Friday Workout - Windows of opportunity; Keeping violence off our screens

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Friday Workout - Windows of opportunity; Keeping violence off our screens

Chris Haffenden's avatar
  1. Chris Haffenden
13 min read

Early this week the issuance window for European LevFin finally reopened, after being stuck shut for 6-7 weeks. Several euro-denominated tranches for predominantly dollar-denominated Lev Loan deals launched and Veonet re-emerged, pulled earlier in the year. With European HY OAS breaking back through the 400bps barrier, I even bet one of my team a tenner that Morrisons (by this point a more mythical beast than a unicorn) would launch before Easter.

At this point, I was doubting myself. As a perma-bear, I’m expecting a return to the 1970s and stagflation, and therefore risk assets and specifically LevFin should struggle. But while my prevailing view last year was very contrarian, of late I felt it was now the consensus standpoint.

As Mark Twain said: “Whenever you find yourself on the side of the majority, it is time to reform (or pause and reflect).” I asked myself, could there be a contrarian view to the prevailing gloom?

So, travelling to 9fin Towers in the comfort of an Uber boat on Tuesday, I took a closer look at some charts and contrary research. Government bonds did indeed look oversold on technicals and while looking horrible on fundamentals — was another nasty squeeze around the corner?

With a ban on Russian gas purchases now appearing less likely, releases from strategic oil reserves and a China lockdown reducing demand, could oil and energy prices collapse from here, rather than hit $150/bbl?

And with talk the US has agreed to the immediate lifting of sanctions if a Russia/Ukraine peace agreement was reached, rising commodities, supply chain issues and the direct Russia effects could dissipate much quicker than predicted.

But just as I was about to waver, my bear case doubts were assuaged by hawkish comments from Fed Governor Brainard (a perceived dove and soon to be vice chair) on Tuesday evening.

The Fed would “continue tightening policy methodically” and reduce the balance sheet “at a rapid pace as soon as our May meeting.” She added the balance sheet would “shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017-19.”

As one of my smart colleagues (taking a cue from Upfield’s Upfielders, we will now be collectively known as 9finest) remarked when I got to the office, she wouldn’t be going off the cuff unless the FOMC minutes were in a similar hawkish vein, which they were when released that evening.

Not surprisingly, sovereign bond yields hit fresh highs on both sides of the Atlantic. US 10yr Treasuries closed at 2.598%, the highest level since 2019, after hitting 2.656% intraday. European sovereign bond yields also soared. 10yr German breakeven hit 2.81%, its highest since the data was first collected in 2009, Italian 10yr breakeven hit 2.63%, the highest since 2008.

Surely, these market moves are enough to shut the window once more

I had thought so on Wednesday morning, but on Thursday, we saw two European leveraged loan launches for Clingen and Cupa Group, the first deals since valentine’s day.

Financing details also emerged for the William Hill acquisition by 888 (likely in early May) with Unilever Tea and TDC widely expected (we are told they are in pre-marketing). Luke Millar, my colleague at Fitch, has flagged a number of HY deals after the break including Miller Homes and Biofarma (the HoldCo PIK junior piece was privately placed this week with Tikehau and GSAM).

So why the rush to push out deals?

As my colleague Owen Sanderson mentions in this week’s Excess Spread “leveraged loan prices have mostly been moving faster than CLO liability pricing, creating an attractive opportunity early on for managers that had locked in capital, and more recently, squeezing the CLO arb, as leveraged loan pricing has bounced back faster than CLO liability spreads.”

He adds “with a healthy number of new issues ramping hard and no new loan supply, there’s a technical bid pushing loan prices back up.”

Owen says the focus remains clearing the current crop of warehouses, but new facilities are being opened, “on the expectation that there will be a worthwhile market in six to 12 months.”

After a decent recovery in the past 2-3 weeks, EHY pricing is now looking tight, prompting leads to recommend to borrowers to push the button and take advantage of recent spread compression. We would caution not to get too aggressive or flood the market too soon — the first deals must be seen to be a success and leave something on the table — the window may not be open for long.

Keeping US creditor violence off our screens

In restructuring processes and deal documentation the worst excesses are often seen in the US. But as the recent EHY covenant trends and observations piece from 9fin’s legal team outlines it is important for European investors to keep abreast of developments across the pond.

Creditor on Creditor violence in the US is becoming increasingly common, and while the latitude under the docs can be similar, what has been missing to date in Europe is the willingness for stakeholders to do so and take on the associated reputational risks.

But we shouldn’t be complacent, events at Intralot last year show that it is not entirely limited to the US. Lawyers and advisors tell us that similar conversations have occurred with sponsors this side of the Atlantic, so the practice might be closer to occurring than you might think over here.

