Chris Haffenden

As expected, Jerome Powell was reappointed as Federal Reserve Chairman this week. His comments however were not – turning substantially more hawkish on inflation, with the FOMC minutes released on Wednesday reinforcing the change in mood. A faster taper and earlier and sharper moves in hiking rates is now likely. With bond yields set to rise as rates normalise, absolute yields for HY should also rise, but what about spreads? I correctly called the top for EHY in late summer, but with European single-B real yields turning negative in the last month, are you being paid enough for the risk? 


With European HY earnings season in full swing, this question was foremost on my mind this week, as I flicked through Q3 presentations. For many deals launched this year, based on full-baked marketed EBITDA numbers, we are already seeing disappointments and excuses from borrowers – as they underperform on their over-optimistic business plans – more on this later. 


LevFin supply in November was substantially below expectations, with lower issuance of riskier single-B names, supportive for spreads which stabilised in November, with 75% of deals BB-rated. We had forecast more refinancing activity, given the sheer number of deals trading at or close to call. Some are less likely given the back-up in the market, but conversely the pipeline of LBO deals is building. With Private Equity firms seeking ever bigger targets - witness the news flow around Telecom Italia and Marks & Spencer this week - the ability of the European LevFin market to take down €30bn plus deals will be sorely tested in coming months.  

The downside risk for sub-Investment grade spreads for listed companies from PE buyers is elevated, and should be priced in. This is especially true for Telecom’s firms - Dial LBO for Merger?

You may be familiar with the Hawk/Dove game theory, two players can choose between active and passive strategies. If both players go Hawk, they fight until one is injured and the other wins. If only one chooses Hawk, they defeat the Dove player. If both players are Dove, it’s a draw, and the shared payoff is lower than if a hawk defeats a dove. 

Up until recently, almost all central bankers were Dove/Dove, but on the other side of the pond this has changed. Even the most dovish Fed Governor Mary Daly is now talking about faster taper, and Jim Bullard has turned hawk, but as Wolf Richter says - you don’t brake by lifting off the accelerator. 

Earlier this week, Deutsche published their IG & HY strategy for 2022. While saying that 2021 was a ‘perfect calm’ and saw one of the lowest volatility years on record, this is unlikely to last and “spreads will sell-off at some point in H1 when markets reappraise how far behind the curve the Fed is.” They go on to say that they could see HY spreads widen by as much as 120-160bps before seeing spreads recovering most of the widening later in the year. 


On a real yield basis, single-B European HY deals posted negative yields for the first time ever last month, note Deutsche, at -0.3%, with BB yields which turned negative for the first time in May at an incredible -2%. Financial conditions are incredibly loose for credit they note, with the US lending standards the lowest on record. 

While this is supportive for spreads, lending standards normally lead defaults by around four quarters which suggests under this reasoning default rates will pick up by the end of 2022.


One of the peculiarities of the Standard Profil new HY bond issue at the end April was the lack of an accompanying RCF. During the Q2 conference call investors were told there were “running discussions” with relationship banks to secure one as a necessary cushion. But fast forward to yesterday’s conference call and there was still no RCF in place. 

Does it really take six-months to seal a deal for a super-senior RCF?

Management said on a two-hour conference call (with Q&A taking up over an hour), that they are still hoping to secure a €30m RCF by the end of this year. There are no ‘blocking points’ and they just need to find ‘the right partner.’ There were a couple of possible ‘suppliers’ with discussions continuing, which are ‘quite intensive’, and must be ‘brought to a conclusion’, they said. The cash position for the Germany-based car sealant business fell from €75m to €47.5m during the third quarter, leaving little room to manoeuvre if it has another poor quarter.


Earlier this week, 9fin’s Alex Manolopoulos produced an excellent preview of what to expect in the third quarter results release. Standard Profil had hoped for sales in Q3 to be flat on Q2 but had highlighted uncertainty on order flow amid semiconductor shortages which had severely impacted car production globally. Alex looked into the Q3 production stats of four of its largest customers:


We highlighted their orders are booked via Electronic Data Interchanges (EDIs). These can be revoked at very short notice, meaning that drops in OEM production numbers hit Profil’s orderbook with no lag. Management sought to address this head-on early in their call, referencing an analyst report received in recent days (any clues?). Their order book had dropped by a third in the quarter. 


We had also highlighted sharp rises on input costs which are difficult to pass on (with only 20% of contracts indexed), difficulties at its Mexico plant, and continued shortages in semiconductors. 

