Friday Workout

Blessed to be Stressed; Sympathy for the Landlords

By Chris Haffenden | Editor |

In a week where the third European Covid-19 wave dominated news headlines, casting doubt over European holiday plans and if full reopening this summer can still happen, risk assets remained bid for perfection. Douglas’ stressed refinancing is a good example. Appetite remains for further liquidity bridges as more funds are needed as reopening is pushed back, with lockdowns extended. Cineworld, Royal Caribbean, and Dufry all came with deals to boost liquidity this week. 

New variants of the risk-on pandemic are emerging, with an outbreak of dividend recaps, as sponsors cash in and pile on yet more leverage, despite business uncertainty. At least, it helps with future distressed pipelines. As the restructuring deal flow dries up with yet more potential deals leaving via refi, I complained on an internal call, “in this market even a dead-cat can get refinanced.”

Support for businesses and their employees was extended into the Autumn in many European countries, as domestic lockdowns last for longer. In the past year, many companies negotiated hard with landlords for rent holidays and deferrals, shifting to turnover rents. But who provides support for the landlords? Virgin Active’s UK Restructuring Plan may be one of the first opportunities for landlords to voice their arrears, with a boast of barristers turning up at the convening hearing, yesterday. 

If this precis whets your appetite, read on…

At 9fin, we’ve been following Douglas’ attempted makeover for some time. Our deep dive in mid-December pointed out that the growth of Germany-based beauty retailers’ online business – with a higher consequent multiple – the senior secured were covered. We were less confident about the SUNs, expecting a larger sponsor contribution and/or an exchange offer with some equity upside. 

But the eventual refinancing was less transformative. A €220m sponsor cheque and new senior bond and loan package was more of an amend-and-extend with the €300m HoldCo PIK sans warrants, effectively replacing the SUNs. 

Earlier this week, we evaluated the proposed refinancing. Deleveraging was marginal, with the sponsor injection mostly covering the costs of the transformation plan, fees and deferred payments. 

The refinancing was marketed off a heavily adjusted €394.5m management EBITDA, which took pre-covid levels adjusted for channel mix, with the €120m benefits from the transformation plan caked-on. Douglas FY20 adjusted EBITDA of €250.2m already used heavy make-up, including management adjustments of €138.3m. 

Our own calculations based on LTM FY20 figures put the deal at 8-9x leverage, compared to the marketed 4.8x senior-secured and 5.6x total net leverage. With EV/EBITDA multiples of 7-9x for the sector, this left little or no equity cushion. Total senior leverage of 4.5-5x, with another 1-1.5x of subs, would be more appropriate, we suggested.  

But there is a story to tell, and a potential route to exit for the sponsor.  

Lockdown accelerated the move to online and arguably provided some validation and much needed impetus to their turnaround plan. Douglas’ business plan is as much about attracting higher multiples and boosting its attractiveness as an IPO candidate, said two analysts and a potential investor. Ratings agencies who upgraded to Single-B from CCC and investors in CVC’s 2014 fund who approved the follow-on investment, have bought in. With online businesses trading at 20x plus multiples, if Douglas can execute on its plan, and gain a re-rating into the mid-teens, its transformation will be complete. 

Under the current market heat treatment, Douglas’ new bonds are priced at 6% and new €475m (upsized from €300m) Holdco PIK at 9%, remarkably reducing their overall interest bill despite some late widening of pricing and tweaking of bond/loans/PIK sizing. 

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Emboldened by Douglas and earlier successes with stressed candidates such as Pure Gym and Aston Martin, bankers are bombarding CFOs on our distressed watchlist with refinancing proposals. But last week, we were astounded by Raffinerie Heide’sdisclosure in its interim financial report that it was in discussions with external firms to refinance its €250m senior secured notes due 2022. 

The German refiner had a difficult 2020, with low demand and overcapacity in its core markets and declining refining margins which have hit record lows, posting zero EBITDA in the third quarter. During the fourth quarter, the gross refinery margin was €32m compared to €44m a year earlier, with EBITDA at negative €7.6m. On an LTM basis net leverage is 5.3x. 

