Friday Workout

Acceptable in the 90’s; Obsessed with Greatness; Giving it 535%

- (9fin)

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

“Time. Time. What is time? Swiss manufacture it, French hoard it, Italians squander it, Americans say it is money. Hindus say it does not exist. Know what I say? I say time is a crook.” Truman Capote

As the week flies by with my stressed/distressed to-do list mostly unchecked, and a blank sheet of paper now facing me, I certainly feel the victim of a time-related crime. 

I confess to getting my apologies early for a skinnier workout than normal. There is a decent alibi, plenty of calls/product meetings for distressed/restructuring improvements and a surge of analyst/journalistic content, testing my editing and multitasking capabilities. 

Swiss Time Pieces

An FT piece piqued our interest earlier this week. After almost a year’s delay, they claimed there would be progress at the EU on the UK’s application to the Lugano Convention. 

This would allow cross-border recognition of UK judgments and ensure they are recognised and enforced overseas. It could be an important development in finding a replacement to recognise restructurings after the UK and the EU failed to agree on a successor to replace Recast which fell away after Brexit.  

Regular readers will remember that the Lugano Convention came up in the gategroup case last month prompting an unusual intervention from lawyers Kirkland & Ellis on whether the UK Restructuring plan was an insolvency process and not subject to Lugano under the bankruptcy exclusions (Lugano was still applicable at the time of the company’s 30 December application). 

This is a bad day for the recognition of future restructurings in Europe, said a lawyer at the time [after Justice Zacaroli decided the UK plan was an insolvency process] Lugano and the Hague conventions were potential routes to recognition, but had carve outs for insolvency matters, “which means that future UK Restructuring plans cannot benefit from their recognition.” 

But English schemes are widely viewed by experts as being different and not insolvency processes. If the UK is allowed to accede to Lugano, it’s a very important [development], said one lawyer. 

The FT piece cited EU diplomats as expecting the commission to give a positive assessment of the application at the meeting on Monday – they had stalled on the application – but there is a time limit, a decision must be made a year after it was submitted.   

But the decision must be unanimous from existing members - the EU, Denmark, Iceland, Norway and Switzerland. The commission in a closed session decided that the UK should not be included as it is not a member of the EEA or ETFA. They couldn’t have their cake and eat it. 

There is extra time available, but it would require a weighted majority of EU members to approve. A follow-up FT article suggests France will oppose, putting pressure on Germany who is reportedly undecided. Cynics might suggest that Germany and the Netherlands might oppose, being motivated by potential business flowing to their courts after unveiling shiny new processes earlier this year.

But as John Cleese famously said in Clockwise: “It’s not the despair, I can deal with that, it’s the hope.” 

Acceptable in the 90s

Speaking to one of the savvier European Lev loan and HY investors this week, he said that after booking supernormal profits last year, it is becoming much harder to pick names for capital appreciation. Worst still, if you hadn’t played in outperforming names such as Aston Martin, Tereos, Rolls Royce and Carnival in recent months, your fund performance would be marginal year-to-date at best. 

Single-B names on average now yield below 3.5%, capping any potential upside, even if you venture down the credit curve - remember, 70% of EHY is BB-rated.  The investor is scouring the market for stressed names in the low 90s (the new 80s) as turnaround stories. 

Using 9fin’s screening tools, there are 40 EHY names trading between 80 and 95, many of which are highly stressed. Of the 40 names, 22 of these are trading between 90 and 95. Some I wouldn’t even touch at prices ten points lower – such as Takko and Ellaktor. What degree of confidence do you have in QPark, Telepizza, Fives and Tendam crawling their way back to par? 

There are more names to pick over in leveraged loans, but unless you are already an existing lender, it can be hard to get information and find enough liquidity. Many are in the hospitality and travel sectors, with more inherent risk and higher starting leverage, such as A&O Hotels and Vue Cinemas. 

As we ramp-up our loan coverage, we will be taking a closer look at secondary loan pricing and the financial performance of credits trading in the 80s and 90s, to feed into our skinny watchlist. 

Going Glocal, playing Bo’s Buzzword Bingo

Restructuring and turnaround sometimes require a change in culture and mindset as much as clever corporate strategy and financial engineering. Business transformations may require a “strong, talented and entrepreneurial leadership team” to enforce change.

