Market Wrap

Friday Workout - A Prax-estimate cost of funds; (Not so) blessed to be stressed; Let the games begin

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  1. Chris Haffenden

After last Thursday’s rate pivot was tabled by the ECB, markets reacted quickly and sharply. Repricing of risk and rate assumption didn’t take long – the Itraxx Crossover widened almost 50bps to 330bps at its worst on Monday - and European Government bonds returned to positive yields territory. In hindsight, it seems crazy 3-month forwards were not pricing in positive Eurozone rates until 2030!

EHY Prices last Friday fell 2-3 points across the board in response, and probably why primary was quieter than normal this Monday. Lack of further aftershocks led to some stabilisation at lower levels and encouraged some buying activity from generally underweight investors (see the Bloomberg European HY survey for more) with the crossover heading back towards 300bps, but yesterday’s CPI print in the US has led to risk-off mode once more, with the crossover closing at 310bps on Thurs, and European bonds yields back to fresh highs.

Events over the past week and well publicised difficulties in getting trickier credits such as Covis and Ion Analytics over the line has created market bifurcation with more difficult to understand deals are suffering as a result. On top of this, after significant rate and spreads moves many leads are now nervously looking at the caps on jumbo underwritten LBOs. Whereas a couple of months ago they were counting their fees and extrapolating their 2022 bonuses, they are now desperately trying to avoid not giving them all away, or in the case of Covis even losing money – we await their final bill. No fancy meals at Petrus for this year. 

Pre-marketing is no longer just a pricing exercise for arrangers and underwriters. 

We note banks are going early to pension funds and special situations funds to privately place and/or anchor the riskier parts of the capital structure. Witness CPPIB taking down the subs on Morrisons, whose launch is not a certainty this month. The leads are saying they are still pre-marketing with accounts – some funds told us this was already happening in November! 

Syndicate managers are getting cagier on the status of their deals. In the good times, you would get an investor update, and a non-deal roadshow and lo and behold a deal launch within a couple of days. IPTs would then emerge within 24-hours, and we would be fed with a stream of constant updates as strong investor interest drove pricing tighter and tighter. 

Now, it can take days for IPTs to emerge, with leads even resorting to sending out easily deniable whispers to selected accounts in the meantime to keep them warm. 

This was evidenced by the communications (or more accurately the lack of them) from the leads on Prax. Admittedly, the UK-based midstream and downstream energy company is not an easy credit to understand, and despite appearing to be launched at the end of January - interestingly with a pink, not a red - sources close to the deal told us that investors want more time (roadshow and one-on-ones were due to end on 4 February) to understand the credit. 

The delay gave my 9fin colleague Owen Sanderson more time to refine our knowledge of the credit. Drilling into the OM and the accounts allowed us to distillate some heavy, albeit crude, assumptions over the funding of the business and what is really driving this refinancing. 

Sources and uses in the company’s pink OM states the bond would be used to pay down $119m of “secured bank loans”, as well as $1.7m of bank overdraft, and $9.9m of vendor loan notes. This largely dates from HKS, a fuel retailer, purchased in 2018, via Prax’s Harvest Energy subsidiary. 

Drill deeper, we find the “bank debt” was provided by Sculptor PFS Investments Sarl. and Nomura European Investment Limited. From the exploration of the Sculptor entity accounts, the loan pays a healthy 975bps over sterling Libor, maturing in October 2023, and $13.8m of pre-payment fees. 

But the business now includes an oil refinery, from the sale of Total’s downstream assets in March 2021. The Lindsay refinery on Humberside was purchased for $160m, seemingly a bargain as Prax later booked a $500m gain on the acquisition – with $667m of identifiable assets including $470m of inventory. But these might already be encumbered, there is a $525m securitisation facility with $488m drawn which might suggest that pledged receivables from inventory sold on were then securitised. 

Three of the securitisation banks are on the bond deal with the notable omission of JPM. In addition to the securitised debt, we have explored further and discovered an ‘excess concentration facility’ of up to $105m with Raiffeisen Bank and an exclusive contract from Trafigura to supply oil – under the deal the trader has effectively lent $87.8m to Prax by the end of November, which could rise to $130m. 

The deal was marketed as being very lowly-leveraged corporate debt at 0.7x, but as you can see from above (and our cap table below) is it a much more complicated structure. 

Clients can see our Credit QuickTake here and the legals here

One of our sources suggested that a club deal with a double-digit coupon was under discussion with enhanced collateral – which makes sense as it was previously limited to just share pledges, bank accounts and structural intercompany receivables. There is no benefit from UK floating charges or any security over hard assets. We also heard of an OID on offer to further sweeten the mix. 

