I agree with Oaktree’s distressed sage Howard Marks: There is a Sea Change happening.

From his memo in December:

“In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes.  I think we may be in the midst of a third one today.”

Marks believes that the effects of ultra low interest rates and quantitative easing post-GFC have resulted in the longest economic recovery in history. But rates are now higher for longer, and bloated central bank balance sheets will have deflate. We will go from a low-return world to a full return world with many conditions worse than seen for much of the last 40 years.

There is no need to invest in high-risk assets to get 7-8% returns, Marks argues.

But how does his words above tally up with the activity that we’ve seen in the past few weeks, with the most speculative and riskiest asset classes all off to the moon?

We’ve seen HY spreads contract to the tightest levels since last April, with the spread to IG now very tight historically, despite rising defaults. EHY BB spreads have tightened 170bps from the wides, and are less than 30bps wider than the tights seen in 2021’s exuberance.

The most-shorted stocks in 2022 are the best performers in 2023. Tesla is up almost 100% YTD, and we’ve seen strong rallies for growth tech stocks, which in theory should be the most sensitive via their DCF valuations to higher rates.

But despite bond yields rising in the past few days, tech and HY have barely budged, and as the chart shows the gaps are getting large.

Admittedly, a 100% rise in a stock which fell 70% last year, is just a 49% retracement from the lows to the 4 November high — don’t you just love maths?

This latest move in risk assets has made this bear uncomfortable, reassessing whether he may have got it wrong. The market could remain irrational longer than I can remain to solve it? Perhaps this is H2 2020 all over again after the overtly pessimistic initial reaction to Covid?

But I was more reassured, after listening to Bloomberg’s Odd Lots podcast this week with Steve Eisman from Neuberger Berman (famously portrayed by Steve Carrell in The Big Short, and for his bet against the housing market pre-GFC). He reminded us that we are in the middle of a messy paradigm shift where the old leadership of tech, no-income growth stocks gives way. Paradigm shifts can be violent and that people don’t give up them easily.

He cites the example of financials in 2009 and early 2010, which “kind of had a last hurrah” (before being the worst performers for a decade) which he thinks might be happening now. He adds that it is unusual when the old leaders become the new leaders as the paradigm shifts.

While risk asset prices float serenely ever higher in the stratosphere, seemingly insulated from what is happening in the world far below, every now again the odd situation encounters reality and the use overwhelming force.

This week, heavily distressed Meme Stock favourite Bed Bath and Beyond’s financing gave me a sense of deja vu from over 20 years ago, and brought back memories of death spiral convertibles and the vagaries of convertible arbitrage.

But first, before I reminisce about trading days past, it’s back to 2023, and some interesting developments this week for Adler and Orpea, the two largest and most live European Restructuring Situations.

The Joy of Six

In last week’s Workout, we shared our initial musings on how Adler Group might implement a cram down of a group of 2029 bondholders opposed to the German Real Estate group’s financing proposal.

To recap, the longest duration bonds are opposed to a plan to use €937.5m of senior secured funding from an ad hoc noteholder group to primarily repay the 2023 and 2024 maturities of its subsidiary Adler Real Estate.

An unusual aspect to the proposed deal is that some of the Adler Group debt (most notably its 2024 SUNs, plus 2023 converts and Schuldschein debt) are to be elevated to second ranking with the remaining SUNs becoming third ranking.

This is one of the main gripes of the 2029s, who argue that the plan favours short-dated holders, most notably the previously pari passu 2024 SUNs. The 2029 holders had blocked a consent solicitation request to allow the financing, but Adler Group did have over 75% in total (by value and number) across the six debt issues, and said it had alternative means of implementation,

After some delay, last month the company said it would use a UK Restructuring Plan.

As reported, the 2029 group recently outlined their own counter proposal. Under their plan, the new money will remain first-ranking and still rank ahead of the other Adler Group debt; but all the other debt will rank second and mature in June 2026. There is also the ability to tender notes at 60 cents from future disposal proceeds, with temporal seniority respected if oversubscribed.

Our original thoughts were that Adler Group would go for a single class under the UK Restructuring Plan, given that it had the numbers across the debt issues to dilute the dissenting 2029 holders votes. The 2029 proposal felt like a straw man, and might struggle to get traction with the court to be used as the relevant alternative comparator.

We also saw merits in in the 2024s being put in a separate class given their elevation and could be potentially be used to cram down the others. Temporal seniority issues could also tested.

After days of hunting around for days to find out what was in the Practice Statement Letter (issued to investors to give them enough information to be able to vote), we managed to get the details earlier this week.