The earnings, posted at 8.45pm on Wednesday evening, showed quarterly EBITDA of just €2.7m – dropping 84.7% YoY – and leverage increased by 1.3x to 4.6x. Full year guidance for EBITDA is now €40-45m, and a “substantial” market recovery is not expected until H2 2022. The group’s €275m 6.250% SSNs dropped from around 83.5 to 80.6 (a YTW of 12%) recovering from lows of 78.5-mid. They are 79.5-mid at time of publication.

Boparan was more successful in shoring up liquidity, but it had to pay up, something that we as consumers are not yet doing for their Chickens. Their FY21 earnings release chirped about £50m of mirror notes to their 7.625% SSNs and a £10m TLB, with the public (not so public if you want to receive financial information) bonds rallying by around 4.5-points not being primed (we believed that there was £90m of super-senior capacity). The £75m minimum EBITDA covenant for the RCF has been relaxed to £50m for the next two quarters with a minimum liquidity covenant inserted. Today, the bonds have given most of yesterday’s gains and are quoted 80.375-mid (14.22% YTW)

Net cash proceeds from the extra funding will be ~£45m, disclosed management on an invitation only call. When asked by an investor 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. 

Net leverage at FY21 was 6.7x, based on reported net debt and cash EBITDA up from 5.4x as of Q3 21. Based on management comments, we assume FCF was negative £35m in Q1 22 with £35m of additional RCF drawings used to keep cash stable. 9fin’s Emmet McNally expects net leverage of 10.5x as of Q1 22 (12.5x if you use £45m of cash to pay down the RCF). 

As our earnings report outlines, “The most noteworthy points from earnings are predictably negative, priming risk aside, with the company having to secure a maintenance covenant relaxation from RCF lenders, £85m of additional funding being added to the capital stack and a sensitivity analysis raising serious concern over the going-concern status of the business.” 

Boparan is pushing through significant price increases to enable cost recovery, saying “we expect that these targeted increases will be seen by our customer bases in the context of a widespread reset of food prices in the market…” The days of a £3 supermarket chicken may be coming to an end. 

We’ve talked before about investors' willingness to see beyond the pandemic and take down new issues based on optimistic assumptions using fully baked-in cost savings, synergies, or even ignoring these completely and going back to the future by using 2019 numbers. 

This week two earnings releases for recent borrowers brought home to me the mispricing of risk, and whether they would be able to fully recover back to pre-pandemic levels. 

APCOA, the Germany-based Car Parking business tried to highlight the almost 100% recovery in its non-airport sites compared to 2019. The third quarter was better than management expectations, but as one analyst outlined in the Q&A if you annualised this figure, you only get to €72m of EBITDA, well shy of the €99.3m of marketed EBITDA outlined in bond materials. Management said there was around €8m of new business to add, and talked positively about EV charging points, Dark Kitchens and Amazon lockers to boost future EBITDA. But with its airport’s car parks unlikely to see full recovery until at least 2024, and healthcare facilities still suffering from restrictions, they admitted that run-rate EBITDA for 2022 was more likely to be in the mid-70’s. 

Actual FY21 EBITDA is likely to be €35-40m (including €12m of German state aid). This means that leverage is going to be around 15x by year-end, and likely to have a seven-handle at best for 2022. There is also €847m of leases in the debt structure. The bonds priced at 4.625% in July, and currently yield 4.85%. The storey doesn’t inspire me. Not an attractive level to park your money.

Like APCOA, Elior was previously seen as low risk with high predictability of revenues (almost infrastructure like), strong renewal rates, albeit with very low margins. The France-based catering facilities provider says activity will not return to 2019 levels until 2024. It’s restaurants in offices, hospitals, schools, local government were hard hit by the pandemic – but investors saw through when it issued €550m of 3.75% bonds in early July, marketing off €298m of pre-IFRS16 EBITDA from FY19 giving a leverage of 2.7x (or 9.5x based of FY20 numbers). 

FY21 cash flow is minimal at €13m and reported EBITDA just €100m, with net debt of €1.1bn. It is suffering from cost inflation pressures and is trying to pass these on, but over 40% of contracts are on an annual basis, and in a traditionally low-margin business, failure to do impacts the bottom line. Add in uncertainty with regards to hybrid working and changing patterns of work, it may never get back to 2019 levels. The bonds are yielding 3% (yes, really), I have no appetite to dine at these levels. 

Last weekend, we saw a lot of subscriber enquiry over the docs for Telecom Italia, after news emerged that KKR was preparing a bid, for the operator which has had a chequered history and has burnt the fingers of many a vain entrepreneur. In his excellent piece for Reuters Rob Cox says that it is “the Investment equivalent of Afghanistan.”

