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Denitsa Stoyanova, CFA

Orpea’s new management has failed to stabilise the French care homes business since they came into office this summer. Not only did they deliver a H1 22 operational performance below expectations due to the PR/ESG crisis amid a tough macro environment, but they also unveiled a negative outlook and hinted at an imminent process with creditors. This was confirmed by Wednesday’s announcement of a debt restructuring via a court supervised conciliation process.

The H1 22 report spooked the market. The 2025 SUNs tanked from the low 70s in early September to languish in the mid-40s as of 23 October 2022. The next day the trading of all equity and debt instruments was suspended by the AMF pending an announcement.

Two days later on Wednesday, management confirmed that they are embarking on debt restructuring with creditors via a court supervised conciliation process. Upcoming negotiations with creditors will be supported by a new business plan to be disclosed on 15 November 2022.

With the company indicating that it is considering equitising its unsecured debt, the bonds dropped sharply again on Wednesday falling by another 20 points to be quoted in the mid-20s at time of publication.

Orpea has appointed Rothschild and Perella Weinberg as financial advisors and White & Case and Bredin Prat as legal advisors to manage the process.

Conciliation is a court-supervised process under the French pre-insolvency code that is consensual, amicable and flexible. It is overseen by a court-appointed conciliator (i.e. an impartial mediator) whose role is to help reach an agreement between the company and its stakeholders to resolve financial difficulties. The aim is to ensure that the group continues as a going concern. The procedure is confidential and Orpea’s board of directors will retain control of the group in the meantime.

The advantage of using conciliation for Orpea is that it could obtain fresh funding, as was the case earlier this year when it used the same process.

The advantage for creditors if they decide to inject fresh cash is that A) they will benefit from super seniority (i.e. they will rank senior to all prior and most subsequent creditors) and B) their claims cannot be written off in a subsequent reorganisation / safeguard plan unless they agree to it.

Orpea specified it is seeking to negotiate with creditors only. This means that wider stakeholders such its employees, contractors, suppliers and residents will not be affected. If the parties reach an agreement, the court can then either acknowledge or sanction it. The conciliation procedure is subject to a five month time limit, which cannot be exceeded.

What are the options under consideration?

Management clarified it is keen to consider the following three options:

Debt-for-equity swap of up to €4.4bn of unsecured debt issued by Orpea S.A.

Amendment of the "R1" and "R2" financial covenants that are attached to €3.3bn of unsecured bank debt, which will not be impacted by the equitization

Liquidity injection from new super senior debt, which will be secured on currently unencumbered assets.

We note that while conciliation can be a stand-alone procedure, it can also be used as a preliminary step within the French pre-insolvency framework to implement a pre-pack agreement or sale. However, this option in not currently contemplated by management, per the press release.

This is the second time in five months that Orpea has filed for conciliation. The first procedure with its bank lenders was approved in June 2022 and resulted in the injection of €1.73bn new money and up to €1.5bn of optional liquidity subject to a €2bn disposal plan which is detailed here.

By 27 September 2022, Orpea had drawn down €2.25bn, or 78% of the total envisaged amount, to refinance bilateral bank loan maturities and to pay for its exorbitant capex plan.

This was meant to stabilise the care home operator for at least another year and buy it time to hammer out a more comprehensive plan. As we discussed in our previous report, we never considered this to be the solution to its high leverage problem. And while the restructuring process did not come as a surprise to us, it came quicker than expected driven by operational deterioration from macro pressures.

Despite the well-publicised scandal that erupted this year, Orpea’s occupancy rate in France wobbled between February and April 2022 but improved since May so the group saw higher occupancy YoY in H1 22. This helped the group deliver top line growth (+10.9% YoY to €2.29bn in 1H 22) broadly in line with its historical trend. This was unsurprising given the fixed and predictable nature of fees and the long-term nature of patients’ residency.

However, all operating costs suffered from inflationary pressures with the most notable movements being staff costs (+13% YoY due to higher wages amid a tight employment market, further exacerbated by an active recruitment policy to address allegations of understaffing), food & catering costs (+15% YoY) and energy costs (+69% YoY explained by the lack of electricity hedging and only partial gas hedging). The size of Covid-19 related support received from the French government naturally slumped this year compared with H1 21. As a result, reported EBITDA plummeted -68% YoY to €163m and the EBITDA margin was also slashed (7% vs 25%, H1 21).

Management guided the deterioration “is continuing in the second half of the year” with profit margin likely to drop even further compared to H1 22. The weak profit will also have a knock-on effect on cash flow generation. Cash flow from operations after taking into account cash interest costs has already weakened -15% YoY to €208m in H1 22.

€700m related parties receivables at heightened risk

Orpea is desperate for cash and is actively looking to collect as many of its receivables as it can. Of the €1.08bn current receivables on balance sheet at end-H1 22, the two biggest components are €477.6m receivables from JV&As and €219.6m of real estate receivables, both of which are facing headwinds. Of the €477.6m, €58m or 12% were receivables from its Belgium associates have been impaired (this was done to cover losses of companies running nursing homes in Belgium).

Most of the €219.6m are advance payments made for the development of RE assets. The company is trying to unwind those transactions to get hold of the assets to on-sell them (€112m in particular relates to a single construction partner in Italy).

