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Private Credit 

Chris Haffenden

In 2021 editions of the Friday Workout, I oft bemoaned the poor value stressed credits represented in secondary. I marvelled at how names that should be an A&E or enter into restructuring such as Punch Taverns and Douglas were refinanced with a six handle. “Even a dead cat could get refinanced,” I remarked at the time. The new stressed was 6%.

Refis of Covid-impacted businesses and reopening trades were another world of wonder to me. Often coming with earnings distortion fields – with generous EBITDA add backs – or if too much bother to pad out the figs, find investors willing to take the pre-Covid 2019 numbers instead.

Most notable were beauty products companies Coty (SSNs at 3.875%) and Douglas (SSNs at 6%). Remarkably, we also saw severely Covid-affected names coming at barely believable levels, taking their full recovery to 2019 levels as a given.

One was Dufry, the airport shop concessions operator which printed €725m of senior unsecured bonds at just 3.375% (yes that is not a typo) last April. In early July 2022 they were at 8.5%. This week it announced a mostly equity-funded acquisition of Autogrill, which when completed next year will set another interesting price point for the debt component (more later).

Fast forward 12-months, we’ve gone into reverse.

Any single-B issuer brave enough to take a gamble, will likely see even their senior secured paper print in double-digits. A year ago, refinancing alchemy removed stress and even got ratings upgrades out of triple-hook for borrowers. Nowadays, primary deals are stressed at birth.

Beauty is in the eye of the bondholder. Despite strong numbers Coty now yields around 7% with its less strongly performing peer Douglas yielding 13.5%. Remove the make-up (numbers), they are not looking so pretty.

Issuing in the current market is a real gamble. 888 last week certainly had to pay to play, its 7.558% SSNs priced at an 85 OID to yield 11.5%, with the SS FRNs paying E+550 bps at 85.

Next up was Schustermann & Borenstein or BestSecret as it now likes to be known. But unlike 888 – an underwritten LBO that bankers wanted to get off their books, this was a straightforward refinancing – putting into stark relief how much discount is needed to make paper fashionable. The €315m senior secured FRNs priced yesterday at E+600bps at 85, with a 1% floor.

At 9fin Towers we were a little perplexed to say the least. Not the best kept secret, we said they could have refinanced last year, maybe with a dividend recap to further accessorise. The members only off-price fashion group should have taken our deal prediction advice last May – a 9fin subscription would have paid dividends – literally:

“Refinancing the 6.25% Notes with a 5.50% coupon would set the breakeven at two years, making a case to go before the par call at the end of the year. CBR Fashion (B2/B) priced €470m of SSNs at 5.50% last month (Apr-21) on 3.5x net leverage and provides a pretty good yardstick for where the company could expect to sell a new issue.”

Net leverage is now 2.8x, but BestSecret still paid double the rate it could have gotten in late 2021. Surely, Private Credit route would be cheaper, especially as the €315m deal size is more appropriate for direct lenders. Retail is a hated sector, however, among many credit funds, so many might have passed, despite it easily fitting into their 7-10% return criteria.

Looking at other single-B FRNs and TLBs with maturities over three-years – our CEO Steven Hunter put together a quick analysis (below) – this deal is one of the outliers.

Many senior secured deals are now indicated north of 10%, fitting squarely into the return criteria of private credit special sits and opportunity funds - that look for low teens - and distressed funds that want mid-teens IRRs and above.

Luke Millar from Capital Structure reported on Wednesday that many other borrowers with late 2023 maturities are also thinking of pressing the refi launch control button before the summer break. But high yield funds are not piling in here, as many investors believe spreads could widen even further in the short-term, he suggested.

But on a longer view, surely High Yield funds and CLOs (remember, many have much larger bond buckets than in past downturns) should be filling their boots at these levels?

Many buysiders had previously blamed poor liquidity and dealers running scared for price falls, telling my primary journalists secondary dealer prices are not indicative. However, primary deals are now pricing even wider, and dragging secondary further down with them. Tail, dog, wag?

While HY funds are suffering from significant redemptions, and forced to sell paper, into an illiquid market and/or hedge via derivatives, CLOs are in a comparatively better flows position. Their difficulty is that the usual 200bps plus asset/funding arbitrage no longer works.