But why is Private Equity suddenly so interested in Telecoms? Why the huge consolidation across Europe by companies such as Altice, Iliad and United Group? One argument is that bond investors appear to be more positive on valuation and are willing to provide debt financing with lower equity cushions, with deal multiples low in comparison to other sectors at around 6-7x, meaning that any multiple expansion (or deleveraging will give a nice return to sponsors). 

Telecom Italia bonds saw a lot of price volatility this week, as investors worried about a lack of documentary protection as most of the debt was issued whilst investment grade. Many don’t have change of control puts, some negative pledge language might require granting pari passu security to the MTNs if secured bonds are put in place. 

Most holders are worried about a repeat of Iliad’s layering of debt on top of existing holdings. Telecom Italia CDS traded on a negative basis this week, and their bonds traded wider to Iliad Opco, but tighter than the Holdco, according to one fund manager. As one FinTweeter said “What worries the bond market is an aggressive re-leveraging and a split between fiber/commercial activities that would harm the business profile.”

Some hope that the Government’s golden share and Vivendi’s opposition will temper an aggressive move. The big question here at 9fin Towers is can the HY market finance €30bn plus deals?

Raffinerie Heide has chosen Credit Suisse as its bookrunner for the long-awaited refinancing of its November 2022 bonds. The format of the refinancing is yet to be decided, as reported. Management of the German-based single asset refinery batted away questions regarding the contribution of the Danish refinery assets (acquired by the owner Klesch) into the restricted group. One analyst also questioned whether long-term shareholder Klesch would be making any equity contribution to reduce leverage, which remains elevated at 6.6x, but again the response was coy, with management saying: “all options remain on the table”, and that they are “in constant contact” with the owner.

The continued recovery in cargo volumes and strategic acquisition of Pinnacle Logistics helped Worldwide Flight Services (WFS) beat pre-pandemic revenues in the third quarter. The cargo handling provider survived the pandemic through the extensive use of the US CARES payroll, which provided €83.3m in the first half of the year, but support ended in Q3. WFS used the remaining €22.7m of Payroll Support Program (PSP) grants in the latest quarter, leaving the company to fend for itself at a time when labour cost inflation is on the rise and regions begin to re-enter lockdowns.

Leverage is around 5.9x on an LTM basis, its August 2023 bonds are now yielding above 7%, after dipping to 5.25% in mid-September, has it missed its refinancing opportunity window?

Hurtigruten released its Q3 earnings call and said that operations are coming back to normal, with operational cash flow turning positive during the quarter. Despite recently pulling a €50m equivalent NOK bond (as the terms offered were unsatisfactory) it says that liquidity is strong, supported by €75m shareholder loan in September, of which €55m was undrawn at the end of Q3. It says that pre-booking levels are at all-time highs and are ‘almost sold-out” for Q122.

Revisiting last week’s workout themes of Sovereign debt

Turkey votes for FX Mess: The Lira collapsed 15.5% on Tuesday, after Erdagon declared “an economic war of independence.” Less independent was accepting $10bn of investments from former arch enemy the UAE, but it did see the Mediterranean Peso recoup half of its previous day losses.


Ecuador used to have a President who was known to his friends as El Loco – the crazy one. Going loco down in Quito is the central bank’s plan to issue volcano bonds to “accelerate hyperbitcoinization and bring about a new financial system on top of Bitcoin,” according to its partner Blockstream. The plan is to issue $1bn of 10-year bonds paying 6.5% interest – with half the proceeds into ‘infrastructure build’ and the remainder in Bitcoin (held for 5-years, then sold down) returning 50% of the crypto profits to investors. 


But as Matt Levine points out, existing sovereign debt trades at 75c in the dollar – you could buy these and invest the remaining 25c in Bitcoin, which would give you better return characteristics. But that isn’t the point – “they live on a crypto trading platform and people who like crypto will buy them and trade them with each other and feel a sense of kinship and community and fun. They are HODLers and whales, they get to hang out with the president of a country on a Saturday night, all this stuff. The specific terms of the financial investment don’t matter.”

DLA Piper has published an excellent primer on the new UK legislation to deal with Covid-19 rental arrears. This includes a novel arbitration process for landlords and tenants. 

JPM warms that S&P500 fair value is 2500 if inflation shocks continue

Howard Marks Memos are always thought provoking – his latest is very big picture 

And finally, for our US friends - it is not only the price of Chicken which is going up - Thanksgiving is 15% more expensive than a decade ago.


Friday Workout - Hawk/Dove; Club deal for Seals; Dial LBO for Merger

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