Friday Workout - Back to the New Normal; Popcorn Economics; Minimum SVP product
- Chris Haffenden
Last week, the Workout highlighted supply chain difficulties and rising costs of doing business. We cautioned that unlike the latest inflation spike, these effects may not be as transitory, with corporate resilience the key to a return to pre-covid levels. But what is the new normal? How certain are we that the pandemic hasn’t accelerated structural issues for a number of industries, and created a few new entrants? But in the new Meme Economy it may not matter. If companies such as AMC can still attract capital, how do distressed players find opportunities to deploy their massive amounts of dry powder?
Earlier this summer, it all seemed much clearer. The rate of vaccinations was fast enough to allow a full reopening and a final lifting of restrictions, amid encouraging signs of effectiveness for new variants, significantly reducing hospitalisations and deaths.
But full vaccination efforts are fading, witness recent events in Florida and the ability in stopping onward transmission and reduced efficacy for new variants is clearer. The CDC has cautioned about Delta but watch out for the more worrisome Lambda from Latam, which caused a significant spike in Chile despite a very high vaccination rate.
This has meant that the level of current activity is lower than we expected three months ago. The Economist has an excellent global study of 50 countries, their activity index is 68% of the pre-pandemic level. Cinemas and Flights remain significantly impacted.
Many countries in the past fortnight saw negative moves in their Economist’s index figures. The US is down 1.9 points, China as it closes its largest port and shuts down travel between certain cities is -5.2. In Europe, France is -6.7, Spain -2.9, Italy -2.3, Germany -0.9, and Britain -0.4. After suffering some of the worst effects of the pandemic the BRICs (ex-China) are now seeing the strongest recoveries, giving some relief for companies with an EM focus.
Looking at the sector activity in more detail, I am slightly surprised by the office figures - I thought they would be much lower. Talking to bankers, lawyers, analysts, and other journalists in the past couple of months, most are keen on the hybrid working route. Two-to-three days in the office is the median answer, and while most are saying that their companies are encouraging more office use in September, very few are enforcing it.
This might be a smart move, as there appears to be a big disconnect between the views of employees and their employers on flexibility, according to McKinsey.
And it’s very different in the new economy:
Popcorn Economics
When Guy Hands and Terra Firma bought Odeon Cinemas he said the management team thought they were part of the film business. “I had the difficult job of explaining to them that they were in the popcorn-selling business."
Late November 2020 seems a long while ago. Cineworld was teetering on the brink and in discussions about an emergency super-senior loan, which printed in the mid-teens, avoiding existing lenders being J-Crewed by a Centerbridge funding proposal.
Around the same time AMC was in talks with a dozen strategic investors to lengthen its liquidity runway to summer 2021 from early 2021 hoping the release of Wonder Woman 1984 for Xmas will “meaningfully extend this.”
Despite further lockdowns and poorer than expected trading from reopening, but like the Cruise businesses, Cinemas have been embraced by equity investors. AMC in particular has taken full advantage of its ‘meme’ stock status – remember the free popcorn offering to new investors in their at the money offering in early June? The shares rallied 100% on the day.
Never one to miss an opportunity, this week AMC said it would accept Bitcoin payments for US movie tickets by the end of this year in another ploy to retain its appeal for its new 3m strong retail investor base. Incredibly, it is valued at 3x 2019 sales - which may never return.
As Matt Levine points out in a post early this week, their boss said he learned about crypto while serving on a board of a SPAC:
“I… write … about … finance? Like, for my job? Why? The chief executive officer of the main meme stock these days, a guy known by his retail investor fan base as “Silverback,” learned about Bitcoin while serving on the board of a SPAC and now plans to accept it for movies and popcorn. Those are all words. I just typed them. I sure did.”
But at least it is more entertaining than replying to stock analysts, asking boring old world questions about triple digit monthly cash burn and which year AMC will be able to deleverage. But despite failing to meet its lowered targets, AMC stock is up 1480% this year.
AMC has decided it would allow individual stockholders to submit questions on its earnings call, which led to inevitable questions about a tie-up with GameStop.
As Levine brilliantly summarises: “Yes, right! Put the GameStop in the AMC! Drive there in a Tesla that you rented at a Hertz! Pay for your tickets with Dogecoin! Cram the whole thing into a rocket ship and send it to Mars! I already said “SPAC”! This is how finance works now; the goal is to say as many meme-trade buzzwords as possible because that is what makes stocks go up. That’s why you do a call like this.”
But loan investors are a little more difficult to convince, with prices falling over two points on the release. Despite most of its movie theatres reopening revenues in Q2 were 70% lower than in 2019. Blockbuster films failed to deliver and like music streaming, could the Cinema industry be facing a structural problem as it loses its three-month monopoly on new releases?
Cineworld reported yesterday. In July, when all its cinemas were open, admissions were at 45% of 2019 levels. Without a substantial $204m tax credit, cash burn would have been a hefty $271m. In the going concern report, the company provided an optimistic base case scenario, supplemented with a “severe but plausible downside forecast”. The base case sees admissions at 90% of 2019 levels by Q421 through 2022, and 95% through 2023.
The severe but plausible scenario involved a resurgence of the virus that would see admissions fall to 45% of 2019 levels from Dec-21 through Feb-22, with no further lockdown period considered. A second more severe downside scenario contemplated another lockdown during Dec-21/Jan-22, with both cases leading to a covenant breach at the June 2022 test.
