Staples, Inc.
New Coverage: Staples’ Term Loan and 2025 Notes Likely Permit Significant Transfers of Intellectual Property to Unrestricted Subsidiaries
Tue 09/25/2018 14:20 PM
Relevant Documents:
Term Loan Summary
2025 Notes Summary
In September 2017, Sycamore Partners completed its acquisition of Staples Inc. for about $6.9 billion. To finance the acquisition, Staples entered into a $2.7 billion senior secured term loan and a $1.2 billion asset-based revolving credit facility and issued $1 billion of senior notes due 2025.
Because a significant portion of the collateral securing the term loan likely consists of Staples’ intellectual property, and in light of J.Crew’s and Claire’s’ transfer of intellectual property to unrestricted subsidiaries, this piece focuses on Staples’ ability to consummate similar IP transfers to unrestricted subsidiaries under the term loan and 2025 notes.
J.Crew’s transfers enabled the unrestricted subsidiary to prepay debt that J.Crew was restricted from prepaying under its debt documents, while Claire’s transfers enabled the unrestricted subsidiary to incur debt that Claire’s was restricted from incurring under its debt documents.
The Term Loan and 2025 Notes likely permit Staples to make at least $2.25 billion of investments in unrestricted subsidiaries, plus additional amounts equal to the lesser of the company’s retained excess cash flow or 50% of consolidated net income since the acquisition, assuming Sycamore’s $1.6 billion equity contribution was designated as an Excluded Contribution.
As Reorg Covenants has previously covered, J.Crew’s transfers ultimately resulted in J.Crew repaying certain lenders’ terms loans at par and converting their outstanding term loans into a new “class” of term loans that would receive a higher interest rate and an accelerated repayment schedule. Because the Term Loan permits Staples to purchase term loans on a non-pro rata basis and explicitly permits Staples to favor certain term lenders over other term lenders, the Term Loan would likely not restrict Staples from consummating a similar J.Crew-like coercive exchange.
Additionally, the Term Loan and 2025 Notes allow for $1.475 billion and $2 billion respectively of additional secured debt. Other key covenants as well as differences between the term loan and the 2025 notes that are not discussed in this analysis but are summarized below.
For a complete overview of the terms and provisions in the term loan, click HERE, and in the 2025 Notes, click HERE.
On Sept. 14, Essendant Inc., a national distributor of workplace items, announced that it was being acquired by Staples Inc. (“Staples”) in a deal valued at $996 million, including net debt.
Staples was acquired in September 2017 by Sycamore Partners for about $6.9 billion. As part of the acquisition, Sycamore separated Staples’ U.S. retail business, the Canadian retail business and the North American B2B distribution business (“NAD”) into three separate entities, with the Staples name remaining with the NAD. This piece focuses on the NAD financing.
Staples’ capital structure as of April 29, 2017, pro forma for the acquisition, is illustrated below for reference. Note that because Staples is a private company, this analysis is based on Staples’ financials as of April 29, 2017, which are the most recent financials we have reviewed.
As illustrated above, in connection with the acquisition, Staples entered into a $2.7 billion senior secured term loan facility (the “Term Loan”) and a $1.2 billion asset-based revolving credit facility (the “ABL Facility”) and issued $1 billion of 8.5% senior notes due 2025 (the “2025 Notes”).
The Term Loan, ABL Facility and 2025 Notes are each guaranteed by Staples’ material domestic restricted subsidiaries and are secured by equity of Staples, each of the guarantors, 65% of the voting stock and 100% of the non-voting stock of foreign subsidiaries directly owned by Staples or the guarantors. In addition, (i) the Term Loan is secured by a first lien on all or substantially all of Staples’ and the guarantors’ tangible and intangible personal property, including intellectual property, and a second lien on the ABL collateral, and (ii) the ABL is secured by a first lien on accounts, inventory, deposit accounts and related assets and a second lien on the Term Loan collateral. Notably, however, the Term Loan is not secured by Staples’ real property.
As Reorg Covenants has previously discussed, as part of a series of restructuring transactions, J.Crew and Claire’s transferred portions of their intellectual property to newly created unrestricted subsidiaries and entered into licensing agreements under which they paid the unrestricted subsidiaries royalty payments for continued use of the transferred IP.
