Thursday Workout

House wins, Déjà vu all over again, avoiding big ships

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

Thank God it’s not Friday Workout – April Ship of Fools edition

This week provided some timely reminders about the dangers of hidden leverage. We also learnt that even in the hottest of markets, that not all HY issues will be heavily subscribed and trade-up in secondary. But a rising tide did manage to float a big boat this week, but we at 9fin remain somewhat Naviphobic.

Archegos forced liquidation of a number of tech names has shown that liquidity can be asymmetrical. From experience it is a lot less on the way down (I was on the other side of LTCM unwind in a past life), especially if everyone is axed the same way. The Market Ear makes a good point, why did some of the supposedly very liquid and strongly performing portfolio names trade down by 20-30%, in a normal market they should have been easily absorbed with 5-10% discounts. 

The irony was that the trigger was an issuance of equity to provide much needed liquidity in Viacom!

A high Market Capitalisation isn’t a proxy for liquidity, and I fear for what could happen if for example ARKK is subject to a forced unwind given the correlation to this portfolio compounded to amounts bought on margin by copycat acolyte investors. Does anyone know who Softbank Northstar’s prime brokers are? Just keep calm and Cathie on?

Douglas’ secondary performance this week provided a cautionary tale on how to handle order books and manage expectations. The stressed refinancing was initially marketed at 5.5% for the senior secured bonds (sources close to the sponsor said books were covered at this level), E+500 bps for the term loans and 9% for the PIK, all at the tighter end of the expected ranges. 

But later in the week the mix was shifted dramatically towards the bonds, and on Friday, pricing was widened sharply to 6% and E+550bps, with the PIK upsized. Bonds broke for trading on Monday and were marked down as much as four-points on the bid side to 96 as accounts found that their orders were filled in full, but have since recovered to be quoted at 98.0-98.50 today. So, what went wrong? Did some of the original orders flake, or did the leads overestimate the levels of demand? Should they have started at 6% and built momentum? 

There was one overlooked benefit of changes to the deal, the larger subordinated piece (in line with our thoughts in our preview) has resulted in a Moody’s upgrade to B2 from B3! 

Douglas is not the only stressed refinancing we’ve seen priced aggressively and then trade down in secondary, Kloeckner Pentaplast is another example. Is it time for leads to leave more crumbs on the table, or as expected in my trading days, to use some of the fees to support the deal on the break? 

House wins

At 9fin we have a healthy level of scepticism when looking at company financials. We know how much businesses are dressed-up to show themselves in the best light ahead of a new issue. Introduction of IFRS16 has complicated matters further and with a plethora of add backs and differing accounting treatments it can be difficult to ascertain true leverage, run-rate EBITDA and cash flow generation. Adding in loose docs and prices which don’t fully reflect risk, over time the odds favour the House. 

Groupe Casino is arguably one of the most difficult EHY credits to assess. The France-based retailer has a complex group structure, with lots of consolidated subsidiaries and with an inbuilt need to balance leverage and find ways to dividend money up to 52% owner Group Rallye, which in turn has a big maturity wall in 2023. It has embarked on a €4.5bn disposal programme (€1.7bn left to execute) to reduce leverage to below the 3.5x dividend blocker in its bond documentation. It is a leverage finance banker’s best friend, undertaking a series of liability management exercises and bond/loan issues in recent months to push out maturities beyond 2023. 

This week may have marked their transition from a stressed credit into the mainstream EHY universe. Casino printed €525m (upsized by €100m) of six-year non-call two senior unsecured bonds at 5.25%, and €1bn of cov-lite term loans due August 2025 at E+400 bps (99.75). This not only took out a €1.225bn TLB due Jan 24 which paid E+550 bps, but also increased their unsecured portion of debt (they only have €280m of secured debt capacity). 

