I’m not an expert on the Telco sector, but soon after I started at 9fin in late 2020, I was intrigued by the low EV/EBITDA multiples (at sixes and sevens) being paid for deals such as Masmovil and T-Mobile Netherlands. But conversely, they had disproportionately high debt loads, with equity cheques in the 20s or low 30s. 

I remember remarking that it would only need a multiple compression of a turn or so of leverage for some of these deals to be at risk of being underwater. But on the other hand, servicing the debt didn’t seem to be a problem with interest cover in most cases above 5x. 

In addition, most of these companies had significant asset backing, highlighted by Cellnex being a prolific buyer of European towers assets at multiples as high as 30x EBITDA. This offered Telcos a decent opportunity for deleveraging if needed. The downside is the loss of control of these assets makes cash flows less predictable. 

But many of the towers deals are now completed, with Cellnex publicly saying it was done last November. Not that surprising as towers and data centre deals are highly vulnerable to changes in interest rates, and multiples are now nearer to 20x than 30x. 

Another trend was the wave after wave of M&A and industry consolidation, with Iliad’s Xavier Niel and Patrick Drahi from Altice at the forefront. LevFin bankers were actively courting Telcos for business, which might explain the willingness of banks to fully back Masmovil’s jumbo merger with Orange last July, with LevFin primary effectively closed at the time. 

Fast forward a year, it is difficult to see a purchase for BT by Drahi (he owns 24.5% already) being funded the same way in the current market environment, or at similar terms. 

The performance of Iliad and Altice International and especially Altice SFR bonds have diverged markedly in the past six months, as the market has penalised the latter’s higher leverage. 

Below is Iliad’s 2028 SSNs on a spread to worst basis from the start of this year, the notes are at their tightest spreads year-to-date, now sub 500bps:

lliad 2028 SSNs, source 9fin data

Whereas Altice France 2029 SSNs are at their widest at around 900bps, almost double the spread at issue.

The underperformance accelerated in the past week on news that the Portuguese public prosecutor was investigating that Altice Portugal (part of Altice International), saying it was subject to a fraud by a number of individuals. This caused prices of both complexes to fall, as outlined by my colleague Owen Sanderson. The junior HoldCo debt dipped below 50, yielding in the high 20s. 

Altice now has the most leveraged debt stack in the EHY Telco universe, Tele Columbus excepted.

Despite doing an A&E for €5.7bn of its term loans in January, there is still a troublesome €545m TLB stub and €1.05bn of SSNs due early in 2025. 

First quarter performance was poor, with adjusted EBITDA falling by around 5%. While the heavy capital expenditure for 5G, recurring restructuring costs and outflows to its media business Altice TV in past years are finally expected to reduce, it is operating in a very competitive local market, unable to raise prices in line with elevated costs. 

As my colleague Nathan Mitchell notes in his excellent analysis piece, with net secured leverage at 4.8x at the OpCo and 5.8x total through the HoldCo there is a danger that equity value is almost eroded. 

Iliad was taken private in 2021 at 6.3x, and the wider Altice Europe group was valued at 6.1x when Drahi did the same. But ex-growth Telcos are trading with mid-to-high four EV multiples, which is where we think a distressed sale is likely to occur. 

Its worth noting that Altice’s leverage was 3.9x and 4.9x respectively when the HoldCo debt was pushed down to Altice France Holding in 2020. In comparison Iliad’s net senior secured leverage is much healthier, somewhere in the 3s. 

Another concern is interest cover, already significantly lower than its peers. Nathan notes “Cash EBITDA minus capex in recent years falls a few hundred million short and with telcos’ negative working capital dynamic this will drain a currently adequate liquidity position.”

But what about the planned data centres portfolio sale, can this help deleverage enough to refi?

If the reported €1bn of proceeds are applied at par, this is just 0.2x of deleveraging, rising to 0.4x if a buyback could be done at 40-50% discount to par. According to our legal team under the docs, the company can’t do open market repurchases, but could launch tenders and even apply proceeds to the 2025 senior secured notes alone without applying this pro rata to the other debt. 

