Matalan is expecting five to 10 bids to come in on Friday’s first round bid deadline based on interest received so far, according to a source close to the situation. The UK discount retailer launched the sales process on 26 September 2022 as part of its recapitalisation plan.

After indicative offers are received on Friday, a selection of bidders will be taken through to the second round which is expected to last 5-6 weeks. The winning bidder is expected to be selected by next month, the source close said.

Matalan said in late September that “over a majority” of its first lien secured noteholders are supportive of the key terms of the recapitalisation plan. It added to facilitate the recapitalisation plan the strategic sales process was launched with Teneo managing the process. According to media reports the sales process is driven by first lien lenders after negotiations with the Hargreaves family over an equity injection.

On Monday (17 October 2022) over 90% of noteholders of Matalan’s £350m 1L 2023 notes approved the group’s proposed six-month extension of the notes to July 2023 from January 2023, giving the company plenty of time to conclude a sale.

The first lien noteholders have agreed to provide £200m of staple financing at a senior secured level for any parties interested in making an offer for the company. According to the company announcement the ad hoc group holds over 50% of the outstanding 1L notes.

If the sale is unsuccessful, the 1L lenders have a framework agreement in place for an alternative recapitalisation plan which involves a “material reduction” in the debt and extension of maturities to September 2027. The 1L group are willing to take full control of the group by part equitising the debt and extending the rest, a person close to the 1L group confirmed.

The 1L holders include Invesco and Man Group and is working with Perella Weinberg Partners (Financial) and Kirkland & Ellis (legal). The 2L holders have engaged Houlihan Lokey and Freshfields.

Teneo and Clifford Chance are the company’s legacy advisors. Teneo is managing the sale process. The current owners, the Hargreaves family, are working with advisors from Lazard and Paul Hastings.

Who’s looking to shop?

The group’s founder John Hargreaves stepped down as chairman so that he could make a bid for the company. Hargreaves is keen to maintain his control over the business he founded in 1985 but market participants are skeptical about the amount Hargreaves has at his disposal for the bid. Hargreaves is facing a £135m tax bill after a court ruled he owed capital gains tax in relation to his £231 million sale of Matalan shares in 2000.

But Elliott Investment Management has put its hand up to back the Hargreaves’ bid, Sky News reported on 11 October 2022, confirmed to 9fin by the first and a second source close to the situation. Elliot owns specialist lender Bantry Bay which provided a £60m asset-based super senior loan to the company this summer to take out an RCF. Reorg reported that Elliot would provide a debt package for the offer, which would wipe out the 2L holders.

The second source close said that the Elliott and Hargreaves partnership deal would take out the Bantry Bay loan and may involve some kind of haircut in the first lien as that’s where they believe the value breaks. The source also mentioned that the Hargreaves family provides IT services to Matalan, which is important to consider for the ideal buyer.

According to the Q2 report, the group spent £1.1m during the 13 week period ended 27 August 2022 on IT services from companies associated with the Hargreaves family. The group is however migrating its online platform to the The Hut Group (THG) in 2023.

The Bantry Bay 18-month ABL facility has a springing maturity prior to the extended maturity of the first lien SSNs meaning it has temporal seniority and will need to be addressed as part of a broader sale or recapitalisation process, as reported.

Private equity fund Alteri Investors is also looking to bid and may have the capacity to buy the whole business if they work with their owner Apollo. “Matalan is the type of business that is kind of their sweet spot and they think they could run it better than Hargreaves [and] modernise the business,” another source close said.

Alteri did not wish to comment.

Aurelius Group and Fraser Group founder Mike Ashley are also in the running, according to media reports and confirmed by the first and second sources.

The sale proceeds will go towards paying down the group’s outstanding debt. The question is where the value breaks in the capital structure.

In terms of valuation, the second source said Matalan would get a 4x EBITDA multiple at a maximum as it is a capex-intensive business compared to its competitors.

A third source said that a valuation of around 4x-4.5x EBITDA is fair considering negative effects from the FX hedge roll off in February and the current economic environment.

A ex-1L bondholder said the valuation should be at 5-5.5x EBITDA, citing House of Fraser and Debenhams as comparable.

These align with 9fin’s analysis which puts the valuation multiple of Matalan in a stressed sale scenario between 4.5x-5.5x.

Is the 1L covered?

The issue with the proposal put forward by the existing Matalan owners is that the value is most likely to break somewhere at the 1L leaving the 2L without any paydown.