But the group has significant off balance sheet financing, most notably a €100m receivables financing facility and an uncapped reverse factoring facility from Macquarie – both of which carry a €40m minimum liquidity covenant. Moody’s estimates that it might come close to this level in the next 12-18 months. Its cash balance is €170m but €70m is deferred tax payments, and if the receivables facility is terminated (already reduced it to €100m from €150m, after one bank didn’t renew) its cash position would be precarious.

Management on their conference call this week, said that banks had been calling them on refinancing, telling them to go sooner rather than later. But they cautioned they would need more visibility on the expected recovery of refinery margins (likely later this year), with no advisors or banks appointed. 

In a normal market we would expect owners Klesch to reinvest some of the €260m they have taken out of the business since they bought it in 2010 or contribute other refinery assets to sweeten a refi. But there may be another route, ESG, via a green hydrogen project with the German Government. 

Haya Real Estate is another late 2021 refinancing candidate. Its management were downbeat on their earnings call yesterday, expecting an uncertain and challenging 2021, in particular during the first half. Regulatory measures extending moratoria until September will affect future NPL portfolios and local bank mergers of existing clients and a revised contract tender from Sareb could create revenue uncertainty. 

Haya has €225m of Senior Secured FRNs and €250m of 5.25% Senior Secured Notes, both maturing on 15 November 2022 (sizes prior to a €51m bond buyback in December). The bonds are currently quoted in the high 80’s. The Spanish real estate servicer is unlikely to deleverage significantly prior to the note becoming current. Given the uncertainty the group will be looking at alternative financing options in the second half, when there is more visibility, they said.

Gastronauts are go

gategroup secured a space station catering contract this week. The headline caused envious glances from the punsters at 9fin Towers this week “Gastonauts are go, as gourmet menus launch into space.”

But for restructuring nerds, the sanction hearing for gategroup’s UK Restructuring Plan might be more stratospheric. Justice Zacaroli has already put a rocket under the recognition (or more accurately the lack of) UK insolvency processes at the convening hearing stage, saying that the new plan is an insolvency process, cutting off routes for recognition and irking London-based lawyers into penning contra arguments and seeking other routes. 

Regular readers know that we have gone into the consequences in-depth in a number of articles, for the uninitiated, this piece is a good starting point.

Today (March 26, 2021), Justice Zacaroli verbally sanctioned the plan, saying that a written judgment would be made available shortly. After the intensity of the convening hearing, the sanction hearing was more subdued, with the only matter that required consideration was the mechanism to amend the bonds, which was dealt with via an order with wording suggested by the company’s Swiss lawyers. 

Under the restructuring plan shareholders RRJ Capital and Temasek will provide CHF 500m of new funding via CHF 25m in equity and a CHF 475m subordinated, convertible loan upon completion plus:

  • CHF 200m provided as a senior secured interim liquidity facility extended by shareholders repayable upon completion of the Transaction or latest 6 months after issuance; and

  • The extension of the maturity of the Group’s syndicated loan facilities to 20 October 2026 and certain other amendments. The margins on the debt are unchanged but step-ups no longer apply, and the borrowers may elect to PIK interest

The deal is conditional on bondholders agreeing to the extension of its CHF 350m 3% February 2022 bonds to February 2027.

Sympathy for the landlord

Journalists often compete with politicians and estate agents as most hated and least trusted amongst the professions. But we could always be comforted by the fact that landlords were below us in the list, seen as more devilish, than the humble hack and muckraker. 

In this pandemic, we often focus on the poor embattled companies, especially well-known high street retailers and their survival. Government support was generous, either via business loans or the provision of furlough payments for employees. 

But there were other means of indirect support via the UK Coronavirus Act 2020. Last March, the ability to forfeit a commercial lease for non-payment was suspended, and the UK government has published a code of practice for commercial property landlords and tenants. The ban on commercial evictions was recently extended further to 30 June 2021. Pinsent Masons have a good guide.