So TLDR, dealing with the 2025 maturity wall could be a significant challenge. 

There are also questions of governance, with S&P saying it is a long-term credit risk, citing “the decision to designate SFR towers as an "unrestricted" subsidiary; upstream asset sale proceeds to repay the take-private debt, rather than reduce Altice France debt; and the consistent operation outside of the company's leverage target--demonstrate an ability and willingness to prioritize shareholder interests over those of creditors and deleveraging.”

One of the key questions I have is whether a restructuring can be done without impairing the OpCo debt, by toasting the HoldCo only? The juniors are heavily structurally subordinated, rated three notches lower by Moody’s. Even if they can be isolated, I suspect some tiering is needed at OpCo too, max 3-3.5x senior secured leverage is my guess.

With the HoldCo SUNs trading in the 30s and 40s, is the restructuring risk fully priced in? 

According to market participants, sizeable trades (over 100m) in both the SSNs and SUNs since Wednesday may suggest that opportunistic funds may be buying into the debt stack. 

But while the SSNs have seen some price recovery, the SUNs have not. No doubt the recent bad experience of Orpea and Casino junior bondholders is a factor here, and there is the added complication of the relationship between the OpCo and HoldCo, with several valuable assets sitting outside the restricted group. 

We have more work to do on exploring the docs and the group structure, but would highly recommend reading Nathan’s extensive piece as a starting point. As always we encourage readers to share their thoughts.

Debt costs taxing debt purchasers

As well as beavering away on producing deep dive analysis pieces on Altice France and German Real Estate, my colleagues have also been turning their attention to the debt purchasers sector. 

As Owen Sanderson wrote in June, taking the short thesis, there are a number of bears in the sector who believe that ratings agencies and longs fundamentally misunderstand how these businesses work. 

Whether you agree or not with their arguments, similar to German Real Estate, increases in interest rates and the flexibility of funding sources are key for determining whether the business models still work. Without the ability to fund further purchases of NPLs or distressed Real Estate assets at rates where you can still able to lock-in an acceptable return, it means you are in run-off. 

That doesn’t necessarily mean as a bondholder that you are automatically impaired. 

The bulls say that the collections from borrowers over time should easily cover the debt burdens. Owen illustrates this well with Swedish debt purchaser Intrum which carries its portfolio investments at SEK37bn, vs Estimated Remaining Collections (ERCs) of SEK76bn. 

It isn’t easy as an investor to stress test the stated ERCs — these are marked to model, an art rather than a science — with plenty of incentives for companies to overstate these. 

But in the Intrum (pun intended) there are a number of pesky debt maturities to deal with.

Source: Intrum Justitia Results Presentation Q2 2023

Intrum faces a steep maturity wall despite the partial refinancing of SEK 1,500m completed in June 2023 under the MTN program, pushing the maturity back by two years. With its longer maturity bonds yielding around 12.5%, the underwriting IRR of 15% for recent purchases isn’t going to work for its funding — traditionally it has maintained a 3x return gap to its cost of funds.

But why not go down the securitisation route? After all, this worked well for its UK peer Lowell. 

As reported by 9fin’s Matthew Hughes, when asked about the future possibility of ABS-type financing (as discussed by 9fin here) to reduce the cost of funds, management said there was a “limitation of secured funding to €250m, of which some was used by private debt placement,” plus commenting on the potential impact of such securitisation to senior unsecured creditors.

So, to reduce leverage ahead of the maturity wall, the near-term priorities are to increase servicing cash flows and reduce net leverage. This means exiting Hungary, Slovakia and the Czech Republic and limiting balance sheet-funded investments to well below replenishment levels. Leverage ticked up during the quarter to 4.6x (from 4.2x) but management were keen to stress there was ample headroom and no covenants or waivers had been sought. 

Lowell is in better shape, able to use securitisation as a competitive funding tool, using Wolf I and Wolf II transactions. But while it is deploying at 20% IRR its bonds are trading wider, at around 23% and it also faces significant debt maturities in the next couple of years. 