This week, the violence between Incora stakeholders was publicised and sensationalised by our colleagues at Bloomberg. But the article left me wanting more information. How exactly was the heist achieved, did they make use of the debt baskets, amend certain voting mechanisms, or even create unrestricted subsidiaries and/or JVs as in the case of Intralot?

Luckily, our friends at Petition, have a deep dive analysis of what happened.

It’s R-rated for passive investors (some CLO positions died in the making of this transaction), if of a structured finance disposition you are forewarned.

In early 2020 (not the best timing in hindsight) Platinum Private Equity bought Wesco from Carlyle and merged it with Pattonair Group to form Incora. As the pandemic hit, earnings dived for the distributor of parts to the Aviation and Defence industries.

According to Petition the debt structure was as follows:

To understand what happened next, you need to look at a precedent — what happened to Trimark in late 2020.

In that deal existing lenders were primed by Oaktree and Ares, who inserted a $120m super priority TLA and a $307.5m super priority TLB (taking out their loan positions, but leaving the others in the TLB behind). They did this by obtaining a simple majority of the TLB, which allowed them to amend the first lien credit docs and remove covenants including limitations on further borrowing.

After putting the new debt in place, Oaktree and Ares then rolled their first lien exposure into second out exposure, meaning that the old TLB was effectively relegated from first to third lien!

This, not surprisingly, was litigated by Trimark TLB holders, with a legal settlement eventually reached. Under the ruling they could now swap their debt for second out debt – but that is still 2L with a lot more debt above!

Incora holders were spooked after a WSJ story in February that another Trimark style uptiering transaction was being contemplated. The sponsor was buying up some of the 2027 SUNs in the background, with Silverpoint and PIMCO known as big holders of the 2024 and 2026 SSNs.

With a raft of advisors appointed to work on a deal for the company, funds and the sponsor, the other Incora creditors got their own hired guns — Akin Gump and Perella Weinberg — to advise on how to block such a move.

In March they thought they had managed to build a blocking position, using purchases of the 2026 notes which were so in demand they had pushed prices above par, despite the company’s distress. This creditor group were amenable to reaching a deal, and were in good faith talks with the sponsor on new money and offering amortisation holidays.

But on 29 March, Incora announced a recapitalisation transaction. The statement included classic piece of PR puff which makes no mention of the unequal treatment and the financial violence dished out to its creditors.

Under the plan, there is $250m of new money, with Silverpoint and PIMCO exchanging their 2024 and 2026 SSNs for $1.2bn of new super priority SSNs due 2026 (effectively amending and extending around $450m of the 2024s). Silverpoint and PIMCO will roll-up their notes (at par plus the $250m of new money) into these newly elevated super priority notes.

According to Petition, to make this happen, Silverpoint and PIMCO were given incremental basket capacity (issued more notes to regain their majority position). They then agreed to amend the baskets under the indenture and strip the liens away from other SSN holders. This paved the way for the exchange of their old notes and newly issued SSNs into the new super priority notes.

Sponsor Platinum also piled in, managing to uptier their 2027 SUNs into new 1.25-lien notes, leapfrogging the minority SSNs, now sitting way back at the end of the queue.

Mindful of litigation from beaten-up 2024 and 2026 SSNs, there is incremental capacity left at the 1.25-lien level which might elevate them to the level of the former junior notes if they win. Not a great outcome, but a costly warning that equal treatment within a debt class is never secured.

This is nuts, there’s the cash

Kloeckner Pentaplast (KP) is one the favourite hedge fund EHY shorts.

After its refinancing and dividend recap in early 2021, the Germany-based plastic packager has consistently disappointed investors. EBITDA guidance was marked down twice, from €305m at the bond launch in Q1 21, to €275m in the Q2, and again to €235m at the release of Q3 results.

KP has struggled to pass on rising input costs, with at least a three to six-month lag for those contracts with mechanisms in place. Surging costs saw Q3 margins fall to 11.7% from 16.9% in the prior year (which were benefiting from Covid-19 tailwinds for its medical division). Management told investors in Q3 that this would be the trough and that price rises would mean that it would fully recoup costs by end-December.

As the Russia/Ukraine crisis unfolded, KP’s bonds were among the worst affected, on fears of rising energy and other input costs. Its SUNs traded down into the high 60’s. But a trading update on 11 March saw a sharp price recovery as shorts covered (one fund tells me as much as 26% of the notes were shorted) with better-than-expected liquidity at year-end, and adjusted EBITDA within 2% of previous guidance.

But as 9fin’s Ben Hoskin noted in his earnings preview, “signs of stabilising resin prices — a key component of the company’s raw materials — seen in December and January have since abated with prices trending upwards once again.” According to this ChemOrbis report (released a few days after KP’s trading update), European PVC prices hit new records in March following price hikes which are expected to continue due to “soaring energy prices and diminishing availability”.