Despite management positivity and some investor excitement about the valuation of their GreenYellow renewables business and their online operations, the mainstream French business faces strong competition and struggles to produce positive cash flow. Optically, leverage looks low, but the bonds and loans are not supported by the Latam business which generates around 50% of EBITDA. Working capital is boosted by over €1bn of reverse factoring - which some may see as debt. Massaging working capital might be improving the overall picture, as does the consolidation treatment of subsidiaries, noted one analyst doing a deep dive on the name. 

But despite recent improvements, it is unlikely that the group will be able to dividend up enough to meet Group Rallye debt payments in 2023, he noted. A recent attempt to tender for Rallye subs at a deep discount was botched, and they will need to find ways to refinance €1.269bn of first lien debt secured against Casino shares and a €301m Fimalac facility due in February 2023. 

The trend may be your friend, previous Casino deals in 2020 did very well, but what happens if this is the final opportunity to cash in your chips? 

The performance of Casino’s peer Iceland since issue in February may be prescient, with the £250m senior secured 2028 notes trading with a 96 handle. The business has benefited from covid and was marketed off a period when cash generation was at its strongest. We look forward to their next set of quarterly numbers, let hope they are not as sub-par-on their earnings figures as another sector peer. 

The Chicken King pulled off an impressive turnaround, managing to take advantage of positive sentiment towards stressed borrowers to refinance its capital structure with £475m of new senior notes and a £80m RCF. The Boparan refi was based off marketed ‘pro forma run-rate adjusted EBITDA’ of £134.8m. But its Q2 20/21 numbers were nothing to crow about. Like for like EBITDA fell 49% YoY to £13.9m, with LTM EBITDA at £96.9m. 

Boparan marketed £13.4m of covid-related add-backs to its marketed EBITDA. It claims the quarter was a perfect storm, with rising feed prices (80% of contracts have pass-through clauses, but take at least three months), Avian flu affecting exports to China and disruptions relating to Brexit. 

Some investors may give them a mulligan (or perhaps that should be a mulligatawny). But at least one long suffering analyst following the name has lost patience. “They’ve spent years saying they had the feed issue under control and then this happens. They say it’s a timing difference but there’s always something,” he complained. “I think it’s fundamentally a poorly suited business to leverage.”

Liquidity is just £39.2m after a £23m RCF draw in the quarter (£67m left) and with £50m capex, £36m interest, £23m pension payments, £4m taxes plus £10m of non-recurring items to pay this year, it is likely to draw more on the RCF. But it cannot face another poor quarter, as the RCF (which can be increased to £90m) has a quarterly LTM EBITDA test of £75m and is reliant on factoring and receivables finance for cash management. 

Boparan 2025 bonds fell over three points to be quoted as low as 96-96.50 on the results but have since clawed their way back to be quoted 98.62-99.0 this morning. Let’s hope we don’t see another Chicken Run on the bonds, previous issues traded as low as the 60s in 2020 and 2019, with the company very adept at buying back bonds at a discount. 

Déjà vu all over again

Codere’s announcement this week left us with a feeling of déjà vu. The company is struggling for liquidity and has said it will utilise the interest payment grace period on its bonds while it finalises super senior financing with existing super senior lenders taking advantage of around €100m in available baskets. 

This may sound familiar to some readers. Codere was arguably one of the most brazen and cleverest CDS trades in the high yield market and was the only credit derivatives deal to get its own segment on Jon Stewart’s Daily Show. GSO took advantage of Codere’s stretched finances in 2013 by providing a lifeline, but not until the company had defaulted for long enough to trigger their CDS position. 

Codere upped the blind and the stakes when it agreed an amend and extend with bondholders last summer, with gross debt increasing to €1.31bn and cash interest costs rising from €93.4m to €126m plus a PIK element. 

As I noted at the time, “It may be out of A&E but could remain an outpatient for some time and may suffer from Long Covid. Despite improvements in liquidity, with a €148m cash balance at end October, liquidity could be just €40-50m in the first quarter after deferred tax payments and bond interest. Leverage surged to 11.5x in Q3 and will rise further in Q4. Management is gambling on a return to 2019 EBITDA levels in 2022, which they believe will reduce leverage to 4x and enable it to refinance, avoiding a restructuring.”

