back down to pre-Covid levels, and we ended the year on a high with the absolute decline in customer numbers in Q4 at its lowest level since 2008.”
Inspiring stuff, but it’s 8.9x levered, not generating any cash flow, with just £30m of cash and £18.2m of annual bond interest, plus £7m of deferred VAT. Pre-covid, their cash only increased by £14m in the Year end March 2020 and it cannot access its £25m revolver above the 35% draw stop unless it less than 6.25x levered. Yell is the business equivalent of the living dead.
To improve its fortunes and break from the past, the corporate entity changed its name to Hibu, according to the Urban Dictionary is a combination of hi and bu - a daily salutation between bff’s on instant messenger. We think the brand should change too – from Yell to a Whimper.
Thursday, I don’t care about you, It's Friday…
As outlined in the intro, we had a flood of stressed, post-restructuring and businesses significantly impacted by Covid-19 reporting yesterday or hosting their conference calls.
Not just Yell, but also OHL, Codere, Vallourec, Dufry, KCADeutag, Frigoglass, Olympic Entertainment, Travelodge and Lowen Play amongst others.
Olympic Entertainment management’s focus is on preserving liquidity. With just €25.4m of cash, before a €8m bond interest payment, €4m of deferred taxes, and cash burn of €1.5m per month, it is restricting capex to just business development and maintenance, spending nothing on building refurbishment or new slot machines. It hopes cash flows can improve on reopening. Latvia and Slovakia are back to around 85% of ‘normal’ since reopening in the past few weeks. Permanent rental reductions of 10-15% have been secured, said management.
The conference call was a shadow of last year, when the company refused to answer questions from angry bondholders on the transfer of its online business outside of the restricted group. This call was short, with few questions. Threatened legal challenges have yet to emerge. The odds on the online biz being >€10m in value now?
Codere announced the day before its earnings it was almost there on its consent solicitation for its restructuring, with just 1% more of its $300m SSNs needed to approve by 28 May, to avoid going down the UK court implementation route. Our Restructuring QuickTake provides more detail.
There is mixed activity across its operations, with Uruguay partially open, Mexico, Spain and Panama fully open, but Argentina and Italy still closed. The Buenos Aires province license discussions have stalled, and Codere may launch a legal challenge next week. The Spain-based gaming company spent heavily in Spain on online advertising in the first half, before restrictions were imposed on marketing spend. Sports betting revenues in March were particularly weak, and online revenues in Q1 slowed against Q4. Online is one of their main hopes for future growth, and the group is working on a ‘comprehensive business plan’ which includes M&A in the online segment.
Lowen Play management talked about a possible refinancing on their earnings call but failed to give a timeframe. As we disclosed in our deep-dive, the Germany gaming company faces regulatory uncertainty, with new measures to come into force in July, and has been hit by renewed lock-downs with arcade reopening at the end of June/early July by the latest. Its bonds become current in August.
The company provided a lot of detail on the new interstate treaty, saying it “expects a significant overall positive effect on Safari Group, as compared to the prior framework.”
GRENKE AG announced that “KPMG has today issued an unqualified audit opinion for the annual and consolidated financial statements as of December 31, 2020. The Company will publish the 2020 Annual Report on May 21, 2021, as announced. This will be a relief to sceptical observers such as ourselves, but it still needs a clean bill of health from BaFin too.
The Vallourec sauvegarde plan was approved on 19 May. In early June, the accompanying rights issue should be launched, with the restructuring expected to become effective on June 30, 2021. The results were issued yesterday (on our to-do list) – presentation is available here
Regis landlords had more success than New Look’s with their CVA challenge, with Justice Zacaroli revoking the CVA. But on closer inspection of the judgment, the win was on very narrow grounds and is unlikely to change the legal picture.
That will have to wait until the New Look appeal.
What we’ve been reading/watching this week
Over the years, I have seen many companies try to buy votes to push through unpalatable deals. But Bombardier takes it to another level – finding a White Knight to buy new bonds to fend off a challenge.
Over 44m Americans own cryptocurrency, with many buying in the past six months. Elon Musk’s comments on Bitcoin and Dogecoin roiled the markets, with $8bn in liquidations from 775,000 margin calls. But what is the technical state of the market? Glassnode provides a good in-depth analysis
Ed Conway from Sky News provides an excellent twitter thread on failures which led to the spread of the Indian variant to the UK
M&G Bond Vigilantes on what the recent surprising US data is telling us about the job market – why is acting like it is already at full employment?
Following on from their successful EV spreadsheet, the FT has developed one for SPACs
And finally, the first SPAC squared?