Priming aversion prompts positive response

Following reports by Sky News on 12 November that Boparan was in advanced talks with hedge funds regarding securing up to £50m of extra liquidity support, 9fin published a piece looking at the capacity for such debt to be raised at super senior level and the possible reasons as to why the company was seeking extra support with RCF capacity seemingly available. The company’s 2025s nosedived on the news, as there was up to £90m of Credit Facility basket capacity to raise debt super senior to the bonds as of Q3 21 and it signalled liquidity trouble at the group. The super senior capacity was partially used across Q4 21 but only with £25m of drawings on the £80m RCF which has a £10m accordion. The extra liquidity support came in the shape of a privately placed tap issuance of £50m mirror 2025 notes on 24 November and a commitment from lenders on 23 November to provide a £10m TLB. Net cash proceeds from the extra funding will be ~£45m, per management. When asked by an investor on the earnings call whether this suggests the mirror notes were issued at ~70, if the TLB raises £10m of cash proceeds, management didn’t argue the point. If the tap was indeed issued at this level, it is well below the trough of 77-mid the notes reached in mid-November. 

It’s not crystal clear if the TLB was raised at super senior level or if it will rank pari passu to the bonds.

The move to issue the tap out of other debt baskets (i.e. £50m General Debt Basket) leaves availability to draw down the remaining RCF capacity of either £55m or £65m depending on whether the accordion facility is available. Management confirmed on the earnings call that the RCF was £60m drawn as of Q1 22 and that proceeds raised from the new financing would be used to repay said drawings with a view to use RCF capacity to support working capital needs rather than to support operational challenges. 

It’s clear the company didn’t have capacity to raise £50m of super senior debt with the RCF being £60m drawn as of Q1 22, leaving only £30m of capacity under a Credit Facilities Basket, however this capacity could nonetheless have been used. That it wasn’t creates uncertainty as to management’s view of liquidity capacity heading into 2H 22 in our minds, as it suggests there was an intention to retain full access to the RCF should it be needed. As a reminder, drawings under the RCF can only be made through the £90m Credit Facilities Basket. 

One might also wonder at the rationale to invest in the tap issuance, as it is difficult to see there being a robust bid for these bonds in the 80-cents-to-the dollar region, notwithstanding the ostensible capital gain available to game parties. 

What does extra funding mean for credit metrics?

Per our definition, net leverage at FY21 was 6.7x, based on reported net debt and cash EBITDA. This is up from 5.4x as of Q3 21 and from 5.2x as of FY20. With management providing detail on RCF drawings as of Q1 22 and guiding that cash remained close to the year-end balance, we can assume FCF was negative £35m in Q1 22 with £35m of additional RCF drawings used to keep cash stable. Applying some assumptions about cash spend (i.e. capex, working capital) we can deduce our definition of cash EBITDA for Q1 22 and determine likely credit metrics. Before the issuance of the additional funding, we expect net leverage to tick above 10.5x as of 1Q 22. If £45m of net cash proceeds are used to pay down RCF drawings, net leverage moves to 12.3x following the issuance of the new funding by virtue of the tap being issued with a heavy discount. As we outlined in our deep-dive in September, leverage above 6-times - which was our ambitious year-end projection as of Q3 21 - is already wholly unsustainable for a business like Boparan. At potentially double that by the end of 1Q 22, the task of restoring some stability to the balance sheet looks an incredibly difficult challenge for management. 

We acknowledge that we frame this discussion of credit metrics around the peak of earnings pressure for the group, however the credit story has reached a point at which we believe it is justifiable now more than ever to apply due consideration to the worst-case. 

Every available lever pulled to scrape through covenant 

Boparan secured a relaxation of its maintenance covenant for 1Q and 2Q 22, with RCF lenders agreeing to move the minimum consolidated LTM EBITDA level from £75m to £50m. We assume the level jumps back up to £75m as of 3Q 22. A minimum liquidity maintenance covenant has also been introduced, to be tested as of Q2 22 and set at a level of £20m. There’s likely cautious headroom baked into this level, but with ~£100m of liquidity as of 1Q22 once the new funding is included, it points to a pretty tough Q2 after ~£35m of negative FCF alone in 1Q 22. To avoid the EBITDA maintenance breach, the company needs to avoid generating negative EBITDA in 1Q 22, a feat that has very likely been achieved given guidance on cash flows and cash balances, while a minimum of £11m of EBITDA needs to be generated across 1H 22 given £39m of EBITDA generated in 2H 21. Taking out £8m of one-off impacts on Q4 21 EBITDA, the company only generated ~£9m of EBITDA which would have pushed LTM EBITDA to £68.3m and below the minimum covenant threshold. 

Even with the £8m one-off help, FY21 EBITDA scraped past the maintenance threshold at £76.3m. The £8m of non-recurring or one-help comprised a £3m R&D tax credit used to offset against opex and a £5m release of accruals for remuneration not paid as a result of the weak results. Reading this another way, the company avoided a breach of its maintenance covenant because management bonuses were not paid due to poor company performance. 

Further mitigating actions were taken post-balance sheet date. These included the disposal of two loss-making sites in October (i.e. 1Q 22) to ultimate shareholders Ranjit and Baljinder Boparan to give an annual boost to EBITDA of ~£15m. Per management, the units had been loss-making for the past five years and would have involved £15m of net cash closing costs, as well as proving difficult to offload due to the importance of the assets to customers. The related sites are in Derby and Sunderland. The company also agreed in principle to a deferral of 6-months’ worth of pension contributions to FY23 with the Trustee which will equate to a ~£10m cash saving in FY22. 

From the outside, Boparan looks to be at a tipping point with little, if any, room to maneuver through an unforeseen headwind or any deviation from what is frankly a staggeringly ambitious recovery plan. 

The precarious position of the company is plain to see in management’s sensitivity analysis outlined in the annual report. Rather than rewrite content from the report, we have  included below a screenshot of the relevant section in the report. To summarise, maintenance covenants may be breached in Q3 or Q4 22 in a stressed scenario (40% net reduction in base plan EBITDA). If cost inflations cannot be passed through to retailers and this leads to a likely breach of the EBITDA maintenance covenant, it “may cast significant doubt upon the Group and Company’s ability to continue as a going concern”. 

There are more talking points to cover from Boparan’s 4Q 21 earnings but in the interest of brevity, we will revisit these in a separate report.