What’s next

Investors are now scouring their portfolios for other shocks that might be hiding in plain sight.

Because that’s one of the big questions about Altice: should it have been spotted earlier? Oaktree suggested as much in a research note, saying “almost no-one thought [Altice] would take such drastic measures” as forcing haircuts.

You can’t quite say the same of European lab services companies. They have struggled to adapt to the post Covid world (we've followed this in detail in analysis pieces such as this and this) where demand for tests is lower, inflation is high and labs are being hit by tariffs.

But just like Altice, lab companies Cerba Healthcare and BioGroup LCD are widely held by European CLO managers. And like Altice, they have lots of debt and are facing strong sectoral headwinds. Those similarities (even amid many differences) are enough for investors to fret over.

Both borrowers recently dropped into single-B territory, and the headwinds they face also impact other names in their sector such as Eurofins Scientific, Inovie and Synlab.

“It’s probably Cerba that is most worrying CLOs,” said one portfolio manager. “The fear is if BioGroup is B- then Cerba is triple-C.”

When Cerba was downgraded back in November, some 58 European CLO managers held €1.9bn of collateral through 490 deals, as we reported. Blackstone and CVC were two of the biggest holders across all deals, but the name was almost universally popular: GoldenTree, Man Group and Canyon were the only managers with no exposure. 

While most managers are only invested in the TLB due 2028, some also hold Cerba’s senior secured notes due 2028. Both slumped in April but have since rebounded (the chart below only shows the loan):

The fact that Cerba’s levels have recovered since the downgrade gives some comfort, but the risk here is not limited to one company.

"Most CLOs are loaded up with European labs like Cerba, Bio, Inovie and Synlab, and they all have been underperforming,” said the the PM. "Cerba feels like the more likely candidate to hit triple-C, but it would be tough for a lot of people if both Cerba and Bio hit that.”

Cash burn blow

As we noted in our Q4 earnings review for Cerba, the company ended 2023 with record high net leverage of 8.1x due to weakening EBITDA and a cash burn.

Cerba has also used €206m of its €450m RCF primarily to fund its acquisition of Cirion and earn-outs at Lifebrain in Austria. Cerba’s senior secured net leverage, 7.2x as of December, is also inching closer to the testing cap set by its revolver covenant.

BioGroup, with around €3bn of debt, will present its Q4 2023 financial statements on a conference call later today (23 May). The company was the largest European credit to be cut to single-B last month, with Moody’s attributing its downgrade to a “weakening financial profile”.

As we have reported, the name is widely held by European CLO managers. They hold €1.72bn of debt across 483 deals, representing around 82% of the European CLO universe, according to 9fin data.

Again, the risk here is not just related to one single company, said a CLO tranche investor:

“I still believe this looks more idiosyncratic than systemic, but how many idiosyncratic cases before it is systemic? The ongoing slow burn of sustained high interest rates, naturally, have an effect. But most companies are still looking solid.”

S&P has warned it could take further ratings action in the next 12 months if BioGroup is unable to deliver cost savings, which could lead to further operating underperformance and slower-than-expected earnings recovery.

"Potential additional large debt-funded transactions at high multiples would also pressure the company's performance, which could jeopardise the long-term sustainability of its capital structure,” wrote S&P’s analysts.

Inovie was cut to B- in November, after Moody’s pushed it to B3 last June. It has smaller loans than BioGroup and Cerba, but they are also held by many CLOs, with €1.38bn in total in CLO portfolios.

Synlab, meanwhile, has higher ratings than Cerba and BioGroup, at B+/B2. Its €385m TLB due 2027 is present in CLOs (Spire holds the biggest piece, according to 9fin data) and that facility is due to be repaid (see p97 here) after Cinven increased its stake in the company.

Second opinion

Despite the obvious challenges in the labs sector, some investors might see a buying opportunity here. Recent trading levels in the sector, such as BioGroup’s debt below, suggest as much:

While they are highly levered, Cerba and BioGroup have no immediate refinancing risk since their nearest big maturities are in 2028. S&P said as much of BioGroup in November, noting that €271m RCF due 2027 was undrawn and there was “ample time” to restore profitability.

But some see echoes of Altice in this narrative too, arguing that Altice’s recent troubles stem back to its term loan refinancing in 2023.

“Investors felt comfortable because of the maturity extension, and saw cheap debt they believed they would be able to take out later,” said another investor. “It was at that point CLO managers started including even the unsecured bonds in CLOs.”

At least with Cerba and BioGroup, it does not appear that too many CLOs have begun buying into the senior unsecured notes, which in both cases are already in triple-C territory.

The triple-C angle

Most sources we spoke to for this article took pains to note that triple-C thresholds are largely a problem for deals out of their reinvestment periods.

“With triple-Cs you need to take the average price, not the outlier,” said one. “Some CLOs may be nearing their bucket capacity, but most aren't. And there's still a lot of flexibility when it comes to selling assets to mend those.”

But another buysider believes Altice was just the start of many more single-name challenges based on higher rates, weak security packages and increased creditor on creditor violence.

“CLO equity IRRs should be even more dispersed in the future than the already high dispersion, including negative returns.”

At the same time, some fear investors are overreaching for yield. For example, single-B borrower Alter Domus was able to price at 375bps earlier this month in what is becoming this year’s third wave of loan repricings; if this continues, CLO liabilities will have to tighten to keep pace.

“Overall we do think that credit markets are a bit frothy,” said one of our sources. “Spreads are at tight levels, as investors are focusing more on all-in yield. Yet there are lots of headwinds from geopolitics as well as a massive election year.”

When borrowers go from B- to triple-C, however, investor eagerness can hit a cliff-edge.

“The implication is clearly that PMs have seldom been keener to earn spread — but are nevertheless likely to run for the hills the moment that default becomes a realistic prospect,” wrote former Citi credit strategist Matt King for his Satori platform.

“Triple-C spreads themselves are likewise at record highs relative to HY indices. The breakdown in the traditional relationship between default rates and credit spreads suggests that it is the better quality names and the index which are mispriced, and not the triple-Cs.”