Market Wrap

Friday Workout - 99 problems, but pricing rich ain’t one; 5x5x5; is 60 the new 50?

Chris Haffenden's avatar
  1. Chris Haffenden
19 min read

Boris Johnson this week had a lot in common with JAY-Z. Over the past year, I might have identified at least 99 problems for risk assets - but pricing rich wasn’t one, and the flood of money – still flowing despite a negatively skewed risk/reward payoff, ensured a positive close for 2021. 

For now, the huge liquidity buffers built up during the pandemic, readily available finance for riskier credits, and rising valuation multiples are boosting issuers and keeping the business doctors away. Restructurings in 2021 were mainly limited to deals initiated in late 2020, with most deal flow drying up by mid-summer. Talking to distressed and restructuring participants in recent weeks, many expect slim pickings for 2022. Watch out for our 2022 preview in coming days for more detail and insight. 

This bleak outlook from restructuring professionals is despite notable recent headwinds, the latest Omicron scare (you were warned here last week) and well publicised difficulties in supply chains and unprecedented raw material cost inflation – yet more examples appeared this week (more later). Inflation is no longer transitory and other pressures are no longer temporary, not all companies have strong pricing power, I think the risk is to the upside for defaults in 2022 from the 2-3% estimates.

2021 was sponsored by the letter M: the year’s narrative dominated by Meme, Momentum and Mergers.

Plenty of top of the market indicators were to be had with the rise of SPACs, NFTs, Crypto – led by animal loving spirits. For value and credit-led fundamentalists like myself, it has been a difficult time, where too much analysis would have led to returns paralysis. Just follow the crowd and the trend instead.

As in the months prior to the Internet crash and the GFC, despite the smart money and insiders exiting and expressing caution months if not years in advance, often the pain trade is even higher – witness the performance of markets after the hawkish Fed minutes in mid-week. It is also worth remembering that not all bull markets end in dramatic crashes and in hindsight we may have already seen the peaks for several asset classes and individual names. NB – I called the top for EHY in late August. 

While the S&P 500 and Nasdaq remain near record highs, if you look below the surface the breadth is atrocious. Apple and Microsoft might be approaching $3trn valuations, but the performance of the remaining constituents is more lacklustre. The top five stocks returned 5x over the past five years. 

Even I am too old to remember the days of the Nifty Fifty. But I do recall the grey hairs on the trading floor at the turn of the century making the comparison to me prior to the internet crash. These were the original growth and tech stocks in the 1960s and 1970s and dramatically drove the bull market at the time. The price-earnings ratios for names such as Polaroid, Xerox and IBM soared to well over 50, before crashing to earth in the bear market of the early 70s, driven by sharp increases in inflation and rising geopolitical risks – does this sound familiar at all?

Admittedly, many of the nifty fifty did provide solid stock market performance in the 80s and 90s, after giving up 80-90% of their gains. In February 2008, UBS devised a new nifty fifty which included names such as BP, Nokia, Ericsson, and Vodafone – neither of which have traded that niftily in recent years. If you had to devise another one today – how many names would still be nifty in 2050? Ask Cathie?

Cinematic smash hits

We may have also reached peak meme – who can forget r/wallstreetbets and the massive squeeze in Gamestop shares earlier this year. It did have some real-world advantages, as many companies took advantage of the inflated equity cushions to raise funds, and in some cases, this ensured their survival. Some companies such as cinema-operator AMC went all in to entice the redditors, offering free popcorn to shareholders, taking booking payments in crypto and more bizarrely, offering movie-themed NFTs

But this week, seemingly under the financial press’ radar many of the meme stocks led by AMC got hammered. Some of it was admittedly due to renewed worries of lockdown from Omnicron, but also insider selling- even the Silverback and meme lover is no longer HODL! at AMC.