Minimum SVP product
There was plenty of scepticism on FinTwit about Strategic Value Partners (SVP) new $5bn distressed fund, after founder Victor Khosla said most investing attention would be in Europe.
After all, in the current market many players have given up hope of a covid-induced restructuring wave, with ratings agencies worst cases of a default rate of 5-6% in 2021-2022.
“How hard must it be for him to have raised a 5bn fund just to see that in the meantime yields were back to square one. I hope he is in no rush since the next two-years won't give him many opportunities IMO,” said one on FinTwit.
“To me, at the moment, distressed opportunities will come only to disruptive business trends, not due to the economic cycle,” said another.
I agreed with the second tweeter, but also cautioned not to be too blindsided by LevFin. A lot depends on the funds’ remit and the return assumptions. There are plenty of smaller bilateral deals to be had as SMEs struggle to repay covid loans in the sub €50m space, for example.
There are also other sectors where structural issues remain, such as Aviation and Commercial Real Estate and other funding markets to explore such as structured finance. But this requires having industry specialists, and good loan sourcers.
Last year, after initially taking advantage of the April-June price dislocation, liquidity finance was a great business for distressed funds, providing the Cineworld-type loans at low-to-mid-teen yields. But according to one distressed manager, funds are now being forced to not only lower their return assumptions, but also to play at the lower end of the capital structure. This means HoldCo PIKs and preferred equity opportunities in the high single-digits.
SVP can always stretch the definition of Europe beyond EU borders. For the brave, CEEMEA always throws up opportunities such as Agrokor in 2019, perhaps NMC Health in 2021?
Finally, I would caution about figures being bandied around on dry powder for distress funds and their returns. Very few deploy anywhere near their total funds size, and many must park their cash in HY while awaiting opportunities.
In brief
Uneager in Riga, Olympic Entertainment management would not be drawn on events at their private equity owner Novalpina in their earnings call yesterday. The message was upbeat, but their tone was anything but. Their biggest challenge is Latvia and access to profitable casinos. Management is positive on demand and liquidity, which stands at €23m. Their expectation is for ongoing restrictions, but they are “reasonably confident” absolute closures are unlikely over the Winter months. Despite a potential change of control event, the bonds remain stuck in the high 80’s, which suggest that beleaguered holders still ruing the loss of Lithuanian and online assets last year view a J Crew are doubtful. Our colleagues at Reorg have suggested that Novalpina’s acquisition of two gaming businesses could be contributed to Olympic to refinance the 2022 bonds - perhaps it’s the hope that kills.
Corestate is a difficult business to understand and arguably even tougher to analyse. It has attracted its fair share of short sellers in recent years, most notably Muddy Waters. There has been a revolving door of executives, and their business model of mezzanine development finance seems to be too good to be true, at 15-20% rates for 12-15 months with virtually no defaults. Loans are repaid after the final building permit is obtained and the developer is de-risked and refinances. Mezzanine bridge loans are fed into their Stratos Funds business with churn rates of over 20% per year, meaning that new fund investors must be constantly sought to support the lending. According to the 2018 bond OM, the hybrid loans give the lender under certain circumstances the right to convert into equity in case of default by the borrower. In its H1 earnings call, it said that its Real Estate Debt business is booming, but we would sound a word of caution, some of their clients like SIGNA are now going direct to HY.
Holiday travel is returning, but there is still a long way to go to get back to normality. TUI said yesterday that peak summer period bookings, including amendments and voucher re-bookings were down 56% versus July to October 2019. Total Summer 2021 bookings including amendments and voucher re-bookings were down 68% versus Summer 2019.
Cost savings and Minimum Annual Guarantee (MAG) payment relief from airport landlords helped Dufry’s EBITDA improve 46% in the first half of 2021 to CHF 370m, despite revenues falling 25% versus prior year (to ~CHF 1.2bn). During a lengthy Q&A for the Swiss travel concessions retailer, investors focused on the recovery plan and cash flow projections for 2023. Cash burn for H1 was better than forecasted at the April bond issuance, with Equity Free Cash Flow (EFCF) turning positive in May and June with 65% of stores open by end H1.
What we are reading this week
After years of stable property prices and higher rates of owner-occupation than the rest of Europe, in the past decade Germany has seen a large property boom, most notably in the big-seven cities. Developers have cashed in, but Berlin’s referendum in September may be a black swan – it seeks to expropriate 240,000 properties from large developers.
We’ve written at length about the Amigo Loans scheme and how it failed after the FCA intervened. But a similar one for Friends Provident managed to pass this week. Shearman & Sterling have issued a good client note on why
9fin engineers biggest bugbear was supporting our tech on Internet Explorer – which we have finally killed off (don’t worry we warned our users well in advance). This article from a YouTube engineer shows how and why they did it a lot earlier than we did
I’m told by junior members of the 9fin team that NFTs are the next big investment. Is it an even better way than the art and property markets for money launderers to adopt?
Alan Rushbridger, the former Guardian editor releases in full his “response to the proposed reform of the Official Secrets Act. The Law Commission, which scrutinises UK legislation, eventually recommended a public interest defence. The British Government has refused to accept that recommendation and is proposing legislation which will punish journalists and whistleblowers. I hope some of this material will help persuade MPs to reject the proposals.”
This is extremely concerning, and I recommend you take the time to read this lengthy post.
On that sobering note – I will take my leave (literally) – the Workout will return on 27 August.
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