Friday Workout

Artificial Gravity Floats all Boats, Wind beneath Wings, establishing Terminal Value

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

Goldman Sachs used to teach its bankers to consider scenarios where previous realities no longer apply. They called it “what if gravity fails.” I would argue markets are operating in ‘artificial gravity’ from a reality distortion field generated by the actions from Central Banks. 

The whatever it takes narrative and newfound belief in Modern Monetary Theory is being embraced by debt markets, with few doubting the ability of central banks to manipulate and control bond yields. With negative rates seen on the horizon, investors are forced down the credit curve, which in turn boosts High Yield demand. This has led to further repricing of risk assets, and allowed a rising tide to float all boats – literally in the case of Carnival - and a new concept to appear, the distressed A&E. 

This overriding narrative has failed to be derailed by current economic realities and potential disruptions to the optimistic timeline of full reopening from vaccination. Recent rises in Treasury yields, supply chain concerns, sky-rocketing shipping rates, tentative signs of the re-emergence of inflation and a potential commodities boom (witness oil hitting 60 this week) – in past years any would have spooked HY prices – are being taken in their stride by markets. 

Grey-haired observers, such as me, however, have seen markets like this before. Stock analysts increasing earnings forecasts to justify lofty valuations - tick. Financial alchemy creating weapons of financial mass destruction – tick (SPACs). New Paradigms for investing – tick (Bitcoin).  

I see many similarities to other euphoric late-stage rallies, such as the dotcom euphoria of 2000/2001, the leverage finance splurge of 2006/7 and the Emerging Markets currency crisis of 1997/98. As Paul Singer notes in this excellent interview, once out of the bag, Inflation is rarely stopped quickly. 

A few questions: Can the Fed keep bond yields low, while still attracting buyers at historically low and at negative real yields? At what yield must 10-year US Treasuries hit before seeing intervention – 1.5%, 2%?  Can tech bulls live with the resultant effects on DCF valuations? How will the Fed react if the US Dollar experiences significant weakness (the World’s most crowded short – if any Redditors are reading this). 

Crypto Charge

Evidence of the disconnect between the real economy and new realities came into sharp relief this week. Tesla announced it has bought $1.5bn of bitcoin – equal to its entire R&D budget. It’s rationale for this is unclear, my view is that it could be a means to replace the environmental credits – used by the company to boost earnings that will disappear this year.

But why is Tesla holding its Bitcoin as goodwill and intangibles – why not as a financial asset, if it is really a liquid security? The FT attempts to answer this question in this interesting piece. For accounting nerds such as us at 9fin, in our downtime we will be re-reading this piece on goodwill accounting for clues. 

While there is no doubt that electric vehicles and battery storage is a growth area, the accumulated valuations of the major players by far outstrips the relationship to the projections. FTAlphaville’s excellent EV bubble Google Sheet is a good place to start. Much lower valued Mainstream vehicle makers such as BMW R&D spend is more than double the combined spend of all EV stocks

NB Has Tesla thrown away its ESG credentials with this knee-jerk move? 

Bitcoin mining uses up as much electricity as Argentina and more than the Netherlands and the UAE. 

Float my Boat

Sitting pretty on this sea of liquidity is Carnival. Despite a ballooning debt burden, uncertainty on reopening and high costs of making its Cruise Liners Covid-secure, it has a market capitalisation of $22.3bn. The share price barely moved, despite being primed further by the issuance of $3.5bn of unsecured debt at 5.75%, adding another $200m to its $1.6bn annual interest burden. 

The new deal takes total borrowing to $33.29bn. Carnival has $4.2bn of capex spend and $1.8bn of debt maturities this year, and recently said that in the first quarter, cash burn would be around $600m per month. Even if adjusted EBITDA recovers to levels seen in 2018 and 2019, leverage will still be north of 6x over the next two-year’s notes Moody’s. 

Rating agencies expect Carnival will see activity return to 60-70% of prior levels by the end of this year. But the company is still uncertain on when it will receive permission to sail from the CDC and it is unclear what the additional costs in fitting out its vessels to be compliant will be. 

Carnival has previously said that it has enough liquidity to survive 2021, even if no sailing were allowed. We would question their motivation to issue more debt - is it just taking advantage of reverse enquiry and significant demand from investors, or are the cash needs even greater? Why not go back to the equity markets instead? 

Interestingly, the latest debt issue adds more capacity to their debt baskets – albeit in eight-weeks’ time – given the current direction of travel, it might be able to tap the latest issue then at a premium! 

Alternatively, it might decide to undertake liability management – look more closely at how to reduce its interest bill – see our prediction in mid-January for its options. 

Summertime and the living is queasy

UK Government ministers’ pronouncements this week on the prospects for the Great British Summer provided great entertainment this week. Their backsliding on whether we can book holidays to exotic locations, have a Sunday Pub Lunch or socialise in groups again, shows how difficult it is to predict when the reopening is likely to occur, and how to balance expectations with the economic impacts. 

