Friday Workout

Rolling up for 4 and 20; the HY Theory of Relativity

By Chris Haffenden | Editor | chris@9fin.com

For a fundamental investor the past twelve months have been difficult. Valuations are completely detached from reality, and we are at the point where most price targets are just arbitrary numbers. Worse still, companies are not even trying to hide the blatant manipulation of their numbers anymore, and hardly any investor bothers to check their figures under GAAP, released later. 

It reminds me of 1999, working at a US Investment Bank, spending some time in the NY office. Our no1-ranked tech analyst had just doubled his Yahoo price target to $200 (the stock was the Tesla of its time). I asked how he got to this figure. He said, “it just felt like a nice round number.” 

At that point, the scales fell away from my eyes - there was no fundamental analysis at work - he was just a cheerleader for the stock, in order to gain client order flow.

Coincidently I was back on the NY trading floor in 2000, when he cut it in half to $100 after a huge earnings miss. It didn’t stop there, with a trader colleague quipping, “there is strong support at zero.”

In those days, it was all about clicks. Nowadays we think we have become more-savvy, talking about KPIs, users and user engagement. But the reality is still about picking target numbers and FOMO. 

I was reminded of Yahoo when ARK upped its Tesla target in mid-March from $1,400 in 2024 to $4,000 in 2025 giving it a market cap of $4trn. “To arrive at this forecast ARK used a Monte Carlo model with 34 inputs , the high and low forecasts incorporating 40,000 possible simulations.” This is a fantastic takedown of the assumptions which then takes a swipe at ARK’ supposed outperformance. 

But over the past week, I think the market has become even more psychoactive. 

Dogedays are over 

In the early 2000s everyone was an expert on the stock market. Last weekend, I was at a post lockdown drinks sitting next to a friend of a friend, who before starting his day job gets up at 5am and spends the next three hours trading cypto. Unfortunately, he knew about my trading background, and after an 18% overnight flash crash, wanted my opinion on trading techniques (his only strategies appeared not to overtrade, hodl on to ride volatility, and buy dips whenever he had spare cash).

His confidence in the big narrative on why Crypto will replace Fiat currencies as we go cashless, and that blockchain will be behind most future transactions was impressive. He was clearly disappointed when I said I wasn’t actively involved in crypto, and that I avoided trading markets where I cannot fully understand their mechanics and ascertain fundamental value. I added that Bitcoin was a skewed and flawed commodity trade – I didn’t see it being widely used to buy goods – despite being impressed by his new Bitcoin-backed Visa Card, that he used to buy the next round. 

I thought I was on safer ground, talking about dogecoin, the joke crypto currency which has surged partly on Elon Musk tweets, a famous user of psychoactives. Forbes says "dogecoin is today the sixth most valuable cryptocurrency, an all-time high for what was originally conceived eight years ago as a meta joke about monetary value and the internet." Dogecoin is up by 5,000% in 2021.

But my neighbour said he liked the low-price canine coin, actively trading it alongside other crypto. He then mentioned @DogecoinRise and the #dogeday campaign to push the price to $1 on 20 April. 

Like Matt Levine, I was blissfully unaware of the cannabis connection to the date, now I get why Elon Musk talked about Tesla taken private at $420. But the social media skills of its HODL’ers were not enough to stop dogecoin nosedive this week. The joke is still on you and me - we didn’t get involved - there are still plenty of dogecoin millionaires out there, who all think they are trading geniuses. 

HY Theory of Relativity 

For those of us covering LevFin, we might see the above as an interesting sideshow and like to think we understand businesses and can assess fundamental value. 

Admittedly it is getting harder, given the latest raft of EBITDA adjustments - “but we haircut that,” is the response I hear the most from investors. What about the loose documents? “We try and push back, where we can - but our main focus is always on the credit story.”

But are we kidding ourselves? Most of the time we are just comparing transactions to others.

When a deal gets done it sets down a marker. For example, Douglas’stressed refinancing, where it priced its SSNs at 6% (with hefty EBITDA add backs to get to sub 5x secured leverage).