Codere said in February that further lockdowns had created a liquidity problem: “This, worse than expected, state of play has had an impact on the cash flow generation capacity of the company. As a result, Codere is still facing a challenging transition period to recover business normality by end of 2021 or early 2022. “In this context, the company has engaged financial advisors to assess financial alternatives to improve its liquidity and support the company to be able to meet its financial and operational obligations in 2021 and beyond.” 

While to many outsiders it is clear that a restructuring and debt for equity swap is needed, the shareholders are keen to preserve their optionality and super seniors are happy to put in more debt knowing that the pain will be borne by the bondholders sitting below them. 

When shareholders appear reluctant to concede control, businesses are too overburdened with debt, there is a need for more creative solutions, especially with regards to equity. 

Wolfgang Felix from Sarria explored this in a recent LinkedIn post.

“Last time we restructured #Takko we got #PIKs and warrants and it went phenomenally well. More generally: In a #distressed world with positive outlook, where #EVs are far removed from debt carrying capacity, we have to think of sensible ways to tranche the equity. What is your experience?”

Takko is a great example, with little/no equity cushion at current levels, but the bonds still trade just below 90. Despite recent injection of new money – utilising super-senior and senior baskets – it is unlikely to recover enough to refinance upcoming maturities and its liquidity runway remains short. As one distressed analyst noted, “I can see EBITDA recovering to €105-110m in 2022, which gets you to a high 5’s to low 6s multiple. Hema sold at 5.8-5.9x with 50% LTV, so was below 3x leveraged on day one. Takko needs to be 3-4x levered tops.”

In the distant past, I traded convertibles. Our investment bank used converts as funding tools in US distressed situations with automatic triggers to convert into equity on the occurrence of certain restructuring events, whilst retaining upside if the business recovered. This could be a neat way to tranche equity – does anyone have any views on whether this deserves a revival?

Avoiding big ships

Regular readers would be aware of my Naviphobia and my bearish views on Cruise and Ferry operators. Some have even suggested I was influenced by this literary masterpiece (I would recommend reading the reviews which are better than the book!).

Moby bondholders could have benefited from reading John Trimmer’s book. Despite some positive developments in the last month which led to the Italian Ferry operator dropping its legal action against bondholders in New York, there was no agreement by the 29 March deadline imposed by the Milan Tribunal. The company has submitted its Concordato Plan which will allow the business to operate as a going concern and will keep creditors at arms-length during the pre-insolvency process which is likely to take six-to-nine months, according to a source close to the situation. For more information on the process, see our Italian Insolvency primer.

Moby told the court it is seeking to sell five vessels valued at €132.7m, two Sardinian properties for €8m and offload their tugboat division, valued at €50m. This will allow €61.6m of bank debt and €121.2m of bonds to be repaid, with the remaining €101.4m of bank debt and €121.2m of bonds downgraded as secured debt (under the Italian process, uncovered debt by collateral value can be converted) will be repaid at a minimum of 13c, which could rise to 19%. Financial investor Arrow Global is purchasing some debt of CIN-Tirrenia (the other entity owned by Onorato Armatori), paying €77m to allow the release of guarantees on the CIN-Tirrenia vessels held by bank and bond creditors.

Naviera Armas has released full details of its restructuring plan, after reaching preliminary agreement with bondholders and lenders in early January. There is €220m of new liquidity, comprising €100m of new money and €70m of new working capital lines (backstopped by the ad hoc committee and Banco Santander), plus €40m shareholder capital increase and €8.5m from an intercompany loan. Holders can participate in the new term loan with a 20-30c reinstatement into a new 7.5-year bullet bond.

Bondholders will also receive a 57.5% economic share interest and 49% of voting shares, with notable improvements in corporate governance (new general manager, two creditor board appointees), and better collateral – as debt is moved to Anarafe from Naviera Armas SA after other vessel debt is repaid – as the chart below outlines. 

