Friday Workout

What do we need to be true; How to Spend it; I know what you did last summer

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

As the second quarter begins, it’s time to reflect on 2021 so far and extrapolate to assess restructuring prospects for the rest of the year. What do we need to be true, in order to change the strong narrative supporting risk assets to bring more deals? 

With little in the restructuring pipeline in Q2, our attention shifts to performance of restructurings completed since last summer, for potential follow-on events. Building on 9fin’s predictions, we are on the hunt for stressed refinancing candidates to take advantage of risk appetite for stressed names. We will also identify names mispriced for risk that may fall into stress/distress. 

What do we need to be true?

Epilson Theory has an excellent post this week, on the nature of the water in which financial investors are swimming in. Ben Hunt comes up with the five key narratives: 

  1. We live in a deflationary world.

  2. We live in a flat world.

  3. We live in a world in which the Fed has your back.

  4. We live in a world in which doing anything other than maximizing top-line growth is value–destructive. 

  5. We live in a world of easy credit, abundant leverage, inexhaustible liquidity and limited regulatory scrutiny.

He adds, “The walls which protect the equilibrium of the water in which we swim from new information are high. And those walls are built out of the things we need to be true.”

The financial world appears to be much more certain of what lies ahead than the real one. 

Narratives can always be tweaked to reassure, as challenges to prevailing views appear, with inflation fears now dismissed as temporary, and investors believing the Fed will seek to avoid a taper tantrum and not raise rates until 2023, whatever the strength of the economy or CPI. 

JPMorgan CEO Jamie Dimon is telling his shareholders that the US economy is at a goldilocks moment where expanding vaccinations, high savings rates and the Biden administration’s massive stimulus bill could trigger a strong recovery lasting well into 2023. Then again, he’s not the best economic sage, last year he was talking about a ‘bad recession’ where US GDP would fall by 35%! 

With so many investment professionals needing the narrative to be true (the consequences of it being false are unthinkable for their wealth), it will take an Ever Given-type event to shake the strong conviction on the list above. But where could this come from?

Sometimes we forget that we are in the middle of a huge economic experiment.

Central Banks are now price makers for long-term interest rates, flooding unprecedented liquidity into markets with likely unintended consequences (not just asset price inflation). This is coupled with a huge existential shock to the real economy, set to unleash pent-up demand on reopening amid supply chain issues in many sectors. The end effects are far from certain.

Bill Blain summarises this much better than I can (full post here

Now, the global reset button has been pressed. The problem is, it’s not the button markets were expecting – they expected to see rates normalise, debt levels magically fall, and stock prices behave in ways they conventionally understand.

Instead, we’re getting a government and politically led reset. And that’s a massive source of risk and uncertainty. At the back of every serious investor's mind is fear. There is a very realistic possibility that Governments know their spending plans, massively increased debt levels, and the market’s current bubblicious levels, can all be “corrected” with inflation – the Ultimate Big Reset.

I would add that the new normal is likely to be anything but normal. 

While English pub gardens are booked solid for the next two weeks (despite the predicted cold weather), I’m not expecting to see full trains and tubes and a rush back to offices. Behaviours will change, from greater restrictions imposed on us by government agencies, and from our own changing attitudes from months in lockdown. Some sectors such as Real Estate and Travel will face challenges for months if not years to come.

Carnival is a good example. The US-based cruise operator is increasingly frustrated by delays and stringent conditions from the CDC which it believes will hinder US cruises resumption by July 4, 2021 – Independence Day, the target for US reopening set by President Biden. 

In its Q1 update call, Carnival said it needs 60-90-days’ notice to hire and train crews to be compliant to new CDC rules. It hasn’t yet committed to full vaccination of guests and crew, unlike its peer Norwegian Cruise Lines. In any event, children are not part of the US vaccination programme, it adds. 

In recent days the temperature rose with Carnival threatening to move its fleet outside the US. The CDC last October issued a conditional sailing order where “cruise ship operators must demonstrate adherence to testing, quarantine and isolation, and social distancing requirements to protect crew members, before passenger travel will be allowed to resume in later phases. Cruise ship operators must also build the onboard laboratory capacity needed to test crew and future passengers.”