A source close to the deal earlier this week maintained that several options were still being discussed. But just prior to publication, the deal was pulled with Prax saying it “has decided not to proceed with its proposed offering of $250 million senior secured notes at this time due to unsatisfactory market conditions. The Company will continue to monitor the market with a view to re-offering when market conditions improve.”

Perhaps that Sculptor facility wasn’t so expensive after all. 

(Not So) Blessed to be Stressed 

We assume Credit Suisse is closely watching the outcome on Prax, given their refinancing mandate for the German Refinery business, Heide, seeking to come to market in early 2022. But the 6.375% existing December 2022 notes are not so convinced, trading in the high 80s. 

While revenues have recovered strongly and are close to 2019 levels, the refinery is being hit by higher energy costs with EBITDA notoriously volatile over the years, leading us to question the most appropriate means of financing and the maximum leverage the business can bear. 

Sponsor Klesch, which had taken out €360m in dividends (including €200m from the 2017 bond deal) in over five years holds the key to unlocking the refinancing. It can either contribute equity or contribute other refinery assets. So far it and the experienced management team have been coy on whether they want to go down this route or try their luck with a straight refinancing. 

In our latest (Not so) Blessed to be Stressed report we offer two further refinancing options, adding amend-and-extend and direct lending solutions to the mix. 9fin’s Ben Hoskin goes into extensive detail on how each option could work and their pros and cons. Clients can access the report here. If you are not a client but would like a copy, please complete your details here.

We have added the rider (not so) to our latest reports (part one is here), to reflect the greater difficulty for stressed firms to get refinancing’s away in the current market. They are not so lucky as peers in the spring and summer of 2021, we are quoted then as saying that even a dead cat could get refinanced (perhaps not the best analogy this week – time to (stand) by the cat and sell the Zouma). 

The second company in our B2BS report is Corestate, the German Real Estate services firm. 

It is falling behind in its deleveraging efforts, aiming to hit a self-imposed 3x target by end December 2021 by reducing debt by €230m to enable a refinancing in H1 2022. It has upcoming debt maturities in Nov 2022 (€197m of converts) and April 2023 (€298m SUNs) to address amid a rerating of the German Real Estate sector after allegations from short sellers. 

Exposure to Adler and Aggregate (for lending and real estate deal flow) is a potential concern, as is the slow progress in procuring investors for its mezzanine funds that feed into its finance for developments. The recent departure of two board members, sitting at its finance arm Corestate Bank, may impact future lending, given strong market relationships. While the German real estate market remains red hot (from a valuation and transactions basis) any reduction in activity and asset prices could affect its performance and management fees, the main drivers of EBITDA. 

Analysts express concerns over commingling, given the provision of bridge loans, which are then put into equity mezzanine funds for its fund investors. Given its risky development lending, its claim to never to have had a loan default, has also raised eyebrows.

With its full-year results not expected until 8 March, and an investor Capital Markets Day postponed, prices of Corestate bonds are likely to be driven by newsflow for themselves and their German RE peers. They continue to yield in the mid-teens.

Unlike Adler and Aggregate the corporate bonds are not directly funding purchases of real estate assets or funding development. A better way to look at them is borrowing against the management fees.

Corestate is limited from issuing further debt by a 3.5x debt incurrence covenant. The November 2022 convertibles could be extended for a further couple of years in return for a reduction in the strike price (current bonds are deeply out of the money), but it will want to come up with a solution for its April 2023 SUNs prior to them becoming current on 15 April. 

The company is targeting a refinancing in the Spring, when the FY 21 numbers and the FY 22 outlook are available. It claims a Plan B for an alternative path in the summer of 2022. 

Mixed use developments for Adler and Aggregate

News flow for other German RE companies were mixed use in their properties this week. 

While Aggregate, one of its major shareholders, claimed a clean bill of health after Hogan Lovells had investigated allegations from short-seller Viceroy Research, Adler is now facing a BaFin investigation. 

Last week, Adler surprised markets by saying that full year numbers would be delayed due to the forensic investigation by KPMG into the Viceroy allegations. Just days later, it announced that Dr Michael Bütter had resigned from theGroup board of directors, which Adler says was driven by Union Real Estate’s decision to grant Dr Bütter more duties which could give rise to conflicts of interest. What Adler didn’t say was that he was also chairman of the audit committee…Today, it was announced that Thilo Schmid, a member of the committee since 2020, had been appointed as Chairman. 

Now according to Handlesblatt, Frankfurt prosecutors are in contact with BaFin about Adler's financial reporting, which a spokesperson confirmed to Reuters later the same day.

Similar to the prime minister’s response to the initial report from Sue Gray, we are a little sceptical of Aggregate’s short declaration of its complete exoneration, we prefer to await more details, and it seems its bondholders agree with prices remaining stuck at around 60. 