KP’s OM cites that prices for their raw materials track that of ethylene, which “reached their highest levels since ChemOrbis started to compile data in 2008 after prices saw hefty hikes of €325/ton since early February”, according to the same report. It goes on to say “initial April expectations call for 3-digit hikes for the next ethylene settlement”.

Reported Q4 Adjusted EBITDA of €45.4m represented a ~25% drop versus Q4 20. EBITDA Margins dropped to just 8.6%, so, no trough yet. The group said it experienced €600m of cost inflation during the year, with a further €250m of costs forecast for 2022.

But a better than expected working capital inflow and lower-than-forecast capex spending boosted cash for the quarter. Top line growth is guided at 25% for 2022 driven by further price increases, with Adjusted EBITDA in the range of €265m-€285m (versus €231m in FY 21).

Margin contraction could continue in 2022 due to index-based pricing contracts, which are reset quarterly. Around 30% of volumes are covered by agreements with customers that permit quarterly price increases based on an index of their raw materials. But management praised the salesforce for their work on passing through the remaining 70%.

There was no insight into the extent of cost inflation in the first quarter, with management saying on Tuesday’s conference call they were “still managing through” the environment post-January. Negotiations with non-indexed contracts are “going well”, they said, and they have opened discussions with indexed contracts.

KP says its energy costs are already 70% hedged for the year. Energy costs which make up 12% of costs, but KP doesn’t say when these hedges were put in place. Fresh headaches could be on the horizon with an emergency fuel plan that will ration gas for energy-intensive companies with operations in Germany, where KP has key manufacturing plants. As of February 2021, (from the most recent OM) the two German facilities below represented ~20% of total 842 kiloton production capacity.

In brief

Haya Real Estate has secured the requisite consents to amend its bond indenture to change the governing law and implement its A&E via an English Scheme of Arrangement. But recent contract losses from Unicaja and Sareb have led to talks with unions over a labour restructuring process.

Intralot released its FY numbers today, showing EBITDA growing 33% in Q4 21 from Q4 20. The strong performance was driven by its US operations, whose security its 2021s grabbed in an uptiering restructuring last August. The conference call is at 3pm on Monday, watch out for news on the 2024s, who recently replaced their trustee.

More good news for Saipem. After unveiling its recapitalisation package on 25 March, it announced $400m in offshore drilling orders in the Middle East and West Africa, and a $150m maintenance contract for the Mozambique Coral FLNG project.

Some interesting M&A for post-restructured names:

Comdata which recently emerged from a multi-year restructuring process which played out in the Italian courts has announced a merger with Spain’s Konecta. It will be headquartered in Madrid, with co-CEOs.

Ithaca Energy, which completed a refinancing last summer with a new RBL and $625m of 2026 SUNs announced the acquisition of Siccar Point — the operator of the Cambo Oil Field in the North Sea in a deal valued at $1.5bn.

Off the charts

A new experimental feature in the Workout, reproducing graphs, charts and stats showing just how dislocated the world economy is.

As BofA said in an Energy webinar yesterday, while LNG is meant to be the solution to dependence on Russian gas, this market is already very tight. The amount of gas in Russian pipelines is twice the size of the LNG spot market. New capacity coming onstream will not keep up with demand.

How bad can food inflation get - lets ask Aldi

How much has QE boosted financial asset prices? $20trn stimulus in 2020, with $10trn going to individuals (the global economy is $90trn)

What we are reading this week

Adam Tooze takes on the fashionable views of Credit Suisse’s Zoltan Pozsar on the changing role of money amid the seismic shocks to the world economy. Spoiler alert, he is sceptical on reports of the death of the dollar.

On a related note, and reflecting my quest for contrarian views earlier this week, Craig Fuller, the CEO of Freightwaves thinks a freight recession is imminent.

But for now it looks as if delivery times are rising again.

Another big contrarian view. From another perma-bear Albert Edwards at SocGen, one of their in-house quant analysts who thinks that the Fed will have reverse when the funds rate hits 1%

One of the surprises of the Russia/Ukraine conflict is the absence of cyber warfare, which the Russians have been extremely adept at over the years. Net Interest reveals that on 27 June 2017, Ukraine went dark. ATMs were affected, as were digital payments, paralysing the economy. Six power companies, two airports and 22 banks and almost every federal agency went down.

My personal experience is that my friends, family and colleagues are catching Covid at a record rate. But surely it is now milder, endemic, and therefore the vaccination programme is finished. Christina Pagel from UCL may make you think again as she debunks these three myths.

And to prove that the FT is not just a handy resource to track down the whereabouts of Russian Oligarch’s yachts, they investigate Goldman CEO’s David Solomon’s prowess as a DJ

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