To our joy, there will be six classes proposed, with the convening hearing (to approve the composition of classes and whether the criteria for a UK RP are satisfied) set for 24 February.

Classes impacted by the plan, are grouped as follows:

(a) 2024 Plan Creditors

(b) 2025 Plan Creditors

(c) January 2026 Plan Creditors

(d) November 2026 Plan Creditors

(e) 2027 Plan Creditors

(f) 2029 Plan Creditor

We were left scratching our heads by this development. After all the two common tests for a UK RP (similar to English Schemes) for class composition are as following:

(a) where creditors affected by a plan have rights that are so dissimilar, or would be affected so differently by the plan, as to make it impossible for them to consult together with a view to their common interest, they must be divided into separate classes, and a separate meeting must be held for each class of creditor; and (b)  it is the legal rights of creditors, and not their separate commercial or other interests, that determine whether they form a single class or separate classes. Conflicting interests are matters that may properly be taken into account at the sanction stage, but do not go to class composition.

It could be a stretch to say that the rights of the Adler Group SUNs: €400m 1.5% 2024, €400m 3.25% 2025, €700m 1.875% 2026, €400m 2.75% 2026, €500m 2.25% 2027 and €800m 2.25% 2029s would be that dissimilar, apart from perhaps the 2024s that are being elevated.

But it is worth noting that the 2024s rights are currently the same as the others, and are only elevated if the UK Restructuring Plan is approved.

Having six classes relieves pressure on artificially treating the 2024s in a different way to other notes by creating a separate class, noted one restructuring lawyer following the case.

But on the other hand, it could open up to accusations of fracturing the classes as an abuse of process. It needs just one affected class to vote in favour (75% threshold) to cram down the others.

It is also worth noting that while Adler received enough support across the debt stack. Three of the debt issues had lock-ups below the 75% lock-up thresholds on the release date of the PSL, which suggests the company may be hedging its bets by choosing so many classes.

So why worry about Adler’s compound fracture?

Courts are quite rightly concerned about the construction of classes to engineer an outcome and where the rights are sufficiently similar they should be placed in a single class.

As we saw in Veon, judges can be unwilling to fracture classes, with Justice Zacaroli pointing to Justice Marcus Smith’s reasoning in Haya Real Estate:

“there is a fundamental distinction between a scheme conferring different rights on different groups of creditors [and] a scheme conferring the same rights on all creditors ... but some creditors are unable to enjoy those rights by virtue of some personal characteristic that they possess. The latter situation should not fracture the class, as it involves a difference in interests rather than rights.”

Zacaroli in his Veon judgment notes that while “it is necessary to stand back and assess the question whether creditors can consult together by reference to the Scheme overall, I do not find it helpful to start with a comparison of two notional creditors at extreme ends of the spectrum. This example requires consideration to be given to, first, differences in rights that might be excluded as being problematic in themselves; second, matters that may not constitute differences in rights at all; and, third, matters which are no more than commercial reasons why Noteholders in either series may be motivated to vote against the Scheme. Standing back and considering the impact as a whole is undoubtedly an important exercise, but best done as a check after first considering the various contentious elements.”

The final point worth noting is the issue of temporal seniority — could this be used to separate the classes?

This seems less likely after the company chose insolvency as the relevant alternative. In this event the liquidation proceeds would be distributed equally among pari passu creditors.

We may have missed something here. Plenty of very smart restructuring lawyers are regular readers of the Workout, please send us your thoughts.

French Letter

Just when we thought that Orpea was able to breathe more easily following the Les Revenants of CDC and a group of French Insurers (aka the Groupement) reaching agreement with “The Guns” — reportedly representing €1.8bn of the unsecured debt — several funds attached to this group are unhappy with the outcome.

As originally reported by Bloomberg (summarised by Boursier here) the group which includes Fortress and Kyma Capital are unhappy with the size of the backstop fee being paid to the SteerCo, and their inability to join the French fund dominated committee.

I do have some sympathy with their gripes, as this feels like a very French politicised solution, with the amount of new money on offer to the unsecureds substantially less than hoped (we had previously reported that The Guns had previously offered to contribute up to €700m).

After us making a round of calls this weeks to the various stakeholders and their advisors, one interesting tidbit did emerge. The €600m of secured debt financing has yet to be agreed.

This is odd, as there are lots of unencumbered real estate assets, and we had expected the G6 French banks to provide this new debt— are they getting maxxed out on their exposure?

Remember, this facility was meant to fund the business through to May/June when the Sauvegarde is projected to complete. It could just be that the overwhelming focus was on securing the equity financing, but it’s worth keeping an eye on the secured creditors here, and whether there could be yet another twist in the tale.

