As a restructuring journalist, I am naturally inclined to see a glass as half full, always on the lookout for the next existential threat to trigger another wave of distress. Of late I’ve flagged Evergrande and Chinese Property, rises in bond yields and bear curve flattening as warning signs. Forget about Black Swans, there are plenty of Gray Rhinos out there, waiting to charge. This doesn’t mean that I’m a perma-bear, but I’m constantly seeking to identify causality, risks and if they are appropriately priced.

I once was described as an undertaker by an investor. I was far too enthusiastic about finding the next victim to bury, he said. I might write about the distress, I responded, but I’m not a financial Sweeny Todd - or more aptly for today - a Guy Fawkes seeking to blow up the High Yield Market. 

Sometimes the triggers for a crash are obvious in hindsight, such as the not-so hidden excessive leverage and the linkages between markets with Subprime and Leveraged Finance in 2007. Or it could be a random event as experienced by Sherman McCoy in the Bonfire of the Vanities, who after taking a wrong turn from the airport into an unfamiliar area sees a series of calamitous events ensue. 

I’m impressed by the ability of markets, especially those in late bull cycles to shrug off news – witness the reaction of stocks making fresh highs after the Fed finally announced a taper this week. Despite the time of year, there are no fireworks here. 

The dichotomy between stocks - trading to meme- and the nervousness of bonds remains interesting, however. For now, Tesla-nomics remains dominant, with little impact yet seen on risk assets. For those who don’t see excess leverage – look at the amount of call options outstanding on TSLA and how much leverage is available in crypto for retail investors. 

Other top of the market indicators are the willingness of the HY market to finance projects which have little or no cash nor hard asset backing. As we outlined in Skillz, thrillz and spillz - could meme credits become a thing? “Given most high yield investors are too old to use Roblox’s core product, it’s fair to say the company and its bankers at Morgan Stanley had a good amount of explaining to do when pitching its inaugural bond. The children’s video game platform—which makes most of its revenue by selling a virtual currency kids can spend in virtual worlds—raised $1bn of real, actual cash through new senior notes due 2030.”

While I see plenty of parallels in 2021 with events leading up to the internet crash of 2001, there is a nagging doubt in the back of my mind, what if this time it really is different?

Could there be a new paradigm? Have we fundamentally changed our assessment on how companies are valued and financed, and therefore my instincts are now completely wrong? 

By removing all the default triggers, with a seemingly endless amount of dry powder, rising deal multiples and big equity cushions, has the beast of distress been slain for good? Has the HY market matured into an asset class where deals are better structured and are more resilient?

If so, I may need to find another speciality interest. 

So, in the interests of balance (always good for a journalist) and to hedge myself against the lack of a crash in a year’s time, let’s look at the case for continued risk-on. 

I’m helped in this by BNP Paribas’ November credit market outlook. Their executive summary states:

“Multi-decade tight credit spreads and the cyclical sweet spot increasingly behind us, make for a challenging investment backdrop, but credit has robust shock absorbers: Central Bank credit conditions are too easy, corporate liquidity too high and market positioning too short for there to be much credit volatility. Carry will drive performance for the rest of the year and volatility will remain low. European High Yield is attractive, and Leveraged Loans (US, Europe) offers attractive carry.”

Credit conditions will remain easy for some time (at least into 2023) and there is too much liquidity (from corporates and sponsors) which means low default risk, says BNP.  This chimes with many analysts, some which see default rates as low as 1.5% in 2022, a remarkable turnaround given where expectations were a year ago, with some seeing double digits. 

The recent cheapening-up of EHY and lev loan prices in secondary, underperforming other assets, makes them more attractive, suggests BNP. Lower leverage, higher interest coverage and higher than usual cash buffers means that credit still offers good risk-adjusted carry. In leveraged loans the CLO arbitrage is probably the best in a long while, which should drive demand, especially after a 75-100bps backup in margins from the tights of this spring. 