Sitting in the UK, we may have a distorted view on the timing of the reopening. Europe is significantly behind on its vaccination programme and given the lags between initial vaccination and its effectiveness, there must be doubts that continental holidays can go ahead this summer. How many of our European neighbours will be in a position to provide air corridors this summer? 

But TUI appears to differ. It says that it intends to run at 80% capacity this summer – despite bookings being down 44% in 2021 from last year - a poor year at 25% of 2019 levels. It is hoping that newly vaccinated Brits will be desperate to get away. Jefferies analysts say that TUI has enough liquidity to last about seven-months if no holidays were cancelled and no refunds are paid. 

Being restructuring focused, I’m a pint glass half-empty (a West Coast IPA if you are buying) guy. The next few weeks will prove to be informative on reopening. My gut tells me that governments will want to be more conservative in emerging from lockdowns, and that general population immunity is more likely to occur late Summer/early Autumn. If right, it doesn’t bode well for TUI. 

Under this hypothesis, it also makes sense to revisit some of the hospitality and travel names once more. Interestingly, there are many more stressed/distressed names in the loan market in these sectors trading below 90 than in HY. We will take a closer look at names such as eDreams, B&B Hotels, Areas, Euro Camps and Apcoa in coming weeks. 

Avation successfully transits short-haul debt into 2026

Troubled aircraft lessor Avation appears to have averted an emergency landing with an amend-and-extend agreement with unsecured bondholders increasing its available runway. In return, holders get a seat upgrade from additional guarantees and security, plus some mileage perks from warrants to equity. But while the Asian market has recovered faster, a number of notable customer failures have created turbulence for Avation, with aircraft prices and lease rates continuing to fall and leverage approaching double-digits.  

Last week, we suggested that the strength of the underlying bond market has allowed stressed A&E transactions (witness Balta and Ferroglobe) to get away, as removing the short-term default risk allows a repricing of the debt. Arguably, Avation takes this a step further, as our standalone piece outlines

After the five-year extension, the exchanged bonds will sit behind $466.6m of secured debt amortisation and $263.4m of balloon payments in the maturity queue – with $284.7m due before June 2022. The company says “it expects to refinance or extend the balloon payments prior to maturity and has commenced discussions with financing providers who have been supportive in providing accommodation and relief thus far.”

Leverage will rise towards double digits in H1 21 from 8.7x as at end June. Avation says that it expects to modestly deleverage by 2025 and “seeks to improve its credit metrics over time.” The 2021 SUNs have rebounded from lows in November of around 60 to the mid-70s, according to trader runs. 

The transaction will be implemented by a consent solicitation to be launched before 19 February. It is advised by PJT Partners and DLA Piper. Bondholders are advised by Perella Weinberg.

Delay and Pray

During the financial crisis, there was a lot of criticism of A&E transactions, with many being mocked being renamed as amend and pretend, kicking the can down the road, or delay and pray. The prevailing argument was that lenders and borrowers were unprepared to address an inevitable restructuring and this would create zombie companies that would limp along for years. 

But with hindsight, it is reasonable to argue that for some it created time to better assess the business turnaround and debt sustainability. Why sell and restructure at the low point, if more value can be preserved later on? Similar to the pandemic, business activity dropped sharply for some sectors such as Automotive in late 2008, but many were able to rebound and grow into their bloated capital structures with more restructuring options when the financing and M&A markets returned. 

For others, however, we saw a series of sub-optimal amend-and-extends and soft restructurings, coming around again every few years. A number eventually ended up in hedge fund ownership, and many are feeding back into the HY market, such as Kloeckner Pentaplast, Stark, Autodis and Balta. Many EHY analysts are too young to remember this cycle and are unaware of their troubled pasts and multiple owners. (I can tell a few stories over a beer or two.) 

News that Codere had appointed Houlihan Lokey and Clifford Chance as advisors for another round of restructuring didn’t surprise us at 9fin. As we pointed out last November with leverage approaching double-digits and further extended lockdowns, management hopes that leverage could fall to 4-4.5x by 2022 to refinance its extended debt appeared wildly optimistic. 

The bonds have fallen by around 10-points in the past two days to 50-52, on the reports. Bondholders have appointed PJT Partners and Millbank, but according to a source close it is still very early days.  

Terminal Value

Gategroup announced yesterday that the English court has ordered two separate meetings for its bondholders and senior lenders for 19 March, with a sanction hearing expected a week later. The company had hoped for a single-class to bind the bonds, held by Swiss retail investors. It remains to be seen if the court will accept a positive vote on a low turnout. 

As reported, the Switzerland-based aircraft caterer seeks to extend maturities to 2026 and 2027 with shareholders RRJ Capital and Temasek providing CHF 500m of new equity. 

But with a swiss-jurisdiction clause, there were doubts on whether the UK Restructuring Plan could be imposed on the bonds. Lawyers for gategroup argued that it could take advantage of a bankruptcy exemption under the Lugano convention, but this raised wider questions and implications if the new UK process is deemed to be an insolvency procedure, noted Justice Zacaroli at the convening hearing on February 2, 2021. 