This was brought into sharp relief this week, as Anchorage’s new short-dated CLO AAA-tranche priced at a whopping 210bps, up from 160bps for recent deals for Investcorp and Soundpoint.

At least the latest trend for mid-80s OIDs is helping CLOs with their par building needs, notes Aly Hirji from Blackrock in our latest 9Questions. It mitigates concerns of diminishing headroom on over-collateralisation tests (CLOs have to mark to market below 80). The leveraged loans index has dropped below 90, so, the theoretical OC headroom is almost halved. But buying loans at a deep OID neatly helps offset as you buy at/near the same discount as the paper you sell.

Distressed funds which profited handsomely in 2020, as they hoovered up paper in the downdraft and rode the recovery wave later that year, should be standing by again.

But what if many deployed too early in 2022? Their performance in the past couple of months won’t look pretty for their investors. Unlike private credit, many have short term (not long-term) capital and have to mark-to-market. They might face redemptions at the worst possible time.

That said, distressed funds do have more flexibility if their positions go into restructuring. Despite many direct lenders tooling up with restructuring talent in 2020 – private credit is less predisposed to take equity and will be keen to avoid haircuts and defaults that may depress promised returns and deter fresh investment.

With so much market dislocation, there should be plenty of room to profit.

The question is by who, and whether the events of the past six months will lead to fundamental changes in the providers of Leveraged finance and also the make-up of the buyer base.

Over the next few weeks, our reporters, and analysts at 9fin will explore these questions and themes in greater depth and detail. We are keen to speak to the various constituencies for their views and insights.

There was some good news this week for some watchlist names, managing to tap the markets to relieve pressure on short-term maturities. Nordex secured a €139.2m capital increase and a new loan facility (details unknown) to repay its 6.5% May 2023 bonds.

The unpronounceable Samhällsbyggnadsbolaget i Norden AB (SBB) hopes that it is not unrefinanceable. Keeping an investment grade rating is of key importance, said CEO and founder Ilija Batljan in an investor call yesterday. A day earlier SBB announced the pricing of $100m of unsecured social bonds due in 2027 and 2032 via the US private placement market at UST+325 bps and +350 bps respectively, which equates to 4.36% and 4.87% yield in euros. It is a first foray into US PP and just over a month after printing a debut Schuldschein.

SBB’s call was less eventful than in February, when it pronounced its innocence to over 1,000 interested parties on a conference call after being subject to an attack by short seller Viceroy Research titled Samhällsbyggnadsbolaget: Hard to pronounce, harder to justify value.

Viceroy alleged suspected related party transactions, highlighted conflicts of interest, governance concerns and the alleged inflation of fair market values in the company’s portfolio, most notably a series of JVs. The short-seller questioned the liberal use of hybrid securities for funding and its effects on reported LTV and expressed concerns over the issuance of D shares as part consideration for acquisitions, a number of which it viewed as round-tripping deals.

SBB’s IG bonds were under pressure ever since, with its 1% 2026 senior notes, trading at a very un-IG price of 69.5-mid yesterday.

In late June, Viceroy had doubled down with another report in which they highlighted material reconciliation challenges’ in a deeper review into SBB’s financial accounts. It questioned the accounting of off-balance sheet funding of investments in a series of joint ventures.

In the first half, SBB took a SEK 1.4bn hit on the values of financial instruments, which the CEO attributed to a series of total return swap derivatives. There is a process to systematically reduce the proportion of joint ventures through divestments to strengthen the balance sheet. He said that the LTV at the JV’s was around 40%, compared to 47% for the wider group (up from 37% in Q2 21), but this will drop in Q3 after a series of property disposals.

With significant amounts of commercial paper and with SEK 3.7bn of maturities in 2022 and another SEK 1.9bn due in 2023, the focus is on maintaining an investment grade rating, he said. Fitch and S&P have maintained BBB- ratings recently, the latter putting on negative outlook, making its grip on its IG status more precarious.

During questioning, he said there were around SEK 6.2bn of divestments by the end of this quarter, leading to around SEK 10bn of cash and cash equivalents, with a further SEK 5bn of disposals planned “in the next few months.” He added that they “would do what is needed to strengthen their financial position.” This included reducing Capex and investments in new projects which would drop from SEK 2.5bn in H1 to around SEK 1bn in the second half.

