As we await the public release of Fifty Sheets of Gray, financial markets are skittish amid concerns of war in the Ukraine with a rout in tech stocks with terminal values blown up by rising long-term rates. JPow for once failed to soothe the market – in fact the exact opposite, more of a KaPow. Now that the Fed put has expired, many buy-the-dippers are badly out-of-the-money. It left us at 9fin to think in the rare quieter moments this week if at some point this will invade and preoccupy LevFin (Owen Sanderson’s Excess Spread muses on loan vehicle issuance) and boom, could this be the end of the party?

But we were particularly time poor this week amid the rapid fire of primary issuance. 

This may not be reflective of a healthy market; it could be a rush to evacuate before the real hostilities begin. The most interesting aspect is that many recent deals are from US borrowers with big Euro tranche components. Deal sizes are escalating as several large LBOs cross the border. Market participants not only point to a healthier European leveraged loan market but also to favourable cross-currency swaps for borrowers. 

Most clearly evidenced in one Euro tranche upsize – a freebie headline for my LevFin colleagues - Wella, Wella, Wella, sell me more

While loan tranches are upsized, bonds failing to tighten at price talk despite decent new issue premia. Some is down to a preference for floating rate – witness Renta flipping its fixed to FRN – but absolute rates are diverging too. Interest rate expectations in US and Europe are wildly different, with some commentators talking about five hikes in the US this year, while Christine Lagarde continues to guide for none in the Eurozone, with markets pricing in just a 0.2% move in 2022. 

But it is worth remembering that less than six-months ago, economists were thinking of just 1-2 hikes in the US, starting in June 2022. Powell’s rhetoric has since changed dramatically as he shapeshifted from dove to hawk. Admittedly, European dynamics are different, most notably wage growth, which is more subdued than the US, but it is a reminder that the consensus changes quickly. 

In the meantime, currency 101 suggests that flows move to higher yielding currencies, meaning as Deutsche points out in a currency briefing that the USD is on track to break 1.10 and “potentially significantly so.” This would result in Europe importing inflation via a weak euro and pressure on policymakers to raise rates. 

While risk spreads haven’t yet moved markedly, as Deutsche points out this cycle is different, the Fed is behind not ahead of the curve and to bring down inflation, growth needs to weaken “and potentially significantly so because the supply side is so weak.” Whisper it, but Stagflation could be coming. 

Covis variant

Looking at some of these transatlantic deals, it is clear where some of the innovation, racy structures, and aggressive EBITDA adjustments that arrived in Europe in recent months are coming from. None more so than the bonds and loans deal for Apollo-sponsored Covis Pharma launched last week to refinance existing debt and fund the $270m acquisition of AstraZeneca Products. 

Covis uses an asset-lite business model for buying and rolling-up pharma IP. Specialising in respiratory and hospital critical care it acquired or in-licensed over 32 products via 18 transactions since 2011. It boasts impressive 51.6% adjusted EBITDA margins and cash conversion of close to 100%, near best in class. According to the bond OM, the growth spurt is set to continue, having evaluated 94 potential deals since the sponsor acquired it in March 2020 (from Cerberus for a reported $700m) with 38 (~$30bn Total Enterprise Value) closely monitored and three (~$1bn TEV) in the near-term pipeline. IS

Leverage is marketed at a lowly 4.5x (more on this later) with strong projected free cashflow given low capex spending projections. Before you rush to submit your order for this roll-up pharma ten bagger, entering the top10 after the latest deal, there are a few risk factors to consider. 

Sales of its largest product, Feraheme (30% of Sep21 revenues) an iron deficiency anemia drug have suffered badly from a generic version from Sandoz launched last July, which has already taken 33% of Fereheme’s market share, with Covis dropping its price by 33% to compete. 

The FDA has proposed to withdraw the premature-birth drug Makena (15% of revs) after findings that it was not effective in a post approval study. The company argues patient samples are very different from its target demographic – and Covis continues to spend significant funds fighting it, and funding other studies. That is not all, according to our ESG QuickTake, 49% of their drugs are administered via an inhaler – these contain greenhouse gases which lead to global warming and could be subject to future restrictions on their usage.