J.Crew’s transfers enabled the unrestricted subsidiary to prepay debt that J.Crew was restricted from prepaying under its debt documents, while Claire’s transfers enabled the unrestricted subsidiary to incur debt that Claire’s was restricted from incurring under its debt documents.
More recently, PetSmart transferred portions of equity of its Chewy subsidiary to both an unrestricted subsidiary and to its parent company Argos Holdings Inc. While the purpose of such transfers remains unclear, the effect was to release the liens on Chewy’s assets that secured PetSmart’s term loan and secured notes.
As illustrated in Staples’ balance sheet below, pro forma for the acquisition, 47% of its non-current assets (or $2.986 billion) that secure the Term Loan consisted of intangible assets, and 34% (or $2.157 billion) consisted of goodwill. Only 14% (or $893 million) of Staples’ non-current assets consisted of plant, property and equipment.
Although the Offering Memorandum did not disclose the value of Staples’ intellectual property that secures the the Term Loan, the value of the IP could be significant, because such intellectual property is included in Staples’ $2.986 billion of intangible assets.
Although Staples’ financials have not materially declined since the acquisition, and although Staples likely would not need to pursue similar transfers in the foreseeable future, given how much of the collateral securing the term loans consists of intellectual property, in this piece, we analyze Staples’ ability to consummate transfers similar to those consummated by J.Crew, Claire’s and PetSmart. Note that because we have not been provided a copy of Staples’ ABL facility, our analysis focuses on restrictions under the Term Loan and 2025 Notes.
The following table illustrates Staples’ ability to make investments in unrestricted subsidiaries under the Term Loan and the 2025 Notes. We analyze these baskets below.
Similar to PetSmart’s debt documents, the Term Loan and 2025 Notes only restrict Staples and the restricted subsidiaries from prepaying debt that is subordinated in right of payments to the term loans and the 2025 Notes. As such, Staples likely would not need to rely on an unrestricted subsidiary to prepay debt that it is unable to prepay, given that it is currently not restricted from prepaying any of its outstanding debt.
In addition, in order to finance Staples’ acquisition, as disclosed in the Offering Memorandum, Sycamore Partners made a $1.6 billion cash equity contribution to Staples (the “Equity Contribution”).
Although the Term Loan’s Available Amount basket and the 2025 Notes’ Builder Basket (which we discuss below) likely do not include the Equity Contribution, the Term Loan and 2025 Notes include baskets that permit Staples to pay dividends, prepay certain outstanding debt and make investments not to exceed the amount of Excluded Contributions Staples has received.
Under both the Term Loan and the 2025 Notes, the definition of “Excluded Contribution” includes “net cash proceeds … received by [Staples] from … contributions to its common equity capital,” as long as such contributions have been designated as an Excluded Contribution pursuant to an Officer’s Certificate.
As such, to the extent Staples designated the Equity Contribution as an Excluded Contribution, it may have an additional $1.6 billion of capacity under the Term Loan and 2025 Notes to pay dividends, prepay certain outstanding debt and make investments.
As illustrated in the Term Loan Summary, Staples can make investments in unrestricted subsidiaries under the Term Loan using an Available Amount basket that is based on retained excess cash flow, plus other typical amounts, including the Equity Contribution, plus $150 million. Although Staples must ensure that no Event of Default is occuring in order to access the Available Amount, it is not required to meet a leverage test.
Staples’ 3.5x leverage ratio likely restricts it from making investments from the Term Loan’s leverage-based investments basket that requires meeting a 3x leverage test.
Staples is also permitted to make at least $500 million of additional investments in unrestricted subsidiaries under the Term Loan, including $100 million under a general investments basket, $250 million under a basket for investments in unrestricted subsidiaries and $150 million under a shared prepayments and investments basket. It can make an additional $150 million of investments using capacity under a general restricted payments basket, but any such investments would reduce Staples’ dividend capacity.