Worryingly, the SEK 9.2bn of disposals in the first half were just below their (recently downwardly adjusted) book value, noted one questioner. SBB remains comfortable in raising rentals as most are index-linked and are with government-owned institutions, Batljan explained.

When asked whether they would buy back bonds in the capital markets with the proceeds, he responded that it was very important to strengthen access to capital markets by repaying debt and this was one part of that. “Our [bond buyback] ambitions have not changed.”

It wasn’t admitted on the call, but the latest US PP cost significantly more than the 1.4% average cost of debt, leading us to believe SBB has decided asset sales to repay debt are a better option. It may suggest some of its more traditional funding routes are either closed or prohibitively expensive. Of course, this will get much worse if it loses its Investment Grade BBB- rating.

So is it 3B, or not 3B for SBB? That is the question

How do you sleep while the beds are burning?

Our colleagues at Reorg revealed earlier this week that Swedish bed maker Hilding Anders has agreed a restructuring plan with an ad hoc group of lenders. 9fin’s Bianca Boorer confirmed with sources close to the deal who have been burning the midnight oil on the deal.

Hit by rising input costs from the war in Ukraine and with significant Russian operations, a breach of covenants was inevitable in Q3. Given the uncertainty and poor capital markets a refinancing of its 2023 revolver before it became current in November was impossible, said one source close.

There was a burning platform (or should that be a burning mattress) but it is virtually impossible for lenders to get hold of the assets and take control - given that Russia made up 52% of EBITDA in the year to November 2021 and sanctions prohibit enforcement.

Under the agreed plan, it appears there is a way for sponsor KKR to put its long-standing and troubled investment to bed. €550m of outstanding debt will be bifurcated with €300m exchanged into a new 2026 loan, and the remainder into a €270m HoldCo PIK paying 12%.

After a period of rest and recuperation, it will appoint a financial advisor on 1 January 2024 to commence the sale of its European business by the middle of 2024. A timeline for the sale of the Russian business was not provided as it’s hard to predict the war in Ukraine, the close source said. KKR will retain contingent value rights for the proceeds from the eventual sale, he added.

Russian subsidiary, Askona will be taken out of the restricted group. Covenants are also tightened up in the proposal. An ad hoc group representing 58% of the lenders has signed up to the plan, with other lenders set to vote on the plan by the end of next week.

The sponsor is unlikely to feather its bed on an exit. Last week, the loans dived from the 50s into the high 30s. This would indicate that the HoldCo PIK is has little to no value on day one.

The company is advised by PJT Partners (financial) and Kirkland & Ellis (legal) with the lenders by Lazard and Latham & Watkins.

Back to our airport stores business, which was the talk of FinTwit earlier in the week. Echoing Tullow Oil’s merger with Capricorn Energy, a transformational deal widely seen as credit positive, there was less enthusiasm for the deal from the target’s shareholders.

Under the planned merger with Autogrill, Edizione (controlled by the Benetton family) will exchange its 50.3% stake in Autogrill for ~20-25% stake in Dufry via mandatory convertible notes. A mandatory tender for the remaining Autogrill shares can be done on the same basis or for €6.33 per share. The EV multiple is a lowly 5x based on €529.9m of underlying EBITDA.

While the first stage will be deleveraging (from 3.2x to 2.4x on a pro forma basis), there could be some re-leveraging depending on how many take the cash offer and and the proportions funded by debt or equity.

However, FY21 leverage for the combined group (using the stated group EBITDA of CHF 595m, pre Autogrill disposals) comes to ~5.5x. Dufry is targeting sub 3x leverage in the medium term.

Essentially, the deal is a diversification play for Dufry, reducing its exposure to airports from around 95% to 81%, expanding its geographical reach and increasing its exposure to food and beverages. Autogrill is seen as more resilient in a downturn. But on a combined basis EBITDA for the two groups at FY 21 is still well shy of pre-pandemic levels (see below):

Participants on the investor call were treated to a 90 second montage of swish store formats and uplifting slogans – nicely backed by Moby’s 2005 hit “Lift Me Up”. (Perhaps party like its 2019 would have been more appropriate).