Ideally, the 1L ad hoc group are hoping for a price target of £410m to cover their debt and the £60m provided by Bantry Bay, preferring a clean exit to owning the business.

According to 9fin analysis, to cover the £60m ABL and the £350m 1L principal, the business would need to fetch an EV multiple of 5.1x to 5.2x on Matalan’s LTM Q2 23 EBITDA of £78.8m or £81.2m of FY 23e EBITDA. Add in the principal plus accrued interest on 2L of £115m, and this takes the requisite multiple to 6.7x LTM Q2 23 EBITDA of £78.8m or 6.5x on FY 23e EBITDA of £81.2m.

The question is whether prospective buyers might look beyond FY 23 earnings towards potential headwinds facing the business in FY 24 and further out. We explore this in our deep-dive report on Matalan (part one here; part two here). We concludes that FY 24 earnings projections face significant downside risks, our FY 24e EBITDA comes in at negative £40m under our stress test.

2L fights back

Frozen out of the talks to date, and in an attempt to stay in the game, the 2L has taken matters into its own hands, by throwing its hat in the ring and deciding to credit bid the 1L.

On 14 October 2022, Reorg reported that the 2L offer includes cash to cover the £350m 1L bonds in full. The outstanding second lien debt will be converted into equity if their offer wins. Their group does not include Hargreaves, who has a £20m position in the 2L. Two sources close the 2L group said the terms in the article were accurate. One of sources told 9fin that the proposal assumes that the Bantry Bay facility will remain in place.

The sources told 9fin that the 2L group plans to use the £200m credit line offered by the 1L group and will be injecting the remaining £150m, which will be raised either through debt or equity. The £150m piece will rank subordinate to the £200m staple.

Bloomberg Law reported yesterday, 18 October 2022, that CQS and Napier Park are among five funds in the 2L group. The sources confirmed to 9fin that CQS and Napier Park are holders and that five in total are in the group. Three sources said System2 Capital are also in the group.

One of the sources close to the 2L group said: “We believe in the fundamental value of the business, there’s nothing wrong with it. Just because Hargreaves doesn’t have enough money doesn’t mean this business need to fail”.

Other bidders reached out to the 2L group after news broke on their proposal, the same source added.

The first source close said the proposal is “pretty racy” given the investors are only protecting around £60m of outstanding principal in the 2L and putting in £150m of new money that will be subordinated to the new first lien staple.

The second source close commented on the proposal saying the business can’t support that amount of debt and that it is not very credible as an outcome.

9fin is working on an analysis piece on the 2L proposal, to be published later today.

The group’s capital structure is here:

Matalan has forecasted £81.2m EBITDA for FY2023. However, 9fin’s analysis believes that their projections are ambitious. If the business were to be sold for £400m to £490m — 4.5x to 5.5x projected FY24e EBITDA — the £60m ABL and the £350m SSNs are pretty much fully covered.

However, for any prospective buyer to use the £200m staple financing offer from the ad hoc group means coughing up £210m of cash to take out the ABL and the remaining £150m SSN principal. The breakdown of the possible recoveries from a distressed sale are reproduced below:

Hargreaves himself owns a ~£20m stake in the 2L, as reported. According to the OM, at issuance in 2018 the Hargreaves family held around £65m of the 2L notes. In 2020, as part of a restructuring, he equitised £50m of his 2L holding to facilitate a deal.

The Hargreaves family own 100% of the shares in the company through their various entities. Here is a breakdown of the shareholdings as of 25 November 2017 from the bond OM:

Bonds rally

Both the notes have traded up over the past month as news flows through about potential bidders. The 1L note traded up to 92.75-mid yesterday, 18 October 2022, from 79.5-mid at 4pm, according to 9fin’s data. Today the notes are quoted at 92.5-mid. Market participants say this could be a short-covering trade and the notes are pretty illiquid.

The 2L £80m PIK Toggle 2024 notes traded up on 4 October 2022 from 63.58-mid to 81.5 the following day and have since remained at that level, according to the chart below:

In our follow up report. 9fin's distressed analyst Emmet Mc Nally looks at the potential economics of the 2L proposal as we understand. Equity value looks well covered based on the company’s earnings projections, however recoveries are below 100% of the requisite 2L principal equitisation and make-whole contribution in a downside earnings scenario.

To request a copy of this report complete your details here.