Holders have until 5 April to participate in the new B2 and D facilities, with the restructuring to be implemented via Homologacion which should begin in the week of 3 May. (We are working on a detailed restructuring review, looking at the key terms and their evolution.) 

They say that immersion therapy is the best way to deal with phobias. In that case we feel compelled to dial into Carnival Corporation’s first quarter business update on Weds April 7. 

9fin coverage this week

Amigo has received the go ahead to pursue an English Scheme creditor vote, despite opposition from the Financial Conduct Authority to its plan to hive off customer complaints claims into an SPV. Under the plan, £15m to £35m will be reserved for complaints with a cash contribution based on 15% of cash profits in the next four years to March 2025. Amigo is projecting that there will be an £85m set-off on the loan book but admitted that this is a mid-point and could be larger. The group previously made a £150.9m provision for known and potential claims as at 31 December 2020. In their skeleton the company estimates that the level of distribution would be around 10p in the pound. 

Absent the scheme, the directors will have to file for administration, the company argues, relying on a report from PwC which says that in an insolvency that the estimated realisable value would be £312m - £325m, with £324m of bonds and securitisation outstanding and £37m of insolvency costs there would be nothing left for unsecured creditors. 

The FCA have sent a letter in which they state that “the methodology for assessing claims does not produce outcomes with the same standards of accuracy or fairness than would be available under the usual complaints handling framework and availability of the FOS.” The fairness of the Scheme is a concern for the FCA, which the company says: “will be considered at the sanction hearing if the Scheme is approved by Scheme creditors.” It adds that the claims methodology has not been comprehensively explained. 

Advisors to Virgin Active Landlords will receive details of the group’s business plan, site-by-site performance of its gyms and cash flow statements ahead of UK Restructuring Plan creditor meetings on 16 April. The landlords had complained that they have not been given enough information and time to assess the proposals, which impose significant reductions in rents for all but all of the most profitable gyms. 

Justice Snowden has ordered that additional information should not be included in the explanatory statement but to named lawyers and their accountants.” This would not just include those which have appeared in the convening hearing, but for advisors to others which make similar undertakings. Snowden recognised that this was an unusual course to take, with inequality of information disseminated, but was necessitated by the compressed timetable. 

Virgin Active will be the first time where a UK Restructuring Plan will be used to force a deal on landlords, via the use of its cross-class cramdown mechanism. But ahead of the sanction hearing, there are two landlord CVA challenge cases for Regis, the hairdressing chain and New Look – a six-day hearing took place last week in front of Mr Justice Zacaroli. Snowden noted there could be some crossover on the issue of fairness, particularly at the Sanction Hearing, pencilled in to start on 29 April and unusually will take in the May 3, bank holiday.   

Following on from a subscriber request, 9fin’s Huw Simpson has posted an excellent update Whatever Happened to EBITDAC? Report. It looks at how companies use covid impacts (costs and/or revenues) to boost their LTM figures for new deals being marketed, and for existing transactions. 

This can have important impacts on covenant compliance and covenant capacity. For non-subscribers, please ask team@9fin.com for a copy.

Our January webinar with ELFA highlighted our predictions for further erosion of covenants during 2021. 9fin’s Alice Holian has produced our inaugural European HY covenants RP and PI trends and observations report which closely analyses recent deals.

March in particular saw a number of aggressive and unusual covenant features. Though there were reports of initial pushback on Ahlstrom-Munksjö and Foncia, ultimately high demand enabled these deals to sail through relatively unscathed.

Alice says: “Given the incredible flexibility we’ve been seeing across the board, we could have focused this debut quarterly covenant report on nearly any area and shown a similar theme of continued covenant loosening.”

Her report focuses on capacity for value leakage away from the Restricted Group via Restricted Payments (RPs) and Permitted Investments (PIs), drawing on data from 9fin’s Covenant Capacity beta tool, and the most recent batch of sponsor deals stack up versus the 2020 headliners.

In brief

What we are reading this week