9fin’s Alex Manolopoulos was listening in, with grumpy Autogrill shareholders complaining that the €6.33 price was too low, with some wariness over Benetton Family & Dufry back channeling, see the FT article here. One investor asked for a Right of Withdrawal to be inserted into the deal.

Some investors are also sceptical that the €80m of synergies in two years will be achieved, remembering Dufry previously had a restaurant business which provided little overlap.

Dufry’s 2028 SUNs rose by around two-points on the news to 79-mid, yielding around 7.9%.

Saipem shares sunk this week, after just 70% of its rights issue was sold, leaving 14 banks stuck with around €400m of underwriting exposure – and deeply underwater, as the shares fell 70%. The banks will take a steep loss, but bondholders were more buoyant, with little impact seen on prices as the €2bn of funds were still committed. The April 2023s are 95.31-mid.

JPMorgan and Barclays will be hoping that their proposed underwrite for Aston Martin does not suffer the same fate. The British supercar manufacturer is raising £653m of equity, with the banks backstopping the £335m coming from PIF - the Saudi Sovereign Wealth Fund, the Yew Tree consortium and Mercedes. In an upbeat statement it said that it would significantly deleverage the balance sheet and fund its electrification strategy. It also revealed that it had rejected a £1.3bn offer from Atlas, a Hong Kong-based consortium.

Danish Telco TDC suffered its second rating downgrade in a week, as the agencies fear that it might not be able to refinance €1.05bn and $410m SSNs from its DKT Finance subsidiary in June 2023. “While Moody's understands that the company is working on a refinancing plan that will be completed in the coming months, current capital market conditions are making this refinancing more challenging and also potentially more costly, given the increase in interest rates.” With negative FCF through to 2025 and Moody’s adjusted leverage of 6.5x, that leaves little equity cushion and if this rises above 7x, could lead to a downgrade to triple hook which could nix a refi.

As we sink into recession depression, I often get teased by long term charts and graphs making comparisons to the dot com crash, 1929, the 70’s oil crisis with inflation and rates comparisons to the 1980s. I particularly like the Nasdaq from 2002 transposed on 2022 (below)

John Hussman says: “In recent months, the financial markets have taken the first step toward normalization. Unfortunately, having taken one step, the most prominent question we hear is “Are we there yet?! If “there” means valuations anywhere near levels that are consistent with historically run-of-the-mill long-term returns; if “there” means a monetary policy stance anywhere near something that would promote productive capital allocation without speculative distortion; if “there” means financial market capitalizations that can actually be served by the cash flows generated by the economy, providing adequate long-term returns without relying on endless expansion in valuation multiples; then, no. We are not “there.”

This weekend, some entertaining legal filings to read. Firstly, Twitter’s filing against Elon Musk (have a copy available on request), and secondly Celsius’ bankruptcy filing.

I had no idea who Sam Bankman-Fried was a month ago, now the co-founder of FTX is seeking to monopolise investments in distressed crypto assets. His latest move is buying Bitcoin mining companies, as their financing unravels. A great substack post from our friends at Petition.

And finally, a minutes silence to reflect on the sad and unexpected death of Justin Bickle, renowned restructuring lawyer, distressed investor and property developer.

I first met Justin as an aspiring restructuring journalist in 2004, at a lunch with him and his junior Kon Ascimacopolus (now of K&E fame) at the Bleeding Heart. I had dived into the deep end, my first assignment was covering British Energy and Cads were advising the British Government in their fight against hedge funds, seeking to restructure the nuclear business. My copy was being cited in a $2bn lawsuit being run by Justin’s boss at the time, Andrew Wilkinson.

He then moved to work for one of Cads clients – Oaktree. I remember some bruising encounters as my reporting sometimes put us at odds at times, but he would still spare time to message me complimenting and commenting on my coverage. In Almatis, he single-handedly took on the Dubai Government, top tier investment banks and most of the distressed community (most notably Akshay Shah) and I often got hit in the crossfire. After 18-months of persistence, he hit a huge home run, taken out by GSO. I remember we had a long afternoon at Nobu after the deal closed – comparing war stories – and brainstorming over the next distressed opportunities.

Justin recognised the opportunity of Dublin real estate post financial crisis and had a very successful third career as a developer, returning briefly to chair Nordic Aviation’s restructuring.

One of the most talented and smartest I’ve met in restructuring, he will be missed by us all.

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