His reasoning will be closely watched by restructuring professionals, and this could result in distinct interpretations and use of the Plan and the English Scheme. 

As the restructuring pipeline slows in the first quarter of 2021, attention has turned to the turbulence in the aircraft leasing market and their airline clients. It is a sector beleaguered by overcapacity and tumbling asset values, with 2019 traffic levels not expected until 2023 or 2024 “every airline” has the potential for restructuring, according to one aviation lawyer. 

Distressed debt traders are seeing increasing volumes of aviation debt flying across their desks. But finding information and gaining an understanding of the market is frequently more trouble than it is worth. Aircraft values and lease rates are tightly guarded secrets and have become more obscure as the pandemic raged on. Not only did abrupt overcapacity tank rentals, but lessors are offering case-by-case rental relief since March 2020, making an easy approximation of an aircraft type’s value or lease rate even trickier. 

Our Learning to Fly Primer is a must read for investors and advisors looking at this sector

Challenges for the aviation market were outlined yesterday by Heathrow. It said:

  • Passenger volumes were down 89% in January as the national lockdown, travel bans, blanket quarantine and compulsory testing deterred people from travelling.

  • The additional inconvenience and cost of quarantine hotels, day2/day 8 testing requirements on top of other measures mean that the UK’s borders are effectively closed. We are working with the Government to try to ensure this complex scheme is workable. 

  • Fewer long-haul passenger flights meant that cargo volume was down 21% in January – a key indicator of the damage that travel restrictions are having on the UK’s exports and supply chain. 

This week we were interested in another type of terminal – those leased by German gaming operator Lowen Play – our second deep-dive analysis, following Douglas.

Our report (available on request for non-subs) suggests regulatory uncertainty from new German restrictions and Covid headwinds lasting longer than expected will impact revenues and liquidity. 

Long-lasting sponsors Ardian and Confima have taken a lot of money out of the asset-lite business, which they’ve grown by acquisitions with lowly 2-3x multiples. If our analysis is correct Lowen Play may struggle to refinance €390m of debt becoming current this August. 

Other 9fin coverage

After falling last week on lower production forecasts and the extension of talks with its RBL lenders, Tullow Oil bonds recovered this week on the announcement of further asset sales and soothing words from management

Management said that there were no major issues in the talks with the RBL banks. The banks needed more time to run through the business plan and its forecasts, and “clearly the asset sales affect the production statistics.” 

Tullow stressed that discussions were centred on a reprofiling of the debt to match future cash flows, complaining about some media reports over a likely restructuring. While it has enough cash in hand to address the upcoming maturity on its July 2021 converts, it is likely to seek a more holistic solution – as we outlined on 18 January. 

Celsa, the troubled Spanish steelmaker, was hoping to hear as early as this week if its application for a €350m loan from Sociedad Estatal de Participaciones Estatales (SEPI) was successful. Grant Thornton is advising the rescue fund to support the solvency of strategic companies, and according to media reports has delivered a 200-page report on the business and its suitability.

Following its recent defeat in the courts, Celsa is set to restart restructuring talks with creditors over its €2bn debt pile. PJT Partners was recently hired by the Marco lenders – the banks which provide working capital facilities, factoring and bilaterals – in anticipation of restructuring talks. A de facto standstill of ongoing payment defaults is in place, with another default likely as a €75m ICO loan is due this month. 

The outcome of the SEPI support and conditions attached is critical for both sides to understand prior to engaging, said a source close to and a source familiar with the situation. Key issues are governance and the use of the funds, they added. 

One of the main issues that SEPI will look at is the state of the business prior to the pandemic, notes a recent article in El Confidential. The role of the Rubiralta family and the indebtedness of the business is seen as central to the story and explains the dynamic and troubled history with its bank and fund creditors. 

In brief

Grenke bonds were hit earlier this week by the resignation of Mark Kindermann from its board. It cited the imminent reason for his departure as BaFin’s criticism of internal audit and compliance procedures in the course of the ongoing audit by Mazars. Viceroy Research flagged up potential accounting issues in September and have stepped up the pressure on the lender this week on alleged delay to its FY20 results. 

Rallye has announced the results of its discounted tender offer for its unsecured debt – reducing its unsecured debt by €156.3m – much lower than the €500m it sought, despite paying 20c, the higher end of the range.

Seadrill Ltd and most of its subsidiaries have filed for bankruptcy protection in the Southern District of Texas. It is the second time in four years that the oil-rig operator has entered into a restructuring. Seadrill says “it is expected that this will lead to significant equitization of debt which is likely to result in minimal or no recovery for current shareholders.”

Virgin Active shareholders are proposing to inject £65m into the gym group, with landlords taking significant rental reductions and lenders “asked to take a meaningful financial contribution” to its turnaround, says Sky News, citing people close to the process. 

What we are reading this week