It didn’t take long for Coty to price inside, despite insane adjustments with 535% EBITDA add backs which made Douglas look conservative. But that was fine, as there was a $7bn equity cushion (from the implied market cap), despite being over 25x levered on a ‘clean’ basis. 

This week, we saw similarly-rated German peer CBR Fashion come with a refinancing which many investors mentioned Douglas and Coty as comparators (not just €21m covid-related adjustments to EBITDA). Mid-5’s price talk looked attractive if you believed the 3.5x marketed leverage figure, based on €114.9m adjusted EBITDA (23% margins for a retailer?) Surely, they could eventually recover to the €152m generated in FY19, and the business is traditionally cash generative, what is not to like?

Source: 9fin

But Alteri, the Apollo-affiliated sponsor has taken several dividends out of CBR, most recently €41m in January 2020. Our legal QuickTake notes that with unlimited restricted payments set a leverage ratio of 3x (just half a turn lower) there is plenty of room to leak value to the sponsors, with Day One RP Capacity: 0.5x EBITDA (35 + 5 + 2.5 + 3 + 10). Other protections are mixed, some of the debt incurrence ratios were reduced, but there is no worse language appearing on limitations on indebtedness and portability set at opening leverage. This can allow FCF to be upstreamed to the sponsor, or dividend recaps, leaving little room for deleveraging. 

As 9fin’s CEO Steven Hunter, and Alice Holian, our legal analyst, outlined yesterday on a webinar hosted by ELFA, add backs and documents do matter. Copy of our slides are available on request

Super-Growers are becoming standard for sponsor deals – adding even more headroom, as you can work off your best-ever EBITDA (augmented by a plethora of adjustments) whatever happens next to your business.  

Permitted Investments capacity has doubled from a year ago, with unrestricted subsidiary and general baskets growing fastest. J-Crew blockers are not as watertight as you might think, btw. 

Worst still, more tests are now leveraged-based, and no-worse language is proliferating. The latest egregious development is the concept of ‘Available Amount’ – please email alice@9fin.com for more info.

As Steven Hunter pointed out, covenant protections matter most in a distressed scenario. 

Most recent restructuring deals were done with transaction docs from 2013 to 2017, so, very few (if any) of the new crop with poor docs are yet to be tested. Creditors could be in for a nasty surprise. Securing priming debt capacity has soared, allowing super-senior debt solutions to the detriment of existing holders – Codere is a great example; use of unrestricted subsidiaries to transfer value out of the restricted group – Olympic Entertainment (watch out for Ellaktor, if its capital raise fails). Many deals also have the ability to issue ‘unlimited secured debt’ allowing layering of second lien (Matalan). 

Slight changes in language matter. For example, under many docs you can designate an entity as an unrestricted subsidiary, if there is no event of default. If you remove the absolute wording of Eod or alter the qualifier (or its timing), suddenly the tap isn’t turned off, just when as an investor, you need it most. 

At the moment, little of this appears to matter, with the financing market open for all but the most stressed names. But when the market changes, and it will, negotiating power will be firmly with sponsors, relatively speaking. At this point, what documents say will matter, and the EBITDA they are working off under the restructuring plan to cram you down, I can assure you, will be a lot cleaner.

Selected 9fin coverage 

This week we focused on businesses hit hard by lockdown and their resilience. 

Q-Park - Now, where did I park my car? 

9fin’s Raul Ortega outlines management’s confidence on prospects for reopening based on mobility data and early signs from the UK and Denmark easing of restrictions. But most of its liquidity comes from a fully drawn €240m RCF. 

Management said during their Q4 conference call they have around €80m of capacity under the bonds indenture to use if lockdown measures are extended further or demand does not pick-up as expected. Leverage is a lofty 29x from 6.9x at refi in February 2020. 