With three drugs generating around two-thirds of revenues facing challenges, and major patent expiries in the next 2-5 years, investors will be keen to benefit from the product pipeline to drive future growth. But bondholders have protections from just five material patents under the J Crew blocker (the three current largest, plus Duaklir and Eklira). Another drug, ciraparantag, about to come to market, will sit outside the restricted group and will not form part of the collateral package. 

Arguably, the lack of investor protection in the bond docs is the biggest worry. Any transmission to other deals could mean that Covis is a variant of concern. Tracking their changes to assess their severity our 9fin legal analysts pointed out in their TLDR:

“Significant scope for value leakage, including via a clause for uncapped permitted investments so long as the Total Net Leverage does not deteriorate pro forma. While there is a “J.Crew” blocker limiting transfers of Material Patents to Unrestricted Subsidiaries, this blocker is materially limited. Any permitted debt can be secured on assets that do not secure the Notes. Significant pro forma EBITDA adjustments. Novel drafting in the Credit Facilities basket could permit more debt capacity than investors expect. Allows automatic release of Collateral if transferred away from the Issuer / Sub. Guarantors in a transaction not prohibited by the Asset Sales covenant.”

In a distressed scenario holders could lose their collateral via an asset transfer to a newly formed non-wholly owned Restricted Subsidiary or a Restricted Subsidiary in a non-Security Jurisdiction. This could allow the Sponsors to raise effectively senior priming debt against assets previously within the bond security package.

It is worth noting that Apollo has shown in the past that it is prepared to use documents and what might be perceived by some as aggressive tactics to protect its investments and keep its bondholders at arm’s length. Most notably with Caesars Entertainment, whose situation produced one of my favourite headlines - Caesars Suing Apollo to Stop Creditors From Suing Apollo.

Investors may point to a decent SIP (sponsor issue premium) that these risks are priced in. IPTs for the dollar SSNs are at 7.5% with euros at 7%, a 200bps pick-up to best EHY comp Advanz Pharma, optically slightly higher levered (4.9x) who priced a SSN tap last week at 5%. 

But Advanz is much cleaner in terms of EBITDA adjustments and potential addbacks. Covis has no percentage limit for adjustments within a wide scope of definitions within 24-months. Reported LTM EBITDA more than triples to $262.2m on a pro forma adjusted basis. 

This is due to the numbers being adjusted by:

$94.2m of AMAG post-acquisition costs, Makena lobbying and legal costs; $70.5m of acquired EBITDA from the AZ product acquisition; an Alvesco normalised Covid adjustment of $19.6m; AMAG annualised cost savings of $11.6m; a $62.2m deduction for the loss of Feraheme’s market share – I’m scratching my head at that one as to why it is deemed one-off and exceptional.

In the interests of balance, there were plenty of other aggressive docs in deals this week:

athenahealth introduces the concept of no deterioration into their docs for RP and portability.  Can have 2x RP capacity for first lien and investments with an unusual qualifying IPO call provision – seen before in Medline, a low docs watermark at its time of issue. 

Ion Analytics just fails to beat Inspired Entertainments record (five) using four EBITDA adjustment metrics, which gets you from PF combined EBITDA (before FX and other gains) of $238.2m to $378.3m (PF combined Adjusted EBITDA with combination synergies including Backstop). Their addbacks are uncapped, subject to no time limit and similar to another Ion Group portfolio company Cedarici can still benefit from addback capacity in poor years for capital markets, as there is the ability in the docs to adjust for average capital markets volumes. Lots more in our legal QT.

Our new cap table feature (released this week) captures this perfectly. I’ve redacted the extensive footnotes, so please ask for the original version if you want the full picture by emailing team@9fin.com.  

Pain in Spain falls mainly on the (junior) claims

WiZink PIKs were the main story in European distressed last week, falling into the 50s from the low 80s as its restructuring plan was announced. On Monday, bondholder advisors Houlihan Lokey and Milbank arranged a call to go through the legal issues (any questions had to be submitted in advance). 

The Spain-based provider of revolving consumer credit was severely affected by changes in regulation following a ruling from the Spanish Supreme Court on March 4, 2020, which claimed that WiZink’s interest rates (26.82%) on its revolving credit cards were excessive.