Earlier this week, AMC stock was down more than 30% from 8 December and 70% off its 52-week high. GME is also down 70% from year highs, Blackberry (-70%), Virgin Galactic (-76%), Bed Bath (-69%), Clover (-85%), Beyond Meat (-70%). But the redditors are not giving up, likening AMC to the VW/Porsche squeeze (btw having followed that situation closely, I can’t think of a single similarity). 

It was also a bad week for AMC’s main competitor Cineworld. It lost its litigation case with Cineplex this week in the Canadian Courts. In May 2020 it pulled out of a planned merger announced in December 2019 citing the impact of the pandemic. A Canadian court ruled that it must pay C$1.2Bbn ($930m) in damages after Cineplex sued for breach of contract. Its shares plunged 40% on the news. Just over a year ago, Cineworld narrowly avoided insolvency by securing a three-year non-call facility due May 2024 paying in the mid-teens and warrants to 10% of the equity at a strike price of $1bn. 

In August, Cineworld told investors it would shoot for the stars (is the CEO a SC7 or Pop Smoke fan?) in Q4. Liquidity in 2021 was boosted by a $213m convertible to around $650m at end-June, with a $200m incremental term loan in August. This would not be enough to pay the fine, but Cineworld intends to appeal – so, no time to die and it may die another day. No bond villains, the euro-denominated term loans are back into the mid-to-high 70s this week, from the high 80s in mid-summer.

Is 60 the new 50?

We have spent a lot of time in recent months reappraising the German Real Estate sector. Almost every presentation and OM we’ve read speaks about a medium-term target of sub-50 LTV. But most use aggressive accounting measures, most notably the percentage of completion method (which boosts EBITDA and lowers LTVs from rises from Gross development values). There have been many cases such as Toshiba in 2015 where income and expenses can be moved around at ease and pull forward revenues. In reality, most of these borrowers have LTVs in the 60s and potentially even higher. 

Signa Development is one of the Real Estate developers in our EHY universe using this accounting method. In its earnings call it took a sideswipe at its tainted peers Adler Group and Aggregate Holdings saying that it does not include receivables and net financial assets in its LTV calculations. As reported, in recent weeks it was on a charm offensive meeting investors seeking to distance itself from the Adler and Aggregate as its bonds dropped into the high 80s and yielding an 8-handle. It wants them to priceSigna closer to Spanish peers Aedas and Via Celere, rather than in Aggregate. It may put its money where its mouth is, it is considering buying back its bonds (low double-digit millions in Q1 22) which it says are significantly undervalued. This helped the bonds rise a couple of points to around 90. 

Signa finances its projects via debt (by cheap HY if it can rather than via double-digit margin development loans) and aims to forward sell at least 50% to property investors prior to completion. It doesn’t receive the sale funds until completion but does book the revenues using the accounting treatment, boosting EBITDA and reducing LTVs by increasing Development values. 

Revenue adjustments are by far the biggest component in Signa Development’s Q3 EBITDA, with €273.69m of adjustments booked in the first nine months of 2021, boosting the revenue total from €89.45m to €363.14m. These included significant PoC adjustments related to the closings of the UP! Berlin office complex, the BEL&MAIN apartment buildings in Vienna and another Vienna project in the first quarter, according to the slide presentation.

Signa also uses fair value adjustments to boost its reported numbers. Under questioning, management said that €2.4bn of completions expected in 2024 at time of its bond presentation in the summer, would now be just €0.9bn, with the remainder pushed into 2025. However, analysts’ focus should be on strong forward sales, with around half of the development pipeline forward sold, said Manuel Pirolt, the CEO. After recent completions, according to their presentation the percentage of its projects in planning is now a lofty 74%. Signa said it is in talks with shareholders over a €200m capital increase to help finance around €500m of investment opportunities in 2022. 

Yesterday, we were surprised to see a Q3 update from Aggregate Holdings. It only has to report semi-annually but it decided to issue an update as management said on their call, “there had been a fair amount of activity.” 