At this point, you might point to the supply side, the record amount of M&A related paper sitting on LevFin leads such as BNP Paribas’ books. Surely, they are motivated to paint a rosy picture, in order to shift product?

History and time will tell. The longer the default cycle extends, the less prepared the market will be for when it turns. Many analysts have not experienced a prolonged market downturn, and if the trend of looser docs remains, with prices near historical tights, the balance of risk/reward is clearly not in their favour. It may appear counter cyclical, but here at 9fin we are getting ready for the next wave and actively building out our distressed capabilities. 

Gamblers Synonymous

The gaming sector was badly affected by Covid-19, and with the rise of ESG concerns, it is now on many investors’ exclusion lists. Governments are placing more stringent regulations as the social impacts of gambling become clearer, but at the same time many rely heavily on gaming taxes. It is not yet clear whether these businesses can recover to their pre-pandemic levels. 

The Gaming sector has had more than its fair share of restructuring candidates in recent years, with Intralot and Codere both undergoing processes this year. 

This week, another one was added to the list, with Reorg Research reporting that Lowen Play bondholders had appointed PJT Partners and Kirkland & Ellis, after refinancing plans were seen as floundering. 9fin readers would be aware that we were bearish on their prospects as early as this February citing regulatory uncertainty, longer than expected Covid headwinds and low industry multiples elevating refinancing risk. 

So, it was more than a little surprising for us at 9fin Towers to see a dividend recap deal for an Italian gaming company emerge this week, with a HoldCo PIK toggle to boot. Owen Sanderson sums it up well:

The €400m Senior Secured PIK toggle from Lottomatica will pay a €375m dividend to sponsor Apollo, and priced at a lofty 8.125% cash (+75bps PIK), which optically offers a decent spread to the senior bonds given the indicated 3.2x net leverage through the HoldCo PIK.

But as we outline in our Credit and Legal QuickTakes, the adjusted Pro Forma Run-Rate EBITDA has a huge €236.4m Covid-19 add back (53%, this beats Coty’s record) for the estimated contribution to revenues, which assume that Covid-19 had not occurred. The heavily adjusted EBITDA allows the Issuer to market the deal with 3.6x net leverage and 3.2x net secured leverage figures. Our legals team have cautioned that although there is no explicit Covid-19 language in the definitions, the issuer might be able to use this adjusted metric for covenant calculations, and this should be queried by investors. 

But in the current market, investors appear to believe that 8 is a lucky number. 

“At 8% it's 100bp compensation per [rating] notch versus senior. Seems fair. PIK is always wider. Last similar issue happens with BGRKNG and the PIK performed better than the senior,” said one investor on LevFin twitter.

And there is always the less sophisticated buyer – as quoted by Eleanor Duncan in her piece at LPC: 

"I love PIKs," said a second high-yield investor. "If the company goes [bust], it goes [bust] - so why wouldn't you get the most aggressive note and highest yield you can?"

Still, there were some nerves among the buyside about the use of proceeds, the LPC piece continued:

"I really like the business, but Apollo always gives me a bit of a scare because they're so aggressive," said the second investor. "Plus, that leverage number has more adjustments than a sellside bonus."

From editing our Credit QuickTake there appears to be a lot of business similarities between Lottomatica and Lowen Play. Admittedly, I have less understanding and visibility on the Italian market and its regulatory issues, but Codere’s recent troubles could prove that Gamblers are Synonymous. 

Selected 9fin content

Earlier this week, as promised we released our updated French Insolvency Primer – which details how the new law which came into effect on 1 October shifts the balance from debtors towards creditors. Almost all the wish list is there, such as absolute priority, creditor classes, cross-class cramdown and protections of DIP financing. But being France, it was probably a stretch to expect that employee rights and entitlements could be compromised, and that the role of the courts would be diminished. We are preparing a podcast comparing this to the UK Restructuring Plan – watch this space.