The ruling resulted in a significant number of usury claims brought by WiZink customers. With total provisions increased by a further €85.2m in September to €191.4m. Further provisions will be announced in the fourth quarter, hence the need for further capital, amid concerns that this would mean a breach in the 13.8% total capital ratio requirement. 

As we revealed earlier this week, Beach Point and Marathon holding over 50% of the Mulhacen Holdco PIK entered into talks in late November with the Bank of Spain. The regulator had insisted on a capital injection to avoid a breach of the 13.8% total capital ratio requirement being committed by early January.  

The deal caught many PIK note holders by surprise, presented as a fait accompli. The sponsor and the two funds (backstopping 50% of the new money requirement) will drive their returns via the provision of new money with Varde retaining majority control in return for its €140m contribution.

Non-participating PIK holders, however, are effectively being wiped out, receiving just a token amount of equity which has limited day one value with their existing claims extinguished. Their only options to protect their investment and unlock future value is by doubling down and participating in the new first lien or by hitting the bid in the secondary market (low 50s). The price may reflect the perceived value of buying in to participate in the new first lien. 

To implement the deal via a consent solicitation, 90% of holders must vote in favour. The ability of dissenting PIK note holders to block the transaction could be limited by certain doc provisions (will withhold the details – but pls get in touch if you are involved). If the deal fails to go through, there is a risk that the Bank of Spain could decide to use bail-in measures as seen in Banco Popular in 2017.

Our Restructuring QT will be published early next week for those seeking more detail.

There is less risk of becoming an outcast in Haya Real Estate debt. 

Regular readers will know that the Spanish real estate servicer was hoping to refinance by end 2021 but was hampered by a slow recovery in NPL portfolio sales and delays in a key Sareb tender which it believes is in pole position to win. In Q4 2021 bondholders appointed PJT Partners and Latham & Watkins to advise on their options, with Houlihan Lokey and Linklaters company side. According to 9fin’s holdings data, Alcentra, Blackstone, Invesco and Tikehau are the largest holders. 

The role of owner Cerberus in driving business into the group is critical to Haya’s future. It is one of the largest players in a declining Spanish NPL market and it is in its gift to push business through Haya to maintain asset servicing levels. 

In addition, there is a potential negative equity position to address, with a shareholder loan of around €90m owed by Cerberus to Haya. If this is written off, this would create a negative equity position, explained one distressed analyst. If there were a debt for equity swap, it would increase the equity capital and have a larger cushion to absorb the write-off of the asset at Haya and avoid negative equity, he explained. 

Indeed, a debt for equity swap was being pitched by the bondholders who were pushing Cerberus hard to support this business, according to local media reports. So it was to our surprise that Cinco Dias reported that a three-year A&E had been agreed with a jump in bond coupon from 5.25% to 7%, with Cerberus retaining control, and convincing that the holders that the debt burden is sustainable with just a small equity stake and/or warrants on offer.

Haya has issued a holding statement this morning confirming the agreement in principle, the notes extension and the transfer of a minority stake in the Company’s equity. It adds that “such agreement remains subject to the execution of a binding lock-up agreement. The Company will update the market with regards to the final terms once agreed.”

Perhaps Cerberus has cured the negative equity issue, or perhaps a Lowen Play type solution has been agreed where the debt is bifurcated, and/or some is moved upstairs to a HoldCo? 

Based on current EBITDA of just over €40m, increased interest costs look sustainable. We will look deeper into the details when available. The bonds are up 1.5-points to 81-82.50 this morning, which suggests some doubts on future value.

Oaktree’s land grab

Oaktree is one of the oldest and one of the smartest distressed investors. They took on the sponsor and most of the distressed community in Caesar’s Entertainment in 2016. This was despite having one of the worst hands to play – at an infamous 23 September 2016 meeting when creditors across the debt stack were asked to pony up $130m to get a restructuring deal over the line – Oaktree refused to match their raise. 

“Oaktree is here to drink the blood of Apollo” one person in the room recalled thinking at the time, according to Sujeet Indap and Max Frumes in their book The Caesars Palace Coup: How a Billionaire Brawl Over the Famous Casino Exposed the Power and Greed of Wall Street.