Last Friday, the CDC updated its guidance, allowing fully vaccinated people to travel within the US without having to be tested or going into quarantine. More technical details were issued on its conditional plan to allow cruise ships to operate out of US ports but it failed to commit to a timeline for the resumption of sailings under conditional sail orders

The majority of investor questions revolved around dialogue with the CDC. A recent Bloomberg article quoted the CDC as saying that ‘restrictive revenue sailings’ would be allowed mid-Summer, this prompted questions for management around whether this meant test cruises or limited occupancy. “We are focused on working with the CDC to figure it out,” responded Arnold W. Donald, the CEO. 

Carnival has pushed back sail dates for its US cruises once again to end-June. But unlike competitors, which can easily switch to operating out of the Caribbean, Carnival says it prefers to operate out of its 14 home ports. If it is unable to sail, it said it would consider operating elsewhere, pointing out there are no restrictions on US citizens flying to other ports without a vaccination. 

Cash burn in the first quarter was better than expected at a mere $500m per month. Liquidity is $11.5bn, boosted by further debt and equity issuance in Q1. Carnival has raised $23.6bn since the pandemic – but amazingly the stock and bond market were incredibly receptive. It has an EV of over $50bn, higher than pre-pandemic and above the $43.5bn of reported tangible asset value. Its bonds remain buoyant, the 7.625% senior unsecured 2026 notes are bid at 109.75, a 4.6% yield.

How to spend it

We were amused this week, when S&P said that IAG “group liquidity is assessed at exceptional”, up from strong. But that wasn’t enough to remove the negative outlook on its BB rating, despite the €10.2bn of total liquidity as at end March. 

The agency says, “although we currently don't see liquidity as a near-term risk, we would lower the rating if air traffic does not recover in line with our expectations, external funding becomes unavailable for IAG, and if management's proactive efforts to adjust operating costs and capex are insufficient to preserve at least adequate liquidity, such that sources exceed uses by more than 1.2x in the coming 12 months.” That’s some rate of cash burn and S&P assumes that they will be coming back to the markets for more debt in the meantime. 

As we come out of lockdown, many companies are in better shape than Carnival and IAG, having built up large liquidity buffers, either by drawing down on existing facilities, or by taking advantage of cheap debt. But what are they going to do with all that excess cash?

Debt investors will say pay down debt to reduce leverage and right size capital structures. But many companies have pared down capex to the bone (and in many cases underinvested in prior years) and will look to reinvest to rebuild their operations. Their equity holders are keen to recoup lost growth and may be tempted to splurge on what they view as accretive acquisitions boosting M&A activity. Disappointingly, in recent months we’ve seen a recovery in stock buybacks despite inflated equity values.

I would add another more contentious one, a number of LevFin sponsors may keep excess cash on the balance sheet a little longer to depress net leverage ratios – allowing them to take advantage of loose documents – to leak out value away from the debtholders.  

A threat to corporate cash balances is the Biden administration tax plans and potential knock-on effects. The plan from Janet Yellen is clever, as it will force large multinational corporations to pay a minimum tax of 15% of book income, and it attacks their incentive to inflate reported income. Coupled with coordinated international action to tax companies based on worldwide income, I can see it gaining traction and causing problems for low tax paying PE-owned businesses, as the public gets onboard with the idea. 

I know what you did last summer

In the depths of the crisis in mid-2020, many corporates had to make difficult choices. They could either look to existing lenders or third-party special situation funds for interim liquidity to provide further runway (CodereMatalanLecta); pick a soft restructuring via a paydown and an amend-and-extend to push out maturities (Selecta); or bite the bullet and undergo a full-blown restructuring (KCA DeutagEuropcarTechnicolor and Swissport). 

Not all will have made the right choices, and many may need to come back to their creditors for more relief in the coming months, most notably Codere, which is currently talking to super senior lenders for another €100m. 