That was clearly an understatement. Since their Q2 report in August we’ve had a short-seller report, a €250m bailout loan from Vonovia to meet margin calls on debt secured against its 26.6% Adler Stake plus an 18-month call option granted on up to 15% of its Adler shares. We then had recent announcements of stake sales in S IMMO and Corestate, amid reports that it was in talks with distressed funds to borrow emergency funds at up to 15%. The bonds tanked into the high 50’s given the increasingly desperate attempts to raise funds but have risen in recent weeks to just below 70. 

The sharp fall in Adler’s share price will result in a jump in Aggregate’s LTV to 60-65% at year-end compared to 53.9% at the end of Q3 – remember it has 65% LTV financial maintenance covenant to be tested at end-December, which would cross-default the other debt if breached. Aggregate’s 26.6% stake in Adler Group is marked at a €960m book value but is worth just €370m based on Thursday’s Adler share price of €11.87 and will be revalued at the end of 2021 for LTV calculations. Vonovia has an 18-month call option to purchase a 13.3% stake in Adler at €14 per share, valuing Aggregate’s entire stake at €436m, a substantial loss for Aggregate if Vonovia exercises their option and crystallises the shortfall.

Our recent deep-dive report calls into doubt Aggregate’s liquidity. (If you are not a client, you can request a copy here.) The developer reported a sharp drop in liquid assets to just €36m at end-November from €180m at H1. But conversely, other financial assets jumped to €532m in Q3 (from €380m in Q2). Management declined to give current liquidity figures and forecasts for 2022. They admitted that there was some debt attached to the S IMMO stake sale to be repaid. Aggregate, however, claims in its presentation that its ongoing interest and overhead costs are now covered until Q3 2022.

Our recent update on the Fürst development acquisition provided more information on the debt financing around the €1.02bn acquisition of the Berlin development asset in June 2021, after a long discussion with seller Vivion’s Investor Relations department. We revealed that another €300m of the consideration was to be paid in cash by Aggregate, after €186m of initial cash proceeds. We estimated another €250m to raise despite Aggregate’s claims it is fully funded to completion at end-2023.

There were a lot of questions relating to Fürst from investors seeking to understand the make-up of the consideration paid and any contingent and ongoing obligations. One asked about Vivion’s reported statements that €300m would be received from Aggregate in Q1 22. “We can’t comment on Vivion’s expectations” was the terse response. Aggregate admitted providing ‘support’ to Vivion and is helping finding buyers for the project bonds, saying “we are confident this debt will be placed.” 

Management were also grilled on its exposure to Corestate, suspected related party transactions and plans to refinance around €285m of VIC Properties convertibles which are puttable next May.

In recent weeks, we have produced a number of bite-sized and deep-dive reports on Adler and Aggregate, posting individual updates on significant developments as these situations evolve. We are encouraged by the response and feedback so far. Our aim is to cover more situations in similar depth as our distressed/restructuring team grows in the first quarter. If you want to know more and help develop our offerings – we have a number of initiatives for 2022 – drop us a line. 

Our stressed and restructuring QuickTakes are a good example. This week, we produced one for Amigo Loans, the UK-based guarantor lender. (If you are not a client, you can request a copy here.) After a failed attempt to rid itself of compensation claims via a Scheme of Arrangement last May, it is back with another try, this time with a substantially improved offer to claimants. On 29 November, Amigo said that £300m of fresh debt and equity finance was needed to relaunch guarantor lending and promote new Amigo products under a new brand. But this required approval from its regulator the FCA which had opposed the previous scheme. 

It has spent months negotiating with an independent complaints committee and has come up with two options - a New Business Scheme contingent on an equity raise and resumption of new lending, and secondly, a managed wind down scheme. If the judge fails to sanction the first Scheme, he/she will be asked to sanction the second option during the same hearing. Amigo this week said it will make an initial cash contribution of £97m with another £15m to come from the planned capital raise. This will reduce the cash pile – which last quarter just exceeded the balance of its January 2024 SSNs – but Amigo is planning to call a chunk of its bonds (steps down to par in January) to reduce interest costs.