Iceland in its Q3 earnings report, lamented HGV driver shortages and cost inflationary pressures that persist, with the expectation these challenges will continue in 2022. But the UK frozen food retailer is betting that Boris can save Christmas this year.

As 9fin’s Ben Hoskin brilliantly summarises: “The frozen food product range is viewed by management as a competitive advantage into Christmas given the lack of supply availability elsewhere in the industry. Indeed, the company has already seen some tangible evidence of this, with turkey sales up over 400% of 2020 levels to date - the British public possibly actioning some PTSD from the recent forecourt mayhem.” Their bonds rallied on the news by over a point, to yield around 6.5%. 

After a poor first half, French seismic group CCG had a strong quarter. But despite strong oil prices and positive noises, E&P companies are still holding back on capex spending for new projects. With the energy transition well flagged, the company is looking for alternative uses for its multi-client seismic library that supports lower carbon intense activities. This includes Geothermal projects, mine waste management - monitoring tailings storage facilities, and data digitalisation.

In brief

Chapeau (or should that be homburg) to our colleagues at Bloomberg for two great scoops on the Adler complex. 

Jack Sidders reveals that Oaktree, and several distressed funds were in talks with Aggregate Holdings to provide funding at rates of around 15%. Vonovia in a recent update has said that it has provided €250m of loans secured by Aggregate’s 26.6% stake in Adler which are due in April 2023. This is €30m more than a margin loan, which it repays. The maturity mirrors the expiry date of an 18-month call option for Vonovia to acquire a 13% stake in Adler Group at €14 per share. Watch out for an Aggregate Stressed QuickTake in the coming days. Clients will be notified when they can access the report on 9fin. If you are not a client but would like a copy, please complete your details here to request the report.

In a second article, Jack Sidders outlines valuation concerns from previous valuers and delays in the construction of a number of development projects at Adler, with angry buyers frustrated at the lack of progress. It cites a number of projects such as Bundesalle in Berlin and UpperNord Quarter in Dusseldorf as evidence of the lack of progress. 

El Confidential has reported that Celsa is set to default on an €120m interest payment due later this month, as it continues to await news on its application for a €550m convertible loan from SEPI. The Spanish government fund for strategic industries has been slow in approving applications from Spanish corporations, with an initial application made by the Spanish Steel company a year ago. Celsa has been locked in talks (with some litigation too) with creditors since 2019. 

There was more positive news for another Spanish corporate, with Naviera Armas announcing that the Commercial Court of Las Palmas de Gran Canaria had issued a court order sanctioning their Master Restructuring Agreement on 27 October. It said: “The entirety of the MRA is now effective and binding on all the parties thereto as at 29 October 2021 which was the Entry Into Force Date and the date when the Court Order was received by the Homologation Group.” A Restructuring QuickTake for Naviera is available to clients here. If you are not a client but would like a copy, please complete your details here.

What we are reading this week

Last week we marvelled at Tesla-nomics, how a $4bn order could result in a $100bn increase in valuation. It is also asymmetric, when Elon denied that Hertz had signed a deal, the stock price barely moved. John Authers at Bloomberg notes that Elon Musk is worth 3x as much as Warren Buffett, some fun with valuations. Berkshire produces the highest EBITDA of any US company, 20x that of Tesla. But Tesla is worth two Berkshires.

While Meme stock investors have fun with car rental companies, cinemas and Squid coins, some of the former tech darlings have come crashing down to earth, most notably Zillow, which discovered that its traders and algos were not as hot as it thought. 

Proof that the Financial Times is not a stuffy paper of record - it does have a healthy sense of humour - it’s 404 page is genius

Belated Halloween bonus content from Bond Vigilantes with some truly scary charts

Co-ooPs26 proof that US journalists are not as smart?

While Crypto surges on hopes that it will become more adopted by institutions, the US Treasury is making a lot of noise on the regulation of stablecoins

And finally, we are fondue of this form of finance - parmigiana capital

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