US LevFin Wrap — Melissa & Doug PIKs up toys, Multi-Color plays ball, PetSmart unleashes growth

David Bell

30 March 2023•6 min read

Major League Baseball restarted yesterday, after a raft of rule changes that are designed to rejuvenate and speed up the game. Perhaps the primary market could take some tips?

Bankers, sponsors and CFOs can’t exactly change the rules of play, but but they are bringing innovation to the plate to navigate tighter borrowing conditions and mitigate the impact of rising interest costs.

Brand new toy

Recently we wrote about how the PIK component in Cotiviti’s record-setting unitranche is part of a growing trend towards such structures in private credit; this week, a PIK feature popped up in a broadly syndicated loan deal.

Kids’ toy maker Melissa & Doug revised the terms of its two-year loan extension yesterday, adding a 100bps PIK step-up coupon if its rating drops to Caa1. The borrower has telegraphed expected ratings of B3/B, but lead arranger Credit Suisse says the ratings will be private.

PIK coupons aren’t exactly a new invention, but they are unusual in the loan market, and they’re one way borrowers can conserve cashflow. Rising interest rates are making analysts laser-focused on interest coverage, especially at CLO firms that are nervously eyeing limits on triple-C holdings.

Easy does it

The primary market still feels a little uneasy — it’s a little ironic that one of the only deals in the market this week is from Credit Suisse, given that it was that bank’s near-collapse (in the aftermath of the Silicon Valley Bank run) that interrupted a strong run of new issuance.

But the saga of the Citrix LBO continues — this week we reported that a draft OM has been circulating among bankers looking to offload the last piece of hung debt backing the buyout, so perhaps there is light at the end of that tunnel.

More broadly, investors have been pulling away from high yield credits, with Lipper data showing that high yield bond funds reported $2.135bn in outflows over the past week. That’s the third consecutive week of outflows, taking cumulative year-to-date outflows to just over $17bn.

That didn’t stop labelling company Multi-Color Corporation, which was taken private by CD&R in 2021, from pricing $300m of 9.5% SSNs due 2028 on Tuesday. Proceeds will fund an acquisition and refinance debt.

It was the first broadly-syndicated high yield bond issued in around a month, but sources said the company’s low ratings (B3/B-) and small size — plus the fact that there was already sizeable reverse inquiry for the deal — meant it didn’t attract a huge audience.

EnLink Midstream followed on Thursday with a $300m tap of its Ba1/BB+/BBB- rated 6.50% senior notes due 2030, which were trading close to par on Wednesday evening.

The leveraged loan pipeline remains threadbare, however. Aside from Melissa & Doug, there’s an amend-and-extend deal from PDC Wellness currently in syndication, but other than that it’s pretty slim pickings.

No man’s land

Concerns about tightening lending conditions are growing, and there’s also the question of how the Fed reacts to banking issues and inflation risks at the next FOMC meeting in May.

This is all contributing to a fairly wide bid-ask when it comes to the primary market. On the one hand, CFOs have sticker shock from high all-in rates; on the other, investors see potential for spreads to widen even further.

Tom Cannon, a portfolio manager at DuPont Capital, said he could see this malaise lasting for several months.

“Being able to borrow at 9% or higher is not very appealing to issuers,” he said. “You’ve got to let the bank stuff settle down and then for high yield you need more clarity on the recession question.”

For now, average credit spreads are in something of a “no-man’s land”, according to JP Morgan analysts.

On Wednesday, they wrote that pricing was “arguably too wide to bring out sellers and too tight to incline buyers to commit capital absent a full recessionary cushion.” But they added that there’s a near-term window for credit markets to do better, “especially given some scope for the direct lending community to step in and fill some of the gap left by the regional banks.”

We wrote about that potential trend, and will be writing about it a lot more as we continue to expand our coverage of private credit. Even though some investors are keen to put cash to work, the threshold to commit is higher than it was earlier in the year.

“We’d want more on the covenant side, and higher pricing,” said Dan DeYoung, portfolio manager at Columbia Threadneedle. “Why buy a new piece of paper at par if I could buy a discounted loan in the secondary?”

Earnings

In contrast to PDC, PetSmart lenders were boosted this week as the BC Partners-backed company reported better than expected fourth quarter results thanks to strong margin trends, in contrast to Q4 2021 when supply chain issues were starting to bite.

Similarly, falling freight costs are helping Apollo-backed retailer Michaels Stores recover from some of the margin pressures that hit last year. The company’s fourth quarter earnings released this week showed strong EBITDA growth, with investors also taking comfort in its strong liquidity and improving inventory picture.

While those two companies paint a picture of robust consumer spending, Great Outdoors Group’s earnings suggested that demand is slowing for bigger ticket items as financing costs rise.

The company, which owns Bass Pro Shops and Cabela’s, reported a decline in EBITDA partly due to a slowdown in boat sales.

Oil and gas producer Encino Energy, meanwhile, posted better earnings for the fourth quarter of 2022 and the full year, thanks to increased production and elevated commodity prices. But it nevertheless managed to burn cash, and expects to do so again this year as energy prices fall.

Before you go

In the run-up to DealCatalyst’s private credit and middle market lending conference in Florida next month, we are partnering with the event’s organizers for a series of exclusive video interviews.

This week we spoke with Cassandra Fahy, a managing director at Pemberton Asset Management who covers the UK and Ireland. You can watch the video, and also sign up for the conference.

For more on private credit, check out this week’s Cloud 9fin podcast. Our US deputy editor Bill Weisbrod spoke with Brian Garfield, a managing director in Lincoln International’s valuations and opinions practice.

Brian helps private credit funds value their holdings in illiquid debt instruments — a topic that’s coming under heavy focus given the sell-off in public debt markets, and the early indications that a secondary market is developing on the private side of credit.