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Brian Dearing

This week Citrix started marketing the bond side of its massive debt raise which will finance the merger of Citrix and TIBCO. The total package, amounting to over $12bn (equivalent), will be comprised of $4bn senior secured notes due 2029 (the “SSNs”), $2.5bn TLA, $4,050m TLB, €500m TLB, and a $1bn RCF (full cap table here on 9fin).

Given the sponsor-backed nature of the transaction, it’s no surprise that the documents are on the more aggressive side. However, there is a particularly interesting development in the SSNs that we felt warranted further exploration.

Usually, as our CEO Steven Hunter is quoted as saying, “one of the key historical protections for bondholders is that 50% of net income can be distributed as dividends and 50% should be retained in the business.” In other words, some of the profits should stick around to pay down debt, invest in the business to grow it, etc. But, as highlighted in our 9fin Educational on the Restricted Payments covenant, CNI is not the only metric that is used in Builder Baskets, on some occasions, alternatives to CNI are used, including EBITDA (subtracting certain deductions). We explore below how Citrix’s EBITDA Builder Basket is one of the loosest formulations we have yet to see at 9fin.

Whilst we are diving in to one specific topic in this piece, we flagged a host of other points for investors to consider in our full Legals QuickTake.

Builder Baskets — how are they traditionally built?

The Restricted Payments covenant historically was designed to allow a company, when it was profitable, to “build” Restricted Payments capacity via the Builder Basket. This was done by allowing them to accrue dividend capacity of 50% of cumulative Consolidated Net Income (”CNI”) (among other things).

As with all things in the land of covenants, this has not remained static, and it has evolved. Some companies / industries use other metrics (or, more often than not, pair a second metric alongside CNI), to build the Builder Basket. For example, Telcos have been known to use other metrics — for example T-Mobile Netherlands — because, as one argument goes, their business is just different, and CNI is not considered the best metric to assess business performance. This could be for a variety of reasons, one obvious one is that asset heavy businesses may continue to invest profits and therefore lower their CNI, and will inherently be more levered as a result. But, EBITDA, which is more indicative of the cash generation of the business, might be a more appropriate measure of performance.

Transactions that use EBITDA to build the Builder Basket will reduce EBITDA by a multiple of the issuer’s fixed charges (i.e., ensuring that the Issuer can still cover their debt payments). So the issuer is not getting credit for 100% of its cumulative EBITDA.

For example, the January 2022 deal by McAfee included a Builder Basket that was built using the greater of (A) 50% of CNI (subject to quarterly zero-floor — more on this later) and (B) Consolidated EBITDA less 140% of Fixed Charges. Even though McAfee is a tech company (and not an asset heavy one), we all know the market was a different place nine months ago and terms could be more aggressive and still get through (please note our analysis of McAfee is based on their Preliminary Offering Memorandum).

So, with that background, what happened in Citrix? The covenant package, including the formulation of the Builder Basket in Citrix is nearly identical to McAfee, which was certainly the basis for Citrix (note: the same law firms acted on both deals, and 9fin’s Similarity Scorer found that they are 75.939% matches). But the drafting in Citrix mysteriously is missing ~10 key words which radically change how the Builder Basket is built.

The drafting in McAfee was as follows, and the deletion in Citrix is shown in red below (emphasis added) — or see in 9fin’s Covenant Explorer here:

“the greater of (A) an amount equal to 50% of the cumulative Consolidated Net Income from the first day of the fiscal quarter during which the Completion Date occurs to the most recently completed fiscal quarter for which financial statements are internally available, calculated on a pro forma basis (which amount shall be deemed to be zero for each fiscal quarter if the Consolidated Net Income for such fiscal quarter is less than zero) and (B) an amount equal to (x) the cumulative Consolidated EBITDA from the beginning of the fiscal quarter during which the Completion Date occurs to the last fiscal quarter of the most recently completed fiscal quarter for which financial statements are internally available (which amount shall not be less than zero) minus (y) 140% of the cumulative Fixed Charges for the same period, in each case of this clause (B), calculated on a pro forma basis;”

This deletion completely strips out the requirement that Citrix reduce EBITDA by a percentage of their Fixed Charges, which, given the amount of debt that will be outstanding, is going to be considerable. As a result, they can apply 100% of their EBITDA towards making Restricted Payments! It’s also important to note that the Builder Basket is built on cumulative EBITDA, with a cumulative zero floor.

Further, there is no ratio test condition on the Builder Basket (as would be typical), and EBITDA adjustments for cost savings and synergies (including revenue synergies) are uncapped and subject to a lengthy 36-month look-forward period. Moreover, the Builder Basket has a very generous 1x EBITDA starter basket, meaning that the Builder Basket will begin building from c.$2.1bn day one rather than from zero.

Does it matter? Three billion reasons to think so

Remember, as mentioned above, EBITDA is a heavily adjusted number. Citrix disclosed a Net income (loss) of $(873.2)m, pro forma for the merger, while the ComboCo’s LTM Further Adjusted Cash EBITDA (based on Citrix and TIBCO stand-alone figures plus estimated synergies) is $2,115.1m. This means that if EBITDA is used instead of CNI (which is negative at the moment), at 100% with no reduction for fixed charges, this generates a nearly $3bn swing. We could predict they would build ~$2bn of Builder Basket capacity in the twelve months following the merger, over and above the ~$2bn starter amount.

Citrix had PF Net Income (loss) of $(873.2)m FY Nov-21, and PF Adjusted EBITDA for LTM May-22 of $2,115m.

Obviously this is extremely favourable for Citrix, and we expect that investors will ask they reinsert the language requiring them to deduct fixed charges.

Setting aside the enormous dividend capacity Citrix is likely to accrue under its Builder Basket, let alone the 2.56x EBITDA headroom we calculate they already have day one to make Restricted Payments, this formulation of the Builder Basket has other implications. They have included the “Available RP Capacity Amount” concept, which allows them convert RP capacity (including the Builder Basket), at a 200% conversion ratio, to debt capacity, which means their debt capacity could balloon very rapidly. Also bear in mind that debt incurred using the Available RP Capacity Amount basket can be secured on the same Collateral as the bonds.

Furthermore, there is no sub-limit on structurally senior debt incurred by non-guarantor debt, and this could be used to prime the bonds as well, but, bear in mind they already have enormous debt capacity, so this isn’t the most important takeaway.

Not to think too far into the future, and certainly not to predict any outcomes, but to the extent Citrix ever went into a restructuring, their enormous RP capacity (via the fixed baskets, but also the Builder Basket), could mean that they have significant flexibility to do J.Crew-style transactions, even when EBITDA has gone down (so long as it doesn’t go down far enough that it wipes out all the positive EBITDA amounts included in the cumulative calculation), where they send assets out of the Restricted Group using RP capacity, and subsequently incur debt secured on those assets.

See our 9fin Educational on J.Crew transactions here.

No Profits No Problem — Citrix’s “EBITDA Builder Basket”

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