Market Wrap

Friday Workout — Spreading Xmas Fear; The Real Ceconomy

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

It was a important week for markets with rate hikes due across the globe, plus US CPI data — whose previous release in November had sparked the Santa Rally — making central bankers’ jobs harder as markets arguably once again got too far ahead of themselves.

Once again, US CPI came in lower than expected, reinforcing market expectations of significant rate cuts by the end of next year, with US Treasury yields falling yet further, confirming the breakout of their 2022 uptrend. As expected the Fed and the BoE both hiked rates by 50bps the next day. But while inflation has clearly peaked, there is a clear disconnect between markets’ expectations (terminal and future rates) and the views of those in the open markets committee.

The infamous dot plots show end 2023 rates well above the terminal rate expectations of markets (4.87%).

Fixed income markets are significantly more bullish on the rates outlook.

So it was once again left to central bankers to inject some Xmas fear into markets. Jay Powell said on Wednesday that the Fed still has “ways to go” before the fight against inflation is well and truly won.

And on Thursday it was the turn of the ECB to play scrooge, raising its core inflation expectations by 0.8% in 2023 and 0.5% in 2024 to 4.2% and 2.8% respectively. Growth projections were also downgraded by the central bank, but it still expects a shallow and short-lived recession.

After raising rates by 50 bps as expected, the ECB says that rates will be ‘raised significantly” further, because inflation remains too high and projected to be above target for too long. This great chart from Refinitiv shows just how behind the curve it is in its policy response.

To reinforce the tough message, Christine Lagarde said in the press conference: “Anybody who thinks this is a pivot for the ECB is wrong. We’re not pivoting, we’re not wavering, we are showing determination and resilience in continuing a journey... If you compare with the Fed, we have more ground to cover. We have longer to go.”

This message had the desired effect, with iTraxx Main widening out 6 bps to 89 and Crossover 27 bps wider to 465, according to one market participant. But some research houses believe there is the prospect for significant further spread widening in 2023, with Deutsche Bank one of the most bearish:

ING’s team, meanwhile, are much more positive on US rates next year, and while they agree that the ECB is is only half-way into hiking mode, they are less bearish than DB on prospects for Europe.

Bank of America sees "baby" bull market for returns next year: 5.5%-6% total for IG, and 7.5% for HY. But they caution it may still feel like a bear market, with hikes, stagflation and "credit events" likely hurting European markets in the first half. 2023 is a game of two halves with a strong performance in H2, as ECB rate cuts come on the agenda and T.I.N.A comes back in credit.

For what its worth, my current thinking is somewhere between Deutsche and BofA, with the potential for a nasty hangover in the first quarter. It is worth taking note that EHY corporate spreads typically discount recession at around 800 bps, a mere 300 bps wider from here. If recession expectations change for the worse, it could lead to yet another repricing of risk.

The Real Ceconomy

While HY has had a strong final quarter, there is now significant dispersion amongst names. At the start of 2022 single-B dispersion was at all-time lows, but it is now in the 70% percentile.

This should create a number of investing opportunities, if you can find names which may have been unfairly punished.

A number were hit hard earlier this year, and have failed to catch much of a bid bid in recent weeks. Maxeda is a good example, though the mood towards the Benelux DIY retailer that might be changing after another okay quarter, and now that the overhang of paper out of the way, rising from the low 60s to high 60s.

One name we’ve been doing some work on of late is Ceconomy, the Germany-based electronic products retailer, which reported its FY 22 earnings on Thursday. In August, management sharply guided down their expectations, and following a double-notch downgrade by Moody’s in September, with a CFO departure, the bonds fell sharply. The agency cited significant negative FCF in 2022, thin profit margins in a highly competitive value-driven consumer market, high management turnover and a drop in economic activity in its main markets.

In an end-October trading update they provided some relief, saying FY 22 would be at the upper end of revised guidance. However, as we said at the time, there was no update on the sizeable cash burn (-€727m LTM to June 22). The largest electronics retailer in Europe historically has cash swings of €1bn between end September and end-December (Q1) and then a reversal of payables by the end of March (Q2). Trade payables usually peak at €8bn at end-December.

This means that Ceconomy is reliant on favourable trade terms and credit insurance to sell inventory before funding the payment of payables. A poor Christmas or tightening of terms could significantly reduce its liquidity runway, as we said at the time.

I recently checked in with one advisor who knows the German trade credit market well. They confirmed that the retail sector is being strictly monitored by credit insurers. There have already been some reductions in credit limits due to weak operational performance and working capital issues (mostly inventory-related). In particular the fashion and beauty industry has seen tightening of payment terms with Asian suppliers with supply chain issues causing late payments. Falling credit ratings for retailers have also led to lower insurance limits, they added.