Let the games begin

We were pleasantly surprised that the Intralot 2024 bondholders may not be giving up on their fight with the company and the former 2021 noteholders. 

This week, it was announced that the Law Debenture Trust, the trustee for the 2024 notes, had been replaced by UMB Bank, who has retained Greenberg Traurig as its legal counsel. 

Trustee replacement is a common tactic ahead of bondholder actions. Incumbent trustees are often unwilling to go legal worried of being sued for wrongful actions such as acceleration of notes and/or undertaking litigation on behalf of minority noteholder groups. This can lead to them demanding sizable indemnities “to their satisfaction” as often described in bond docs, language which leaves a lot of wriggle room.

This makes me feel old, I was present at the House of Lords for the appeal by Elliott Advisors against Elektrim, the Polish Telco in 2005. One of the few items of case law on the indemnity point. Law Debenture had demanded a $1bn indemnity (almost twice the size of the convertible notes) citing a legal letter from Deutsche Telekom as its justification, and was unwilling to accept the hedge fund’s backstop, it wanted one from a bone fide bank. 

At this point, my very belated apologies to Gordon Singer and James Roome. The book you urged me to write on Elektrim – a potential real page turner - never got beyond the first chapter. In my defence, I was waiting for the 50+ legal actions to play out and wasn’t offered an indemnity to avoid being sued by multinational corporations and Polish oligarchs! 

But I digress. Let’s briefly recap the events last year for the Greece-based gaming operator:

The 2021 SUNs cunningly managed to drive and impose a restructuring which grabbed security and positioned themselves at Intralot Inc, the US business which generates the majority of EBITDA, while extending their notes to 2025. This was achieved by Europe’s first drop-down financing, borrowing elements from J Crew. To get over the 90% threshold to amend the notes, there was a partial optional redemption funded by the 2021 ad hoc group who subsequently issued new notes to themselves. 

The 2024s were meant to rank pari passu but were offered just a 49% stake in a new US topco via a debt exchange or take their chances with full repayment at maturity. 

Not surprisingly the 2024s cried foul, and as we reported had prepared a litigation strategy.

They claimed that Intralot was unable to use three baskets - a Restricted Payments general basket, plus Permitted Investments general and investments in joint ventures baskets, to designate the US topco as an unrestricted subsidiary. The 2024s believed under their interpretation of the indenture, the company can only use either RP or PI capacity, not a combination. 

Secondly, the 2024s believed that the US business, which provides the bulk of wider group profits, constitutes “substantially all” of the group’s assets and therefore would trip the change of control and/or the merger covenants under the 2024 notes indenture. 

But these issues were not substantively argued in court. As we reported the 2024s failed to secure a last-minute temporary restraining order. On 2 August, Judge Mary Kay Vyskoci rejected the application and was terse in her interactions with the plaintiff lawyers. She was clearly unimpressed by the late filing with little time for detailed arguments. 

As we said at the time the accounting treatment and the interpretation under the documentation for the fair market value used for the transfer merits further investigation by market participants, but unfortunately these were not argued in detail at the TRO hearing. 

Vyskoci said there were arguable merits on fraudulent transfer arguments but noted that there is already an adequate remedy under law, whereby these could be voided at a later date, and as a result the plaintiffs could not show the irreparable harm required for a TRO.

Bondholders had told us privately, after the hearing, of their willingness to continue to pursue their legal claims. It may be that there are further games to be played, which may begin soon.

Level Yell, more, more, more?

Those hoping for more detail on Yell’s restructuring, their 14-minute Q3 conference call – had no questions from investors/analysts – left us wanting more, more. But there wasn’t any more. 

These days, it is almost level Yell, after years of substantial decline, customer churn for the digital business directories business, while still outstripping new users is more balanced. EBITDA in the quarter to end of December was better than expected, mostly due to a reduction in spend due to Covid. A mass of new sales trainees after a summer exodus are ready to be launched on new prospects, with Yell hoping for 10% revenue growth next year. 

After almost two-years of negotiations, there is finally an agreed restructuring plan, but details are skinny on the implementation, the stakeholders without the customary listing of advisors and their contact details. It must be agreed by shareholders too. 

Under the proposed plan bondholder’s will write-off around 70% of their claims. The remainder exchanged for cash pay 2027 notes, with interest reducing to £5.69m per year. In return for writing off their debt, they will receive the group’s equity, save a 5% minority interest. Leverage will reduce to around 1.8x (based on September 2021 LTM EBITDA of £26.6m)

Robots in the wars

Regular readers will know that I’m not a fan of Ocado’s bond issue, despite the lowly LTV. 