One of my bugbears when leading restructuring coverage at my former shop, was the lack of journalistic focus on post-restructuring situations. Live situations are the sex and violence, once restructured they became boring and less salacious to cover. 

But many post-restructuring deals will not see a hockey stick shaped business recovery and will fall back into restructuring. Projections are invariably too optimistic and revised capital structures are still suboptimal. It often takes more than one attempt to fix a business, and it can require a further shakeout to concentrate the number of stakeholders in order to do so. 

Conversely, impatient and involuntary owners from last-year’s restructurings will be looking for an exit on any sign of a confirmed business turnaround. CLOs, hedge and special situations funds are not set-up to be long-term equity investors, after all. 

Over the remainder of this year, 9fin will be tracking post-restructuring situations very closely, as we expand our distressed/restructuring offering capabilities. A number of the above names have reported recently -  we will be taking a closer look at their performance to plan - and assess their capital structure options.

Spring forward, fall back 

The first quarter was certainly an interesting one for restructuring practitioners with a hard Brexit for UK insolvency recognition after no contingency plans were put in place for after December 31, 2020. The effects were compounded by Mr Justice Zacaroli’s ruling on gategroup’s UK Restructuring plan. To recap, the judgment means that the new process, introduced to force cross-class cramdown, was viewed as an insolvency process, hindering recognition in Europe, which could lead to parallel processes or even forum shopping away from the UK to mitigate, with the US, Netherlands and Ireland the most likely beneficiaries. 

This quarter, there will be rulings on further challenges to the new UK Restructuring Plan and the well-trodden CVA route from landlords, objecting to the fairness and process for Virgin ActiveNew Look and Regis, who are trying to impose sharp rental reductions. The judgments will be important for retailers and other businesses seeking to break leases. If landlords lose, the consequences are stark, many are facing low occupancy rates and sharp drops in valuations, leading to LTV breaches and cash traps (and worse) for their securitisations. Commercial real estate finance is an area to watch closely in the coming months. 

Outcomes from the new Dutch scheme will be closely watched, as the process is rightly seen as the main threat to the preeminence of the UK for large European restructurings. Despite few deals going through the process in the first quarter, the initial signs are favourable. 

We expect further progress on European insolvency law changes, most notably France and Spain. The former may not help Comexposium lenders, the company is likely to follow the Groupe Rallye playbook and keep its creditors at bay, using borrower-friendly Sauvegarde for HoldCos. On the flip side, the regime has shown large restructuring can be done consensually, via conciliation and Mandat ad hoc with Europcar and Vallourecrecent examples.  

Spain has seen a number of high-profile names enter into restructuring, with the Spanish Government likely to play a prominent role (see section on Abengoa below) via SEPI, its strategic fund for business. The fund has already flexed its muscles on corporate governance seeking board representation and contributions from all stakeholders. Duro Felguera and Celsa are top of our watchlist for the second quarter. 

With our restructuring watchlist getting thinner by the day, as stressed businesses take advantage of hot markets to refinance – DouglasBoparanPure GymAston Martinamongst others – we are pivoting to look at other candidates which can take advantage of the appetite for stressed names, and looking for those which are mispriced for risk and could fall into stress/distress building on the success of 9fin’s predictions. 

NH Hotels is the first of our stressed refinancing predictions. The Spanish urban hotels operators’ 2023 bonds are now trading close to par. While the company could wait until 2022 for better financials to refinance, we think that the price to pay for going now is relatively low. It could be a cheap maturity wall policy, protecting against any new variants of the virus or any other reopening impediments.

Aben-a-goer?

“I love deadlines. I love the whooshing noise they make as they go by,” Douglas Adams.

Abengoa is no stranger to missed deadlines, we’ve lost count how many have whooshed in the past 12-months. But on 10 March it looked like time had run out after the Spanish concessions and renewable energy group said it would be forced to file for voluntary liquidation at the Seville Court. Guillermo Ramos from EY Abogados was appointed as insolvency trustee (administrator concursal)

Abenewco1, the main subsidiary, is where the most valuable assets reside. The business requires €249m to keep operating and on 17 March it submitted a request for funds from SEPI. 