So how easy would it be to unwind those transactions and at what potential discount? In its H1 22 results, management said that it “does not anticipate significant future losses on these receivables given the value of the underlying real estate assets”.

However, in the latest press release it made a U-turn, suggesting that €697m of receivables are at a risk of impairments if negotiations fall through.

In FY 21 and H1 22, the company had €4.7bn of intangibles on the balance sheet split between €1.7bn goodwill and €3bn the value of operating licenses. During H1 22 management tested 37 cash generating units (CGUs) for impairments. This included a key Brazilian subsidiary Brazil Senior Living (BSL) that accounted for over 5% of total goodwill. In H1 22 Orpea bought out the outstanding minority stake in BSL, which necessitated its fully consolidation. To do that, it had to revalue the anticipated cash flows from BSL for the next five years using a higher discount rate (10.1% in H1 22 vs 7.23% WACC in FY 21), which reflects the jump in the risk-free rate. This led to impairment of €78m goodwill and €49m operating licences after the consolidation. There were further €22.4m impairment at some smaller unidentified CGUs.

However, we note that in FY 21 Orpea had 983 facilities in operation with each nursing home or hospital representing a CGU. With only 37 CGUs tested in H1 22, this left 946 CGUs untested and raised the risk that further impairments could be unravelled by year end.

We now have some clarity on the size of those impairments.

In Wednesday’s press release, management guided it would book at least €1.3-1.5bn impairments on goodwill & intangible assets in its FY 22 results.

In FY 21, Orpea reported €8.1bn of real estate assets on balance sheet, which increased to €8.4bn in H1 22 – saying this was due to the acceleration of capex investment that boosted the share of assets under construction. Those fixed assets were valued using an average cap rate of 5.27%, which in no longer realistic in a rising interest rate environment and suggests a value loss.

We now have some clarity on the contemplated asset write-downs.

To date management has examined €5.8bn of real estate assets (out of the €8.4bn above) and estimates those will be subject to €0.8-1bn impairments (equal to 17% of €5.8bn), per its press release.

This leaves another €2.6bn of real estate assets that are pending re-valuation, which creates risk of write-downs of ~ €450m per our estimate (assuming €2.6bn is also haircut by 17%).

Orpea cautioned that any changes to calculation parameters such as WACC and yield on real estates between now and 31 December 2022, may result in additional write-offs.

For real estate assets, management guided Wednesday that every 0.25% rise in the cap rates would lead to €240m drop in asset value.

Management did not provide sensitivity analysis for intangible assets in the press release. But we can do a read-across from its H1 22 results. Regarding the impairment testing for the 37 CGUs in H1 22 (discussed above), management indicated that a 0.50% increase in the WACC used to discount cash flows would lead to €97m extra impairments of those CGUs. However, the value of the 37 CGUs was only €900m out of €4.7bn total intangibles. This implies that the impact on the total intangibles, may be ~ €506m in our estimate.

As of 30 September 2022 Orpea had €9.53bn gross debt, of which €4.48bn is secured and €5.05bn unsecured. Of the unsecured bank debt, €3.34bn is subject to two financial covenants (R1 and R2).

R1 is a financial leverage covenant calculated as (Net Financial Debt– net real estate debt) /[Ebitda LTM excluding IFRS 16 – (6% x net real estate debt debt)]. In H1 22, the group was in compliance with that covenant with a 3.58x test versus 5.5x maximum allowed. However, given the fast deterioration in EBITDA, management expects to breach this covenant by year end.

R2 is a financial gearing covenant calculated as (Net Financial Debt) /(Equity + Quasi Equity). In H1 22, the group was also in compliance with the covenant with 1.87x test versus 2.0x maximum allowed. However, in light of the large upcoming tangible & intangible assets impairments (which will be recorded mainly as a reduction in equity), Orpea expects to breach this covenant too.

We expect the company to first obtain waivers for the covenant tests due on 31 December 2022 and, second, to negotiate much looser covenant levels to accommodate the weak profitability and much reduced asset base in line with the new business plan.

Orpea sold around €108m of assets in the first half of the year (judging by ‘Assets held for sale’ figure falling from €387m in FY 21 to €279m at end-H1 22), but worryingly those properties appear to have been sold at a loss (of c. €23m per our estimate).

In June 2022, as part of its first conciliation plan, the group agreed to dispose €1bn of assets by the end of FY 23 (i.e. over 18 months) and another €1bn by the end of FY 25. The pro-rata share over 12 months is €667m, which is the number we would have expected to see reported under “Assets held for sale” on the H1 22 balance sheet. Instead, the group put up only €279m assets for sale thus far, of which it delivered €94m disposals in the Netherlands in September 2022 with another €30m pending in Q1 23.

Given the volatile interest rates and inflationary headwinds, most institutional investors and industry buyers have unsurprisingly put their M&A plans on hold. This explains Orpea’s significant underperformance versus the plan, but also blows its de-leveraging timeframe out of the water.

In view of the above, management is seeking to equitise as much of the €4.4bn unsecured debt (issued by Orpea S.A) as possible, in order to reduce the level of total debt to a more manageable level that can be serviced with the reduced disposal proceeds.

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