Pure Gym feels the burn in 2020, looks to healthier performance as gyms reopen

The low-cost gym operator has had a difficult year with its gym goers enjoying 63% of open trading days compared to 2019. Liquidity is £231m, £145m from an undrawn RCF, with a three-year waiver, not tested again until August 2024. Net Senior Secured Debt to EBITDA must be below 7.7x (springing 40%), with the gym chain using artistic license to disclose a 4.6x figure as at December 31, 2020, based FY19 £161m EBITDA. When using FY20’s £37.7m, the figure jumps to 19.5x. 

As of 20th April, 56% of gyms had reopened, but the heavy lifting came from the English estate, with Danish clubs (~36% of the total number of gyms) still closed. In total, 300,000 members were lost between December 2019 and March 2021, with membership down to 1.4 million.

One other area of concern is club capacity constraints, which will potentially be limited to 30%-50% below pre-crisis levels. Pure Gym claim they can handle this, but the graph below suggests if some members don’t alter their daily routine, they could be turned away when going for their post-work session.

Provident Financial, the UK specialist lender has followed a similar route to Amigo Loans and has set up an SPV to deal with compensation claims. However, the terms appear less generous, and in common with Amigo, the regulator, the Financial Conduct Authority is not supportive. 

The FCA says that they do not support the scheme, but it is not opposing the convening of a single-class scheme, as other issues can be addressed at the sanction stage. For context, the total possible quantum of claims could be £3.6bn, but shareholders are just putting in £50m. Even if the number of claims is in the 10% to 30% range as predicted by the company, the dividend payable to claimants is just 5-10%, said Tom Smith QC, acting for the FCA.

Smith questioned what is the right amount of shareholder contribution on the other side, and could a better scheme of arrangement be possible? Unlike other Schemes, this was not the result of negotiations with Scheme creditors to determine an outcome. The FCA has sent a letter to the company outlining its concerns, but these matters can be dealt with at the Sanction Hearing stage.

Next week, we expect an important judgment for New Look, with a group of landlords challenging a CVA which seeks to impose turnover rents as unfair. Later in the week, Virgin Active’ssanction hearing will also hear challenges from landlords, concerned that the UK restructuring plan could be used to cram-down their dissenting votes. Implications from both cases are likely to be significant, and we are working on a feature outlining the key points for publication next week. 

In brief

Ellaktor debt prices yo-yoed this week, downgraded to triple-hook with concerns that its planned share increase from its construction group subsidiary would be blocked by Greenhill, an existing shareholder. But the injunction failed, and it looks as if the fund raising will go ahead. 

Our fears on Codere were confirmed. A larger than expected €125m new money need resulting in a full-blown restructuring, as super-senior baskets weren’t enough to bridge liquidity. Senior noteholders will receive 95% of equity in a new topco, with 25% of their notes reinstated, and 29% exchanged into a PIK stapled to the equity. We will explore the deal in more detail next week. 

Troubled UK-based property company Hammerson has confirmed the sale of seven retail park assets to Brookfield for £330m, an 8% discount to December 2020 confirming its exit from the sector. Last week it revealed that it had collected just 40% of the £45m rent as at end-March quarter day. 

What we have been reading/watching this week

SPACs your lot  Researchers found that between 2010 and 2020, buying a SPAC at its IPO and selling it at the time of merger would have yielded a return of 9.3% annually. For SPACs held for a year after a merger, the annualized loss was 15%

The surge in cases in India and their new variants is not getting enough widespread media attention as the narrative switches to recovery from lockdown, is this a White Swan?

It wasn’t just the UK government coming up with space ambitions during lockdown. PureGym staff were also shooting for the Moon

JPMorgan is no stranger to football-related controversy. Manchester United fans bombarded their head office with unwanted pizzas when they financed the Glazer takeover, and ex-JPM banker and Man Utd board member, Ed Woodward remains a target for their ire. JPMs role in the much reviled failed European Super League could have led to a repeat (Go long Deliveroo shares!), but there was another downside in addition from the lost fees, it was given a lower sustainability rating as a result

Count Binface has come up with a compelling manifesto for London – we could be persuaded 

And finally, creative add back Kings Kantar have announced this week a deal to buy Numerator – imagine the pun fun we are going to have when the financing comes to market.