Californian fund Terramar had submitted a proposal to invest €200m in return for 70% of the equity. According to local press reports this deal would be implemented in two stages, with a €35m loan and a €40m guarantee line in the first phase, and in the second phase the company would sign a restructuring agreement similar to the one agreed with creditors on 6 August, with Terramar providing another €115m of financing and subscribing to a capital increase. The remaining 30% would go to current creditors, including Santander, CaixaBank, Bankia, KKR, Blue Mountain and Melqart.

Yesterday, El Confidential said that the Amodio Brothers who control fellow Spanish concessions group OHL (which is about to emerge from its own restructuring) had submitted an €250m offer partially funded by Artic, the Norwegian firm to the insolvency administrator. 

And today, yet another offer appeared from Grupo Caabsa, EPI Holding, Ultramar and Abengoashares shareholders. The offer would inject €135m of loans and €65m in financial instruments

In brief

Some of the larger global restructuring deals are emerging or close to emerging from US Chapter 11. 

Hertzhas selected Centerbridge Partners, Warburg Pincus and Dundon Capital Partners to provide equity funding for its exit from Chapter 11. The enhanced plan beat a competing proposal from Cetares Opportunities and Knighthead Capital Management. 

Over the past week, changes to the proposals negated the need for Hertz Holdings Netherlands, the European arm, to sell US Guarantee claims via auction. The existing Hertz Holdings Netherlands €225m 4.125% 2021 and €500m 5.5% 2023 senior unsecured notes with The Hertz Corporation (THC) as parent guarantor will now be repaid in full. Their guaranty claims against the US entities will be unimpaired. The plan sponsors agreed to provide an EUR 250m facility to fund the European businesses’ immediate cash needs. 

Wizink Bank, the Spanish subprime lender received some bad news. Last year the Spanish Supreme Court had claimed that interest rates on its revolving credit cards were excessive. However, it was hoping that the European Court of Justice would rule favourably on an appeal lodged by a competitor. 

But this week that failed. Wizink said that “while the ECJ decision is not favourable to WiZink’s position, it has only established that a cap in prices does not contravene European Law but has not engaged the issue of whether the application of the cap in Spain has created legal uncertainty.” The Bank adds, “As the procedure and timing for potential future cases are uncertain, however, WiZink is still not modifying its strategy or approach in anticipation of a favourable future ruling.”

Seadrill is one of the last major oil services firms to go through a restructuring. Reuters reveals that it will asks creditors to write-off 85% of their debt 

Accorinvest’s restructuring has slipped under the radar, luckily Hogan Lovells has provided some details of the agreement via this release 

What we are reading this week

Enjoyable Milken Cookies Substack post on a live google doc conversation between LevFin twitter users on the state of distressed debt investing - US-focused, but still well worth a read. 

Janet Yellen’s tax plans get a positive response from Wolf Richter, but he wants her to go even further. 

A couple of articles this week show the extent that the pandemic has changed our high streets and shopping habits. This clever article and infographic from Quartz takes a look on the effects on the incumbents on famous shopping streets around the world.

It’s clear that a lot of commercial real estate will need to be repurposed as hybrid working becomes the norm. Canary Wharf Group is already shifting its office building plans to residential. The Estate Gazette page also has teasers for other articles - plans for vertical farms in empty department stores - and when are distressed hotel portfolios going to hit the market? That tells you a lot about where we might be heading. 

ESG is arguably the biggest trend for European LevFin this year. 9fin already tracks ESG related news and issues a monthly Sustainable Junk report. But the difficulty has been establishing clear guidelines and standardisation on measurement. This initiative from ELFA and the LMA should be warmly welcomed.  

Ellakator always makes us chuckle with their poorly translated public announcements, but this one is arguably their best.

“It's indeed the time for serious decisions about everyone and everything.”