Chicken Little, Unhappy Nappies, Seasons Depletings

Boparan issued its Q1 2021/22 update this week. But there was little fresh meat from the poultry producer, which after all had provided a lot of information in its 25 November FY 20/21 release. 

Headline numbers were even worse than our estimates, posting just £6.7m of LfL EBITDA and a cash burn of £37.7m to end October, it narrowly avoided a minimum EBITDA covenant breach. Boparan continues to be affected by labour availability issues and price inflation, pushing through one round of price increases and is currently in negotiations over a second round. These should become effective in the second quarter, but most of the benefit will be seen in Q3. 

Management said that the low point was in Q1 and remained committed to improving margins and delivering the pro-forma EBITDA numbers (£135m) outlined in their bond presentation of last October in the medium-term. But LTM EBITDA is just £62.1m and leverage 8.1x, over double that a year ago when it pulled off its stressed refinancing. In November it secured extra liquidity support from a privately placed tap issuance of £50m mirror 2025 notes and £10m TLB add-on, so leverage is likely to come in above 10x in Q2. As we outlined in our deep-dive in September, leverage above six-times - - is wholly unsustainable for a business like Boparan. A restructuring is my prediction for 2022.

In common with Boparan, Ontex has been on the watchlist of restructuring advisors a number of times in the past decade. Remarkably, it managed to pull off a HY refinancing at just 3.5% in the summer. But the third quarter was an unhappy one for the nappy producer, with the Belgium-based manufacturer of branded hygienic and disposable products seeing its EBITDA fall 29% with “significantly higher raw material prices, the main driver for the decline.” The Adjusted EBITDA margin of 7.8% was down -344 bps versus prior year. 

This week, we were introduced to New Ontex by management who said it had lost its way in Europe and its Emerging Markets business is not returning the expected return on investment. Ontex will refocus on private labels and adult care products which are growing strongly. It is focusing on partner brands & healthcare in Europe and North America, extending its cost reduction programme and intends to make a number of divestments to refocus the business. The aim is to boost margins to 12.5-13.5% and reduce leverage back below 3x by the end of 2023. The lower margin Rest of the World business will be now managed for value and divested by 2023.

After four years of net losses in Europe, they are now turning the corner, said management. Ontex is seeking to fully pass through costs and assumes that current high levels of inflation will continue for the next two years. But most customer contracts are for two-to-three years and are renegotiated around nine-months before their term ends. Ontex saw big contract losses in Europe in 2017 to 2020, admitted management who said that the situation had stabilised and should return to growth in 2022. 

Lowen Play released its Q3 numbers this week. But the focus on the call was renewed restrictions in Germany and the Netherlands hitting utilisation rates and gross gaming revenues (GGR) hard after the period ended. In what is historically the company’s best month, December 2021 has not brought much joy for the arcade operator with seasonal depleting’s from Covid-impacted utilisation rates at its arcade sites. 

Negotiations are ongoing with authorities over new regulations that have pushed the company into a restructuring - see our QuickTake here for more details - although the decisions are fairly concrete in most of their key regions.  If you are not a client but would like to request a copy of the QuickTake, please complete your details here.

As we outlined in last week’s Workout, Lowen Play is projecting €82m of FY22 and €99m of FY25 adjusted EBITDA (giving net leverage of 6x and 5.5x respectively). Our deep dive in February cautioned that the right EV/EBITDA multiple could be as low as 4-5x, potentially leaving the new HoldCo PIK impaired. The restructuring plan assumptions do not reflect any Covid-19 related lockdowns or 2G regulations. Management estimates these will have an impact of c. €25m to sales and c.€17m lower EBITDA / cash from mid to end-November 2021 until March 2022. 