Worst off is UK-based NPL and distressed real estate purchaser Anacap Financial Europe, which has a sole €325m E+500 bps SSFRN maturing next August. It tried and failed with a refi in February 2022, pulling another SSFRN deal indicated at E+675 bps citing market volatility. The 2025 SSFRNs are now in the 50s, and recently downgraded to Caa3 by Moody’s citing a constrained liquidity position and an untenable capital structure. 

One near term trigger has been removed after its RCF maturity was extended from June 2023 to this December. But this came at a cost, with the size reduced from €90m to €60m, and while it is “actively evaluating public and private refinancing alternatives, with sustainable leverage in line with long term target, strong interest coverage and increasingly compelling investment environment,” a restructuring is likely if it cannot refi by the end of Q3, as the RCF comes due. 

Liquidity should rise from low levels (€14m in Q1) despite a need to repay €19m under a credit facility in July, but to preserve cash, it has decided to reduce portfolio purchases to €30m, well below the €76m replacement rate needed to maintain ERCs, which are expected to fall to below €475m (from €550m) by the end of this year. 

Leverage is set to rise to above 4x, from 3.7x currently. As NPLs roll-off, an increasing proportion of AnaCap’s balance sheet is direct real estate investments, rising to 52% from 35% a year ago.

Source: Anacap Q1 presentation

We will be taking a closer look at this name in the coming weeks, watch this space. 

German RE governance 

One of the main lessons to be learned over the past couple of years for the German RE sector is questionable corporate governance amid concerns over related party transactions. 

We were reminded of this earlier this week, when a strongly worded release landed in our inbox from advisors representing a group of bondholders in a mid-market real estate firm, PREOS, or to give its full name PREOS Global Office Real Estate & Technology AG. 

It is a leading driver of office real estate market digitalisation, with big data analysis and PropTech, according to its website. 

Given the lack of transparency in the German RE market on transactions, you would have thought this tech would be in high demand, but its shares are down 67% this year, for a market cap of €125m. 

On 13 July, as 9fin’s David Orbay-Graves reports, PREOS announced a vote regarding its €250m-outstanding 7.5% December 2024 convertible bond. Holders are being asked to approve a five year maturity extension to 2029, capitalise and reduce interest to 2% and adjust the conversion price upwards — yes, upwards. The converts are currently indicated at 5.9 cents. PREOS said the vote was tabled by a bondholder. The company also noted that its largest shareholder Publity holds €78m of the bonds, though it did not specify whether Publity had requested the vote. In addition, PREOS also held some €108m of its convertible bond as of H1 22, according to its most recent financial statements. 

Advisors to the bondholder group, Houlihan Lokey and DMR legal were particularly critical of the attempt to install the chairman of largest shareholder Publity AG as common representative for bondholders. “Such offer is most likely unprecedented even in the German Mid Cap bond market.”

The advisors have asked that that PREOS and Publity be excluded from the vote and held a call yesterday (20 July) for disgruntled bondholders. The vote is to take place on 28-30 July. 

In brief

Earlier this week, we released our special report on the German RE estate sector. The 39-page report is a must read and comprises the following sections:

• Key Terminology Explained — a review of the key metrics and ratios used in risk evaluation and their elevated importance in the current macro climate
• Maturity Walls Determine Company Fates — a discussion and analysis of restructuring and refinancing events that transpired for companies with 2021-2022 maturities, and an exploration of the outlook for companies facing significant 2023-2026 maturities
• Secured Debt Capacity Not All It Seems — a dive into the potential contractual and commercial restraints on the ability to raise additional secured debt to repay unsecured debt
• Valuations Not Yet Troughed — an overview of how portfolio values have evolved across FY 22 and Q1 23 and why they have not yet troughed; plus our view on the outlook for H2 23
• Market Liquidity Dries Up; The Value Opportunity — many companies are edging towards becoming forced sellers, but liquidity is poor creating execution risk; how to find pockets of value and identify opportunities across the financing spectrum for investors with conviction

The listing for the long awaited appeal by Adler Group 2029 bondholders was revealed this week, with the Court of Appeal to hear the case on 23 October. It is unclear at this stage on what basis the AHG intends to appeal, but there were some clues given at the conclusion of the UK RP hearing, with one of the most contentious issues being the non-pari passu treatment of the various Adler Group SUNs.