“We had to claw our way to victory. We’ve driven this case to its conclusion, and you are not spending our recovery,” [Oaktree’s Kaj] Vazales said. He was a mild-mannered fellow far less prone to theatrical outbursts than his colleague Liang, yet he remained militant. Unlike Millstein, the teams from Oaktree and Appaloosa believed there were higher stakes at play. Private equity firms, they believed—best exemplified by Apollo—had become far too abusive of creditors, wielding legal documents and hardball negotiating tactics as swords to take value from loan and bondholders that simply did not belong to them. To Oaktree and Appaloosa, nothing less than the sanctity of the US capital markets was at stake in this room.”

Roll onto January 2022, and Oaktree may not be only putting itself at odds again with most of the distressed community but possibly the Chinese government too after storming Evergrande’s castle. This week, it appointed a receiver over ‘Project Castle’ a 2.2m sq ft Hong Kong New Territories project – which Evergrande had originally planned to turn into a Versailles-inspired building – but had been trying without success to sell the land for months in a fire sale with a $1bn sticker price.  

This has caught other distressed investors who had piled into the offshore bond debt in the teens and twenties in recent months off-guard. They were recently asked by Evergrande not to enforce and wait six-months while it prepared a restructuring plan.

According to the FT, Project Castle was expected to form a significant part of the proposed deal for the offshore bonds. If a Hong Kong court accepts the application, it could be back to the drawing board. Evergrande debt is trading in the high teens, with the offshore arm Scenery Journey at 11-13.

A week ago, it all seemed rosier for those piling into Chinese Property at rock bottom prices. Reuters had revealed that China was going to make it easier for developers to access escrow accounts to address cash shortages. Developer prices rose 7-10 points on the news, but have come back in recent days, with Deloitte’s appointment at Shimao causing nervousness. 

What we are reading this week

Do you want chips with that? Tesla is finally making profits from car making but is now facing semi-conductor shortages which will affect 2022 deliveries. 

Or should that be freedom fries? France’s largest semiconductor company worried about a Chinese takeover got blindsided and ended up being nationalised.

Elon Musk appeared on Tesla’s earnings call, but investors hoping for cool new EV vehicles (remember the Semi, the cybertruck) were disappointed – he now wants to make robots. But at least he is devoting his energies for the greater good of mankind, such as trying to get McDonalds to accept dogecoin.

But his joke tweet backfired when McDonalds said they would accept dog crypto if Tesla started to accept grimacecoin (a McMade Up currency). Within 24-hours 10 Grimacecoins appeared on the Binance platform. 

The spactacular rise of Tesla, caused a frenzy of investment looking for the next EV winner. But many were a sham, or at best they were economical with the truth with their claims. The Nikola truck video rolling down the hill is infamous. But as this excellent article outlines Nathan Anderson despite exposing it as a fraud Hindenburg Research has struggled to make money in the frothy markets of 2021.

Gravity has been restored of late with many meme stocks and IPOs coming back to earth, often at terminal velocity. Ranan Royand Can Duruk have posted an excellent piece on Robinhood, early access to IPOs and the democratisation of finance. 

I don’t understand and am not into Crypto. Adam Tooze, who is much smarter than me, has a similar view. His post on Crypto and the politics of money is excellent: 

I don’t like to talk about crypto because I regard it first and foremost not so much as a technical or commercial proposition but as a conservative/libertarian effort to escape the shadow of the political order of money that has half-emerged from the collapse of Bretton Woods. 

To paraphrase Gramsci, crypto is the morbid symptom of an interregnum, an interregnum in which the gold standard is dead but a fully political money that dares to speak its name has not yet been born. Crypto is the libertarian spawn of neoliberalism’s ultimately doomed effort to depoliticize money.

Getting Brexit done - I received this from Jack Wolfskin (my order of trail socks):

“While we are now able to ship orders again, there are unfortunately problems with British customs, the solution to which is beyond our control. Unfortunately, we have not yet received any information as to when these will be resolved, otherwise we would of course pass it on to you. We can only tell you that lots of our goods have been there for 2 weeks and more and have not yet been cleared.”