In brief

Olympic Entertainment’s Q3 conference call was livened up by a bondholder using the Q&A session to call for other bondholders to reach out to himself or legal advisors Kirkland & Ellis to join a noteholder group. The casino and gaming operator had produced another disappointing set of earnings figures and provided further disappointment for its beleaguered bondholders by addressing recent speculation that Entain was planning a $1bn bid for the group. Management said that “from a business perspective, we’ve never spoken to Entain, and they’ve never spoken to us.”

Ocado Retail posted a disappointing trading statement with just £100m of EBITDA forecast for 2022, compared to £114.2m LTM to May 2021 at the time of their bond issue. Regular readers will know that I was not a fan of the HY bond structure, its guarantees, and its venture capital nature. Bondholders are funding the solutions business liquidity gap, as we pointed out “The Ocado Retail JV, which generates most of the group’s revenue and EBITDA, sits outside the Restricted Group, so will not be subject to the covenants or provide any credit support. There is significant covenant capacity to pay dividends and to invest further in the Ocado Retail JV and other entities outside the Restricted Group.”

But there was good news for bondholders this week, with a significant win for Ocado in the US courts which rejected three of the four robots patents challenges from its Norwegian competitor Autostore. Ocado management are continuing to pursue their own claims against Autostore but admitted there were three more cases in Germany in January/February, one in London in mid-March, and cases pending in New Hampshire and Virginia. The bonds were little moved, trading with a 97-handle. 

Travelex in a situation and trading update announced that it has gone to its existing lenders for a fourth £35m funding tap to hit its coffers by January 2022. Operational losses have more than halved versus 1H21 “As a result, the EBITDA loss for 2021 is expected to be at least in line or favourable to the last update provided in September 2021 for losses of less than £60m for 2021.” Travelex projects around £20m of EBITDA in 2022, well short of the £71m generated in 2019. It anticipates a £70m funding need for next year which it says will be sourced from new money taps rather than third party financing. 

Chapeau for our colleagues at Debtwire who I’m reliably told had a scoop that Takko pre-marketed a stressed HY refinancing via Deutsche in November. But investors were wary, and the business update from the company on 26 November cleansed those funds that had been wall crossed. 

What we are reading/watching this week

If the authors are reading this, a signed copy of Elaine Nolan’s and Tom Smith QC’s definitive book on CVA’s is near the top of my Christmas list. 

The noise on Evergrande may have died down a little, but the entire property sector is suffering from the fallout with house prices falling 0.3% in November and volumes -16.3%.

Shimao - seen as a solid BB name in the Chinese HY sector failed to deliver 96 properties in Shanghai which backed a trust loan. Today there was some rebound as REDD reported that it would make payments on trust loans in the fourth quarter

One-third of US leveraged loan issues in 2021 had leverage in excess of 6x, the threshold set by regulators. In Europe, the average is around 5.9x, but this is on marketed numbers with ample add-backs, so we shouldn't get too complacent. 

As we prepare ourselves for life in the metaverse, we might need an expensive pair of virtual trainers to look sharp. Your’s for just $30,000. 

Sometimes the best alternative investments are more analogue and can offer tactile enjoyment such as classic cars and fine wines. I can now add another one to the list, apparently over time investing in lego is more lucrative than gold

9fin’s Owen Sanderson has another chapter for the surreal story of Rizwan Hussain - the wannabe destroyer of securitisations. Over the years he has pretended to appoint administrators, be a director of various SPVs, pretend to enforce security, tender and vote securitised bonds. Emerging from a stay at Her Majesty’s pleasure, he’s back and trying to break-up Business Mortgage Finance, with the other side trying to put him back in jail. He found a new frontman to head up a new SPV, his former cellmate Artemakis Artemiou.

Real Betis fans show that it is still the season of goodwill - throwing thousands of toys onto the pitch for disadvantaged children

This is the final Workout of 2021. Thanks to all for your positive feedback and support this year. Seasons wishes and a Happy New Year.

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