Ocado wants to be seen as a tech business not a grocery company. Its future revenue growth will come via Ocado solutions – a smart platform providing “an end-to-end solution enabling existing grocery retailers to build their online offerings.” 

Over the years, it has been rewarded by an insane market cap, which despite the latest share falls, is still an incredible £9.94bn (4x revenues), on just £61m of FY21 EBITDA. 

But the new tech division is burning huge amounts of capex and is unlikely to produce meaningful EBITDA until 2024 and is currently loss-making (UK in profit, International posting large losses). Most group profits are coming from Ocado Retail limited, the food delivery service, but revenues and EBITDA here are starting to flat line as Covid tailwinds diminish and higher logistics and other costs impact profitability. 

International Solutions should be breakeven in 2022 (negative £119.3m of EBITDA in FY21) but Ocado will spend a hefty £800m this year in Capex with 50% devoted to International Solutions. The company cautioned it would take 4-5 years to have a sufficient portfolio of customer fulfilment centres to cover its cost base. It currently has just 10 International partners, lower than projected.  

Remember, Ocado Retail Group sits outside the restricted group, in my view the bonds are effectively venture funding for the solutions business. 

And by the way, there is further potential negative headline risk, with robot wars between the company in the courts in the US, Germany and in the UK with German competitor Autostore. In March, a key English High Court hearing begins between the two battling it out. 

Group liquidity is an impressive £1.5bn, but down £500m on the prior year, despite benefiting from £275m of net proceeds from the bond financing. With yields approaching 6%, the 3.875% 2026s are getting closer to where I would have priced the bond issue in October. 

In brief

After their 20-points fall the prior week, Saipem bonds struggled to recover much this week. JPMorgan equity analysts suggested that bondholders might have to take a haircut and that the equity hole could be as much as €2bn. As we outlined in our piece last week some of the revisions relate to issues at a EDF wind farm off the north coast of Scotland which Bloomberg suggests could cost more than €500m, compared to €200m previously. An Il Messaggero article suggesting talks with banks over a €500m bridge loan to repay the April bonds while a €1.5bn capital increase was being prepared failed to result in a significant rebound, with the banks reportedly saying that Eni and CdP must backstop the equity raise with a further €1bn. Watch out for our QuickTake in the coming days.

For Audiophiles, a 10-minute segment from yours truly on this week’s Cloud9fin podcast

Iceland bonds, which had been sliding into the high 80s, posted decent gains following the release of its Q3 earnings with management forecasts of a positive YoY EBITDA and a reduction in net debt and leverage by year end (leverage currently sits at 4.9x). As 9fin’s Alex Manolopoulus writes cash to be held in the freezer as energy costs heat up “investors were understandably eager to press on how Iceland expects to utilise its £150m of cash in hand, bolstered by a Q3 working capital bump which helped to add £23m of cash inflows to the chest. Buybacks on the discount retailers' discounted bonds were the obvious focus, and although the door remains open to this possibility, management were rather firm on the desire to keep reserves in place for Q1 22/23 given the expected uptick in input costs - most notably in energy.”

KME bonds rallied a couple of points to 96, following the completion of the speciality division sale and the provision of a new €75m loan facility, with receivables and factoring facilities extended too. Still awaiting news of the expected bond repayment, but the picture looks much rosier than six-months ago. 

There was also good news for Frigoglass which finally received €42m in insurance payments for the fire damage to its Romanian glass plant.

Hat tips to my colleagues at Debtwire and Reorg for their scoops on PGS in the past week. The creditors to the $873m Term Loan B have reportedly appointed Moelis as financial advisor with Kirkland acting company side. Despite an A&E last year, poor performance from the Norwegian seismic services operator means that amortisation payments in September will be challenging. 

What we are reading this week

As US inflation continues to surprise to the upside (after yesterday’s 7.5% print, some are now going for an emergency hike before the March meeting), Ben Hunt from Epsilon Theory looks at why companies are increasing prices at a higher rate than their costs. A taster: 

“The common knowledge of whether we are in an inflationary or deflationary world has now shifted. It will not shift back for years and years, because common knowledge is a stable, self-reinforcing phenomenon. Common knowledge is a barge, not a speed boat. Common knowledge is incredibly difficult to stop, much less turn around, but once it starts going the other way it will keep going. At whatever point in time you think inflation will start to fade, you are being too optimistic.”

I’ve seen a few entertaining activist and short-seller presentations, this one by Blackwells Capital for Peleton is up with the best. We particularly like the candidness of the CEO. 

Bloomberg causes panic amongst Nato generals last weekend after jumping the gun:

Will leave you with a scary chart – from S&P LCD on projected versus actual EBITDA – please don’t have nightmares.

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