But with its 2026 SUNs trading in the mid-60s (yielding 14.7%), and with an undrawn €1.06bn RCF, just how bad would it have to get to result in an impairment of Ceconomy’s bonds?

9fin’s Emmet McNally posed this question internally, recently. He calculated that leverage would have to reach close to 4.9x from around 2.6x currently (based on EV multiples of peers). While positive FCF could be challenge in FY 23 if earnings fail to recover, even in a downside scenario of 5% revenue drops and a 4% margin decline, it would need to burn €1.6bn to hit this level.

Yesterday, on a conference call which started at 7.30am London Time management sought to allay investor fears, and to outline to bondholders what it is happening in the Real Ceconomy.

Revenue increases were ‘real’ not a result of price increases, they stressed. A number of one-offs in 2022 affected liquidity leading to the cash position dropping to €800m at end-September.

“This development paired with a gloomy opinion of macroeconomics have clouded the view of certain external parties on our business. Given the one time nature of many of last year's cash outflows, the encouraging start into the Christmas quarter, and our prudent financial policy, we believe that we are not properly characterised in this isolated view,” said management.

Management added that liquidity should improve to around €2bn by end-December, with the €1.1bn RCF still undrawn and the one-year extension option “accepted by all bank partners.”

After a positive start to the peak season, Ceconomy is more confident of a FY 23 scenario with a slight increase in sales and clear increase in adjusted EBIT.

But under questioning, there was little detail provided, with the bonds unmoved, and the stock fell by 5% on the news. Look out for a more detailed piece from Emmet soon.

Impaired Vivion; Is Hindsight 20:20?

It’s certainly been an annus horribilis for German real estate companies.

After allegations were made by short-seller Viceroy Research last October, Adler Group and Aggregate Holdings came under scrutiny, leading to attention from auditors and regulators alike. Investors started taking a closer look at other HY businesses in the sector such as Corestate and SIGNA Developments with the whole sector coming under pressure.

A year ago we pointed out the interrelated nature of the German RE market, amid concerns about whether transactions are at arm's-length, which may have artificially boosted valuations, and the use of aggressive accounting policies such as fair market values and percentage of completion methodology.

We said that “even if these firms avoid flipping into restructuring in 2022, their ability to tap HY for cheap finance has probably gone for good.”

Fast forward a year, Corestate bondholders recently took control after writing-off 80% of their debt, and Adler is in the middle of a full blown restructuring. Aggregate bonds are now in the high 30s, and it is being forced to sell its trophy assets to meet upcoming maturities.

But well before Aggregate and Adler broke, Vivion was in the cross-hairs of short sellers, as early as late 2020. With around half of its real estate portfolio sitting in UK hotels affected by a national Covid lockdown and amid a tax investigation into the Dayan family shareholder, many hedge funds had shorted its bonds with 16% reportedly on borrow.

We suspect that many have long since covered their shorts, with Vivion managing to print €340m of SUNs at 3.5% in July 2021.

On Wednesday morning, it felt like deja vu all over again, with Muddy Waters issuing a short seller report. The allegations have some similarities to those from Viceroy on Adler Group.

“In order to borrow even more debt from third parties, Vivion inflates the values of its real estate portfolios through fair value gains. Our research leads us to believe that these gains are generally unjustifiable, and appear to be built on transactions with related parties and significantly exaggerated occupancy rates,” alleged Muddy Waters in its report.

“At the time Vivion issued its first bonds [in 2019], it had a balance sheet of €3.1bn, but its shareholders had only contributed cash equity of €53m. Substantially all of the remaining €313m of shareholders’ equity came from highly questionable, non-cash fair value gains,” the report continues.

Muddy Watters alleges that Vivion Investments’ controlling shareholders, principal among them Amir Dayan, have potentially extracted €360m from the business through the repayment of shareholder loans, despite evidence suggesting a significant portion of these loans were never actually funded by the shareholders.

For more, 9fin’s David Orbay-Graves initial take is here

As 9fin’s Owen Sanderson writes in this week’s Excess Spread (some good sleuthing in there on Vivion’s UK Hotel CMBS btw) everyone in German commercial real estate appears to know each other — Stefan Kirsten, the chair of Adler Group, who joined in February 2022, was formerly CFO of Vonovia, and also spent time on the advisory board of Vivion.

Asked about his Vivion activities on an Adler analyst call this Spring, Kirsten said: “I was advising Amir [Dayan, owner of Vivion] on obtaining the waivers for the CMBS in the UK, getting his accounts into a shape that we can go for a rating, getting a rating, and getting the first bond out. Afterwards, I stayed on the advisory board. I had, at no point in time, anything to do with Aggregate bonds”.

Vivion has a number of connections to Aggregate Holdings (a 29.9% shareholder in Adler Group until recently when it defaulted on a margin loan provided by Vonovia), after selling the Fürst development in Berlin to it, being paid in a complex mix of cash, bonds and “non-traded bonds”.