BC Partners is shedding ownership of Keter, after the company agreed to undertake a sale process, set to be launched later this year, and conclude by mid-2024. To facilitate the sale, a majority of its lenders have agreed to a one-year loan extension to end December 2024 and to provide a €50m facility to fund working capital. 

Daniel Kretinsky’s offer for Groupe Casino is the only one under consideration by the troubled French retailer and its conciliator, after the 3F consortium pulled out last weekend, and distressed fund Attestor switched allegiance. The revised Kretinsky offer is less favourable for Casino creditors — the SUNs were indicated 2/3 this week — we will be providing further analysis in the coming days. 

Last Friday, Justice Trower convened meetings for Italian construction group Cimolai for its UK Restructuring Plan, writes 9fin’s Will Macadam. 

The case is interesting as it is the first to be done in conjunction with a parallel Concordato Preventivo process in Italy. Cimolai told the court in its skeleton argument that its financial difficulties were caused by two former employees who caused the company to enter into 19 derivatives contracts without the knowledge of the group’s board of directors. The current shareholder is injecting €10m with secured creditors paid in full and unsecured creditors estimate to recover 15-20% of their claims via future cash flows. 

What we are reading, watching, playing this week

China’s disappointing growth figures this week has shone the spotlight onto one of the expected areas of growth for 2023. But as the Macro Prophet (aka Dan Alderson) wrote earlier this week:

“Given China’s historical influence on tech, commodities, currencies and even US Treasuries, it is surely a moment for credit market professionals to sit up and take notice. China’s seeming absence from forward outlooks on US and European markets does not mean the world’s second largest economy is any less important. In fact it implies a distortion of global metrics that could soon seek realignment, creating opportunity in some segments and a new set of problems for others. Moreover, China will become a much bigger component of US discussion into the 2024 election season.”

Nomura’s Richard Koo is concerned that China’s issues are becoming structural, and there is a risk of a balance sheet recession and Japanification. He outlines what measures the authorities should do about it — in his Bloomberg Odd Lots podcast which is a must listen.

The release of Weil’s Distressed Index is a welcome reminder that distress in the wider market remains elevated, despite the improvement in EHY and LevLoan prices.

On my reading list this weekend is yet another Viceroy short-seller report, for Hexagon AB — Six Sides to Every Story

Yet more leverage in the Private Equity space, as sponsors seek to raise money against portfolio companies which they are struggling to exit (the lowest in a decade according to Pitchbook) —many are also over-levered and underperforming — what could possibly go wrong? 

And finally, some heroics from yours truly. In an epic game of Nemesis — the board game loosely based on Alien — as the Mechanic, I selflessly gave my life in my final move.

My friend Marvin Fried, summarises the action in his short story detailing the amazing finale:

“And it was then that the Mechanic did the inconceivable and extraordinary. He engaged the adult alien in the evacuation pod in hand-to-hand, or rather hand-to-claw, combat. With his last breath and using his rusty wrench, the Mechanic charged at the adult xenomorph, swung, and landed a good hit. If there was nothing more he could do, at least he would go down fighting. Then a miracle happened. The adult alien, despite taking minimal damage, retreated from the Evacuation Section. Seeing my chance, I ran, escaping yet another alien swipe, and reaching the Evacuation Section where the Mechanic was waiting. Self-destruct was on its final cycle. I tried to open the hatch the way he had tried before. One wrong move and the noise would attract even more aliens. Unbelievably, I succeed, and entered the pod. I turned around, as there was just enough time to grab the Mechanic by the hand and pull him in with me. It was then that I heard a cascade of explosions begin around the ship. The Mechanic disappeared from right there in front of me, sucked back by the force of the depressurization. He was gone…. The Mechanic saved me with one swing at an alien he knew would be his death. He had no alternative, but it was a melee attack which saved my life. I just wish I could have brought him with me. Silently, I thanked him for his courage.”