Last May, Selecta decided to host a conference call to unveil disastrous Q1 results on a UK May Bank Holiday Monday, despite it being where the majority of its investor base is located. It failed to provide a live Q&A session and offered little financial detail. Sponsor KKR fired the chairman and CEO on the same day, injecting €50m into the business and hiring PJT and Kirkland & Ellis ahead of a likely restructuring. After a further sponsor injection, a less severe A&E was concluded in October. 

The company may now be trying too hard to woo investors and customers. Listening to Selecta’s Q4 and FY20 update earlier this week was tough going, with Joe Plumeri the Executive Chairman in full corporate messiah mode bigging up their transformation. 

We heard about ONE Selecta, their transition to a GLOCAL model, and their new cultural values. But 20 mins in, we were yet to hear a financial statistic (the first appeared 20 slides in). While we awaited anything of interest that might deserve an editorial update, we decided to play corporate buzzword bingo, to keep our interest - it was approaching 6pm by now, after all. 

But no full house, Agile failed to get a mention. 

Notwithstanding the dodgy slide deck formatting, if I was one of the remaining 70% of employees (or FTEs as they like to call them) I would be suitably inspired to retain, grow and win business in the client-centric culture. 

“When people ask what you do, tell them that you deliver joy to go.”

When we finally got to key metrics, the business did just manage to avoid being FCF negative in the fourth quarter despite hefty restructuring costs. Adjusted LTM EBITDA to December 2020 was just €36.3m compared to €246m in 2019, with leverage rising from 6.3x to 25.1x. 

Selecta was in earnings decline prior to Covid. When traffic returns to offices, railway stations and airports, we will be treated to new Smart Fridges, and Starbucks self-serve coffee stations, and lovely fresh food. I hope customers are not put off as much as I am by the new branding. 

Their extended 8% 2026 bonds are bid at par. 

Giving it 535%

EBITDA add backs are one of 9fin’s biggest bugbears. We recently detailed which businesses used Covid-related adjustments to boost EBITDA, and our legal team has noticed ever looser definitions on what synergies and other items can be added back to numbers. 

Add backs to Douglas’ stressed refinancing were widely commented upon, with ‘management adjusted EBITDA’ boosted to €394.5m from €250.2m (already heavy with add backs). 

But Coty takes the adjustment game to a new level, going from $201.9m of adjusted LTM EBITDA to $1,282m (the 1 is not a typo!), a 535% increase. 

The metric used by Coty to market leverage is “Covenant adjusted EBITDA”. When asked for comment on the accounting treatment, Coty confirmed to 9fin this is the figure provided to the company’s banks, which, “as per our Credit Agreement - allows certain add-backs, the biggest of which are future anticipated savings tied to our Fixed Cost Reduction program.” 

However, in public documents, adjusted EBITDA for continuing operations will continue to be the reported figure. 

Some vague language in the 2018 Credit Agreement paves the way for the inclusion of the $567.2m of Covid-19 impacts, of which the vast majority (~$500m) are aggressive “lost revenue and earnings” add-backs. For fiscal 2020, 2019 and 2018 Coty has estimated “credit due to expected synergies on specified transactions of $654.5m, $525.3m and $354.5m respectively.” For LTM Dec 2020 the synergies are expected to be $506m. 

It makes you wonder if those expected synergies will ever come to fruition. Even the company’s own language sounds doubtful:

“While the Existing Credit Facilities and the Existing Indenture permit, and Indenture will permit covenant adjusted EBITDA to be calculated inclusive of potential synergies and estimated EBITDA from acquired entities, the inclusion of such synergies and EBITDA should not be viewed as a projection of future results but is simply provided to permit investors to understand how covenant adjusted EBITDA is calculated under these debt instruments.”

The effect of the add backs is to reduce leverage by 20x, lowering net leverage metrics to 3.8x total and 2.6x levered through the seniors. If that wasn’t egregious enough for investors, here is the TLDR reproduced from our legal QuickTake for you to mull over:

“Enormous EBITDA add backs contribute to low covenant leverage, leaving significant covenant headroom for incremental debt. Weak guarantor coverage (limited to US subsidiaries only, representing less than 30% of net revenues) and significant scope for structurally/effectively senior debt incurrence. Generous dividends capacity, which will not be blocked during a default that has not ripened into an Event of Default.”

Is Coty going to be the highwater mark for 2021 deals?  Equity investors appear to be as bullish as the company, the market cap is almost as elevated as the EBITDA at $7bn.

What we are reading/listening to this week