Conversely, there is no support for commercial landlords who are facing a raft of non-payments and companies seeking to renegotiate rental terms. As Giles Boothman from Ashurst posted this week: “With U.K. businesses owing circa £7 billion in unpaid rent and insolvencies at a 30 year low, I worry that we are storing up problems for later in the year.”

A common restructuring technique is to use a Company Voluntary Arrangement CVA to reduce rental payments. New Look and Pizza Express went down this route, and used separate processes to deal with their financial creditors. But, as we outline in our primer, the new UK Restructuring Plan can use its cram-down provisions to impose a deal on dissenting creditors negating the need for a CVA. 

Virgin Active’s plan is the first time that the UK Restructuring Plan will be used to reduce amounts due to landlords. We were surprised when at least five QC acting for various landlords and landlord groups appeared on the Teams hearing. But when the submissions began it became clear why. Most of the burden under the restructuring is being borne by the landlords and their lease treatment varies wildly, from full repayment to zero, They are being split into five groups A to E based on the profitability of the UK gym operator’s sites. 

Class A landlord creditors are seen as essential to the business continuity and will get full repayment including rental arrears, but Class B will get substantially less, receiving 120% more than the ‘estimated administration return’. To illustrate, it was disclosed in submissions that one of the landlords downgraded to Class B from Class A, saw his recovery drop from £1m to just 7,000 pounds. 

The plan will be hotly contested, especially its underlying assumptions. In their skeleton argument an ad hoc group of landlords – including Aberdeen Standard, KFIM, Land Securities and British Land bemoaned the lack of consultation, limited time to review the plan, and skinny information, most notably the refusal to disclose the assumptions behind the Deloitte model for the estimated returns.

They also refer to a February 10, 2021 Kirkland & Ellis letter on behalf of their client Carlyle which suggests that a number of funds were interested in buying the business, which might have led to better recoveries. But there is no evidence of a formal marketing processes, they complain. 

As well as disputing class composition, the fairness of the plan will also be challenged. The landlords in total are sacrificing around £100m of value whereas the bank debt is being kept whole (albeit extended) with existing shareholders remaining unimpaired after a £6m equity injection and after procuring £45m of new money financing. 

Virgin Active counters that the group is set to run out of money by May, and that the secured creditor lenders would receive much better recoveries in insolvency than the landlords. 

Just over 80% of Virgin Active lenders have already signed up to the plan, agreeing to an amend and extend from 30 June 2022 to 30 June 2025 with the majority of the interest being converted to PIK for the first 18-months, with amendments to minimum liquidity and minimum EBITDA covenants. Shareholders in turn are providing £45m of new funding – with £25m being provided pre-implementation, with the remainder available if the restructuring becomes effective. 

With plenty of issues regarding discovery and how the UK Plan should proceed, the parties were set to carry on discussions overnight. The hearing is set to resume at 2pm today (March 26, 2021). 

Right Time to Re-mortgage?

As we wait for the latest round of M&A to feed into the leveraged loan pipeline, coupled with ready appetite from CLO and distressed funds for lower-rated B paper has led to a number of dividend recaps and even HoldCo PIKs in recent weeks. Weaker covenants, business uncertainty and overtly high leverage, and with sponsors no longer having skin in the game - are we storing up problems for the future?

9fin readers will know our thoughts on Foncia’s covenants and legals, but it was overlooked that the deal will also fund a €475m dividend to sponsors Partners Group, with leverage climbing to 9x from 6.1x say Moody’s. The residential real estate company is admittedly highly cash-flow generative, but has been highly acquisitive with most its growth being acquired rather than organic. 

We are always wary when sponsors do not have skin in the game and pay themselves multiple dividends. Xella, the building materials group is a good example. Purchase by Lone Star in 2017 for an Enterprise value of €2.2bn with an equity contribution of €750m, the sponsor has since taken out €780m out of the group in June 2018 and May 2019, with the latest refinancing anticipates another €510m to be paid to sponsor. Leverage will rise by 1.5x to 7.5x (9x through the preferred equity certificates), which looks toppy given its exposure to cyclical construction markets. 