With plenty of dissent, and lots of moving parts, using the fast track Sauvegarde Accélérée might be optimistic, and my gut feel is that the timeline will slip.

To get appraised of Europe’s largest restructuring, we have produced a Restructuring QT this week, available here for clients or by request here.

Bloodbath & Beyond

I’ve always wondered why convertibles are not used more as sources of emergency liquidity. There is more room for bespoke instruments such as convertible prefs, while avoiding hefty interest costs and immediate shareholder dilution.

For those subscribing to the converts, it can offer a route to the equity — either at maturity if a mandatory convert, or if the equity recovers, it gives the option to buy cheap stock.

At this point, in the interests of full disclosure, I should outline my interest. At Jefferies around the turn of the century, I used to trade converts for a living, in addition to some fledgling European HY and EM.

At the time there were plenty of interesting names such as EM.TV (which had the rights to Formula One) and Elektrim — a Polish Telco, subject to a three-way fight between Deutsche Telekom, Vivendi and Elliott Management (Gordon Singer and James Roome, I still owe you that book we talked about. It has it all, 50 plus lawsuits, ex-Stasi spies, a strange call with Bill Clinton’s ex-lawyer and a $7.5bn late Friday night Floridian lawsuit!)

Most of the converts I traded were busted — their implied equity options were far out of the money — with emerging TeleCos such as NTL, UPC, TeleWest, Netia, Colt Telecom suffering from a glut of dark fibre and blow-back from the fraud and subsequent collapse of Worldcomm.

In the middle of the internet stocks crash, I was invited to scope out a distressed convertibles biz for Jefferies in the US. When I arrived, I found a cheerleading equity-focused Converts team in midtown Manhattan who knew little about credit and their sales team had no distressed contacts! But over in Connecticut, we had a very experienced ex-Drexel HY team that had carved out a decent secondary trading operation, headed up by Rich Handler, now Jefferies CEO.

The most obvious solution was to get the two teams to work together. But that was more easily said than done. At that time most businesses within the US Investment Bank were very siloed and entrepreneurial, so sharing P&L wasn’t going to be easy.

It was around this time my interest in restructuring was on the rise, hanging out with Bill Derrough and his team (Bill is now Co-Head of Recapitalisation & Restructuring at Moelis). Our telecoms practice was top notch, and we were also the go to shop to restructure Donald Trump’s HY Casino debt.

Death spiral converts were a big topic of conversation amongst the Jefferies HY team and the advisors — they were giving my convertible bonds a bad name, but also offered a cool solution to finding rescue finance.

Death spiral converts allow you to convert into equity at a variable price at any time, with the share conversion rate a moving target (always less than the prevailing market rate). Typically issued when companies are in financial trouble, the holder is likely to be heavily short of the stock (often in advance) and therefore can still win on the way down.

The SEC then started to take an active interest, with Rhino Advisors subject to civil action in 2003 over Sedona, paying a $1m fine in 2003 relating to a $3m convertible debenture in Sedona.

Roll forward to the present day, and after exhausting At-the-Money equity offerings and the patience of the day trader bros, former Meme Stocks such as AMC and Bed Bath & Beyond are having to get more creative to raise funds, as they desperately try to avoid bankruptcy.

But being closer to the zone of insolvency brings them to the attention of the SEC. After the debacle with Hertz, the regulator is not happy with near-bankrupt businesses raising hundreds of millions from ill-informed retail investors and handing the funds over to creditors, potentially just days/weeks before a filing.

But as Matt Levine outlines in his excellent Bloodbath & Beyond piece this week, if institutional investors and/or funds want to provide $1bn of funds to bail out Bed Bath & Beyond, there will be less resistance, as they are big boys and can do their own due diligence. They know the risk — $2bn of debt is trading at ultra-distressed levels at between five and 10 cents on the dollar.

Admittedly, the Bed Bath & Beyond deal isn’t a particularly vicious spiral as the conversion price is capped in a range (TBD) and is floored at $0.716 per share (the stock has gyrated between $3 and $5 in recent days). The market cap remains above $500m despite the high risk of bankruptcy (beware of option value, particularly for highly volatile stocks, see M&G Bond Vigilantes piece here, for more)

There is plenty of room to make money here (but they will lose money if the equity price drops below $0.716). If the stock recovers, there are plenty of further warrants to subscribe to over the next year at a 5-7% discount. But the preferred warrants are mandatory, and the issuer can declare a forced exercise under certain conditions, forcing investors to put up money.