Muddy Waters suggests that a 89.9% stake in the Fürst project was held via a company called Ionview (no connection to my past employers) which was then moved inside and outside Vivion’s structure via a series of transactions, which Muddy Waters claims is an extreme shell game. An alleged related party Rent24, a WeWork clone supposedly owned by Dayan (which features heavily in the MW report), agreed to lease over 9,500 sqm of office space in 2019, it adds.

Vivion has said that the report is full of inaccuracies and will respond in detail in the coming days. In the meantime, we will find time to take a closer look at the MW report and look forward to assessing the company’s rebuttal.

Pizza Sliced

On the same day the Muddy Waters report landed, we had another incendiary update, this time for Food Delivery Brands, the owner of the much derided Telepizza franchise.

El Confidential said that its future will be decided at an extraordinary meeting today (16 December). A capital reduction of €190m must be approved to cover past losses. But more interestingly, the article says it has proposed a 75% debt haircut (€200m) to its bondholders or it will hand over the keys for €1. The sponsors, KKR, Torreal, the Safra Group and Arta, are not prepared to inject any more funds into the business for which they paid €640m in 2018, the article adds.

The news drew little sympathy from FinTwit, with one saying it was rightful punishment for the company inventing “Volcano de Nachos”. For those whose interest is piqued (native Neapolitans look away now) it is a pizza with a melted cheese volcano bowl with Nachos on top to dip into!

As reported, on 25 November, the Spanish pizza delivery operator said it had hired Kirkland & Ellis, Uría Menéndez and Houlihan Lokey as advisors to evaluate its options. The pizza house said in a 20 minute recorded presentation that it is looking to effect changes to the business, capital structure and to the Yum! Alliance.

FDS has operations in Spain, Portugal, Mexico, Chile, Columbia and Ecuador. It has been affected by a slowdown in sales, with the duration and depth of economic downturn worse than management’s prior estimates. Its franchisees are suffering and had not yet fully recovered from the impacts of Covid-19. This has led to a slowdown in new restaurant openings (a key driver of earnings) and a larger than expected number of closures (less franchisees).

As a result, FY 22 EBITDA guidance was revised further downwards to €36m-€39m, impacted by inflationary headwinds derived from rising input costs associated with energy rental and labour expenses as well as main ingredients costs.

The focus remains on preserving liquidity, said management on the call. But with €10.5m of bond interest due in January, liquidity will become even more constrained. Leverage is expected to rise from 7.8x at end September to around 10x in 2023, clearly an unsustainable level.

Chicken Little (to report)

Boparan reported earlier this week. There was a time where these releases (once we could gain access) were the main event for the team at 9fin towers, but the latest set of earnings didn’t give our distressed analyst Denitsa Stoyanova much to feast on, with little new news.

On the conference call management in the main avoided a roasting by investors, after posting headline numbers in line with guidance. Net leverage is down to 4.5x, below their 5x target. But once again profitability was as disappointing as flagged up in our previous article (Q1 23 EBTIDA plummeted to £17.8m at 2.4% margin from £43m at 5.7% margin in Q4 22).

Management hoped to hit £135m annual run-rate EBITDA (as pitched at time of stressed refinancing two years ago) but delivered only £113.7m in LTM Q1 23. When questioned on the call, they insisted meekly that this annual run-rate level is still deliverable, noted Denitsa.

Going forward, Boparan will switch from Adj. EBITDA to Adj. EBIT as a leading profitability indicator (we didn’t catch the reason why). Management declined to give EBIT and EBIT margin guidance for Q2 23/FY 23 when pressed on the call but said to be cautiously optimistic, so investors will have to wait and see.

In the new financial year, staying FCF positive could be challenging, management admitted on the call. Citing commercial sensitivities they declined to give colour on a loss of a big customer and the status of talks to sell its Pastry business.

The £475m 7.625% SSNs due 2025 did not budge from their 68.6-mid level, yielding 22.8%.

Veon’s costly International Put

Veon this week has come back with an improved extension offer.

As 9fin’s Bianca Boorer highlighted at end November, a group of international holders of the Dutch-headquartered telecoms company 2023 notes were hoping to negotiate a higher fee in exchange for the eight-month extension proposal. In return, an amendment fee of 75 bps was on offer for the $529.3m 5.95% notes due 13 February 2023 and its $700m 7.25% due on 26 April 2023.

This has now been increased to 200 bps, which will be payable on the new maturity date.

Veon is launching an English Scheme of Arrangement to implement the maturity extension and make amendments “to certain voting provisions, consent thresholds and quorum requirements that apply to any modifications to, or waivers or consents under, the 2023 Notes.”

Russian holders of the 2023 notes are in favour as it avoids the principal owed being stuck with the paying agent due to sanctions on the Russian National Settlement Depository (NSD).