Yet more divi-recaps were announced this week: 

UK life sciences firm LGC has launched a £496m dividend recap for sponsor KKR, which bought LGC for £650m in 2015 from Bridgepoint. 

Swedish enterprise software company IFS has finalised a €1.2bn loan this week, which pays another dividend to the sponsor, who did a previous €180m dividend recap in 2019. 

Belron, the auto glass firm has launched a €1.575m equivalent TLB which will part fund a shareholder dividend, the fourth in little over four-years. 

In brief

Amigo has failed to secure support from the Financial Conduct Authority (FCA) for its proposed scheme of arrangement but is pressing ahead anyway. The regulator informed the guarantor lender on 23 March of its views “that the scheme may not be compatible with the FCA’s rules, principles and strategic objectives.” Amigo says the FCA is not currently proposing to take any additional regulatory action that might stop the scheme if it were sanctioned by the court. FCA is concerned that scheme creditors will receive substantially less than under rules from the Financial Ombudsman Service. Provident Financial which last week, announced it might go down a similar route will be watching closely. 

DIA has announced the details of a debt/equity swap, agreed in principle with its lenders last November. The equity capital will be increased by €1.028bn, including a €769.2bn debt capitalisation tranche – from debt purchased by LetterOne and then converted into equity. The remaining debt will be restated and extended from 31 March 2023 until 31 December 2025. Full details are available here.

The founder and former chairman of Nordic Aviation Martin Moller has expressed interest in providing support to the troubled aircraft lessor “in the event of a restructuring”. In a restructuring update the company said that five new independent directors have been hired to guide the company through the disruption caused by Covid-19. Ahead of the expiry of forbearance and standstill agreements, two further groups of senior lenders hired advisors on the creditor side, say sources.

Naviera Armas has published its lock-up agreement and additional materials relating to its restructuring agreed with its bondholders late last year. There are €75.3m of new ICO loans, and a new delayed draw €185m bridge facility which will fund liquidity (€57m), working capital (€20m, Santander to provide a €44m WC facility) and to refinance the vessels facility (€60m). The restructuring will be implemented via Spanish Homologacion in May, with completion for end-July.

Avation announced the completion of its amend-and-extend transaction.The 6.5% 2021 notes will be extended to 31 October 2026, with the 6.5% cash interest rate retained, with an additional 1.75% cash or at the Company’s option, an additional 2.5% PIK coupon. The bonds are callable at 103 until 18-months from completion, then at 106 until October 2024, stepping down to 104.5 until October 2025 and callable at par thereafter. Bondholders will also receive 6m warrants exercisable to 31 October 2026 to purchase ordinary shares at 114.5p per share. There is a ‘general strengthening of covenants’ and the granting of additional guarantees and security, including fixed and floating debentures and security over shares of Avation PLC and Avation Group (S) Pte. Ltd.

A number of pandemic credits secured or sought to secure additional liquidity this week. 

Alongside its FY20 resultsCineworld has announced $213m of convertible bonds due in 2025 at a 25% premium to the current share price. Net debt is now $8.3bn, and the cinema group says it is relying on a $224m tax rebate in April to avoid a covenant breach. Meanwhile, Warner Brothers has reduced the time period that new films can be shown at the cinemas, before uploading to its HBO Max streaming platform (coming to the UK this summer) from 60-days to 45-days. 

Royal Caribbean issued $1.5bn of senior secured notes due 2028, upsized from $1.25bn initial size. Alongside the deal, it amended and extended its $1.55bn unsecured RCF due October 2022 RCF and $1bn unsecured term loan due April 2022 by 18-months, with the new issuance paying down 20%. Earlier this month it issued $1.5bn of common stock. The cruise group is burning through $250-290m per month and is hoping to resume cruises this summer. 

Dufry has placed CHF 500m of 0.75% senior convertibles due 2026, with a 45% conversion premium. The new converts fund an incentivised conversion offer to its CHF 350m 2023 converts of which CHF 200m have expressed their interest to convert – the offer expires on 6 April. The Switzerland-based travel retailer also released its FY20 results saying that 55% of its stores globally are now open. 

What we are reading this week