All very convoluted and very complicated. I will leave the final comment to Matt:

“What Bed Bath has done here, I think, is that it has sold the right to do meme-stock offerings to some institutional investors. The investors get the ability to pick their spots to sell stock, and can get the stock at a discount from Bed Bath. They also get warrants: If they succeed in saving the company, they have a lot of equity upside. In exchange, they are putting up a lot of the money now, and promising to put up $800 million more whenever Bed Bath wants it, as long as they keep being able to sell it profitably. I am not sure, but it looks a lot like meme-stock financial engineering.”

In brief

Cineworld finally gave some clarity on what was happening on its restructuring process this week, with an update call held on Wednesday. An outline financing plan was submitted last weekend.

Talking to 9fin’s David Orbay-Graves, one lender said that the plan involves Cineworld’s $2bn DIP being repaid by raising up to $800m of equity worth up to $800m from the AHG, alongside an exit facility. Post-restructuring debt could be in the region of $1.6bn.

There was less definition seen at competitor Vue

Last week, a request was put into the Credit Derivatives Determinations committee seeking to identify whether a restructuring credit event had occurred with respect to Vue International Bidco Plc. Following the cinema group’s restructuring which closed a couple of weeks ago, new debt was issued from Vue Entertainment International Limited, a newly incorporated entity. It will be interesting to see if an orphan entity was left behind.

We will delve into this in more detail next week, but the situation is clearly not that highly defined, as the committee have yet to make their decision, despite several days of deliberations.

Spanish Steps

Food Delivery Brands (Telepizza) bondholders are set to take control and are willing to provide up to €60m of super-senior financing as revealed by 9fin’s David Orbay-Graves this week.

David’s piece fills in most of the gaps from the company’s announcement, which we assume is to cleanse the funds in the bonds. Interestingly, the plan is to cram down the €40m ICO-guaranteed loan. It sits behind the SSNs, but the move could be controversial.

I’m not paranoid, but they are out to get me

Events at GenesisCare, or perceived events, were one of the hooks for my creditor-on-creditor violence pieces earlier this week. As I said last week, lenders were concerned that a drop-down or uptiering financing could be done around them.

It was with amusement I read that Reorg had reported that lenders were seeking to sign co-operation agreements to ensure that none of their brethren were up to something behind their backs. It’s time to reprise Justice Richard Snowden’s quote:

“If you are not sitting at the table, that is because you are lunch.”

Creditor-on-Creditor Violence

GenesisCare was the inspiration for our two-part report this week on creditor-on-creditor’ violence or the more genteel ‘liability management’ as lawyers would prefer to call it over here. There are plenty of horror stories of first lien lenders becoming third lien overnight, as loose docs were used by others in their class or by third-party lenders to prime them behind their backs.

Part one looks at the motivations of borrowers and lender groups to undertake priming transactions. The report explains how up-tiering and drop down transactions work and reviews latest legal developments in the US.

Part two explores the differences between the US and Europe and what aspects to consider if you are structuring a European drop down or uptiering transaction. It also looks at coercive amendments such as Keter, the increased use of exit consents and the potential erosion of sacred rights.

What we are reading this week

Most of my time this week was reading court documents and practice statement letters, but there was still time to check in on the latest developments at Adani, as Gautam Adani tries to repair the damage following the short seller report from Hindenburg Research. Earlier this week it repaid a $1.1bn share-backed loan early, to dispel fears that it is under pressure to cover losses on margin loans. The FT writes that Adani was facing a $500m margin call on the loan.

Sticking with the FT, their report on Abu Dhabi’s stock market’s meteoric rise driven by the huge growth in valuation of International Holding Company is a cracking read. The huge conglomerate with a market cap of $236bn has received a number of asset transfers from Royal Group, controlled by Sheikh Tahnoon, for one dirham, and had subscribed $400m to Adani’s abortive share sale.

As Google struggles to recoup lost ground from ChatGPT, Microsoft shows how it can be used to summarise financial reports. The only downside is that it runs in the much derided Edge browser!

One investor found these gems on Isabel Marant’s website when doing due diligence for their latest HY issue — €55 for a pair of socks, hmmmm.

Most attention this weekend will turn to Rugby, not football (Brighton are playing at Crystal Palace this weekend in the M23 Derby, if we win our two games in hand we are just three points from a champions league spot!)

Last Autumn, the JUBEL brewery rented a Twickenham driveway to hand out cans of beer to Rugby fans. When they tried to do so again this year, they found Brewdog had pinched their idea.

Cue a cheeky response — if you don’t like the Brewdog, just pop it in the loo and swap it for a cold can of JUBEL! #LOODOG