As reported, Veon found a creative solution for its Russian subsidiary. It is planning to sell Vimpelcom to its local management via a MBO. But the DutchCo wouldn’t be able to access the proceeds due to the aforementioned sanctions. To get around this limit, the sale will be financed by Vimpelcom buying up $2.1bn of Veon’s bond debt.

The proposed bond extension will allow Veon time to complete the sale, which is expected to be complete by 1 June 2023.

In addition to the fee increase, there is a put right at 101 for holders, requiring the company to repurchase $600m of the 2023 notes if Veon has $1bn or more in cash (net of the aggregate amount drawn under the multi-currency RCF) on 2 May.

We assume this provides more certainty to holders, but we won’t need to wait long as the convening hearing starts on Tuesday (20 December) which should provide more context.

In brief

Restructuring activity is picking up in Spain and we could probably justify a business trip in the coming months to cover the machinations of the various situations. Some winter warmth would also be welcome, hopefully we can find better food than Telepizza.

Things are definitely hotting up at Abengoa. The environmental projects and engineering group was set to be bought by Urbas out of bankruptcy. But according to Cinco Dias, two counter offers have emerged from RCP, led by the former group president Clemente Fernandez, and Ultramar an original bidder prior to its bankruptcy filing on 30 June.

Another interesting situation going through the courts is CELSA. Creditors are pitching their own restructuring plan seeking to reduce the debt by €1.29bn and extending the remaining €1.56bn by five-years. It successful, it would be first deal submitted by creditors without the steel company’s approval. The long running restructuring had been held up, awaiting €550m of funds from SEPI, the Spanish government vehicle set up to support businesses during Covid. But the use of the funds was contested, with the creditors led by Deutsche Bank and Goldman Sachs reportedly wanting the first €550m in operating revenues plus 49% of the value generated until 2029.

Another former highly contested deal, is coming back to the courts next March, is Galapagos, now known as Heat Exchangers. It’s a complex case which tbh I missed first time around, but Akin Gump has a good summary here which is helping me to catch up.

Advisors have told us another restructuring may be in the wings, but the latest set of numbers don’t look too bad, though we are still trying to get our heads around how nEBITDA is calculated. Per management — ”these figures represent Management’s current view on nEBITDA/nEBIT which is indicative and illustrative only. For instance, we have not included a number of adjustments permitted to be made based on the financial covenant definitions in the Finance Documents, including (without limitation), impairment of inventories and customer cash discounts as well as FX gains and losses. In addition, all figures are presented before IFRS 16 adjustments.”

And it might be time for a new Covis variant to appear. We heard noises a few weeks ago that legal advisors were appointed by worried creditors to Covis Pharma, the Apollo-owned pharma business, ahead of a liability management exercise. This was confirmed by Bloomberg on Thursday.

As we outlined in the Friday Workout in January, leverage was marketed at a lowly 4.5x, but with three drugs generating around two-thirds of revenues facing challenges, and major patent expiries in the next two to five years, investors should ideally benefit from the product pipeline to drive future growth. Bondholders have protections from just five material patents under the J Crew blocker. For example, we said that ciraparantag, about to come to market, will sit outside the restricted group and will not form part of the collateral package.

I wrote at the time: “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.”

9fin legal analysts pointed out in their TLDR for the Legal QuickTake:

“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.”

What we are reading/watching this week/next week

Unfortunately, there is no rest up for the 9fin restructuring team in the week leading up to Xmas.

This weekend we have the Adler Group bondholder vote, plus the aforementioned Veon convening hearing. We are also working on a restructuring review of 2022 and preview of 2023.

If that wasn’t enough, look out for updates on Telecolumbus and Ideal Standard (poor quarter) who are hosting a call on Monday.

Last weekend, I caught up with the strange story of South Africa’s President Cyril Ramaphosa, written by the excellent FT correspondent Joseph Cotterill. The SA premier is embroiled in a scandal involving a Sudanese businessman, buffalo, half a million dollars hidden in his sofa on his private game farm. A parliamentary investigation failed to believe his story over the half a bill theft, saying they had substantial doubts. Sounds like a load of bullocks to me.

This weekend, something more heavy duty to read through, the proposed EU directive on insolvency harmonisation. Luckily, K&E have put together a primer. The TLDR: similar to in Germany, dire ctors could be criminally liable if they don’t file. Introduction of pre-packs, but unlike in the UK which are out of court, these must be court approved, with other limitations.

As he sells another $3.5bn of Tesla stock to boost his liquidity (and perhaps pays margin calls), Elon Musk finally issues a warning about the dangers of debt, when the Fed continues to raise rates. FinTwit wasn’t slow to respond:

And finally, congratulations to Alexis Mac Alister as the first Brighton Player in a World Cup Final:

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