As illustrated in the 2025 Notes Summary, the 2025 Notes permit Staples to make investments in unrestricted subsidiaries using the Builder Basket if it can meet a 2x fixed charge coverage ratio (“FCCR”) and if no Event of Default is occuring. While both the Builder Basket and Available Amount include a $150 million starter basket, whereas the Available Amount is based on retained excess cash flow, the Builder Basket is based on 50% of consolidated net income.
Staples’ approximately 4x FCCR likely permits it to make investments from the Builder Basket.
Staples’ 3.5x leverage ratio likely restricts it from making investments from the 2025 Notes’ leverage-based investments basket that requires meeting a 3x leverage test.
Staples is also permitted to make at least $550 million of additional investments in unrestricted subsidiaries under the 2025 Notes, including $150 million under a general investments basket, $150 million under a basket for investments in unrestricted subsidiaries and $250 million under a basket for investments in similar businesses. It can make an additional $150 million of investments using capacity under a general restricted payments basket, but any such investments would reduce Staples’ dividend capacity.
The 2025 Notes do not include a proceeds basket.
Assuming Staples wants to preserve the ability to pay dividends under general restricted payments baskets, the Term Loan and 2025 Notes likely permit Staples to make at least $650 million of investments in unrestricted subsidiaries (which includes the $150 million starter basket under the Available Amount, plus additional amounts equal to the lesser of the company’s retained excess cash flow or 50% of consolidated net income since the acquisition. To the extent Sycamore’s $1.6 billion equity contribution made as part of the acquisition financing was designated an Excluded Contribution, Staples may be permitted to make $1.6 billion of additional investments in unrestricted subsidiaries.
As Reorg Covenants has previously covered, J.Crew’s transfers ultimately resulted in J.Crew repaying certain lenders’ terms loans at par and converting their outstanding term loans into a new “class” of term loans that would receive a higher interest rate and an accelerated repayment schedule. As discussed, J.Crew’s ability to consummate these transactions likely hinged on its ability under the term loan to purchase the term loans on a non-pro rata basis and its ability to amend provisions governing sharing of payments made to the lenders.
Unlike J.Crew’s term loan, whereby J.Crew arguably was not permitted to purchase term loans on a non-pro rata basis, Staples’ Term Loan explicitly provides that:
In our coverage of PetSmart and American Tire Distributors, we discussed how PetSmart’s and ATD’s term loans likely permitted coercive exchanges, given that PetSmart and ATD were permitted to purchase term loans on a non-pro rata basis and that amendments to the pro rata sharing provisions could be amended by a majority of lenders. Under those agreements, we concluded, the term loans would likely not restrict PetSmart or ATD from creating a different “class” of term loans with better terms, including higher pricing and an accelerated repayment schedule, than the initial term loans.
While, as discussed in the Term Loan Summary, Staples’ Term Loan also permits the pro rata sharing provisions to be amended by a majority of lenders, Staples would likely be permitted to consummate coercive exchanges even if amendments to the pro rata sharing provisions did require consent from all affected lenders.
If Staples makes a voluntary prepayment of the term loans, the Term Loan provides that:
Because the Term Loan explicitly permits Staples to create a different “class” of term loans with better terms, including higher pricing and an accelerated repayment schedule, in order to consummate a coercive exchange, an amendment to the pro rata sharing provisions would likely not be necessary.
Taken together, because the Term Loan permits Staples to purchase term loans on a non-pro rata basis and explicitly permits Staples to favor certain term lenders over other term lenders, the Term Loan would likely not restrict Staples from consummating a J.Crew-like coercive exchange.
Term Loan Summary
2025 Notes Summary
Executive Summary
In September 2017, Sycamore Partners completed its acquisition of Staples Inc. for about $6.9 billion. To finance the acquisition, Staples entered into a $2.7 billion senior secured term loan and a $1.2 billion asset-based revolving credit facility and issued $1 billion of senior notes due 2025.
Because a significant portion of the collateral securing the term loan likely consists of Staples’ intellectual property, and in light of J.Crew’s and Claire’s’ transfer of intellectual property to unrestricted subsidiaries, this piece focuses on Staples’ ability to consummate similar IP transfers to unrestricted subsidiaries under the term loan and 2025 notes.
J.Crew’s transfers enabled the unrestricted subsidiary to prepay debt that J.Crew was restricted from prepaying under its debt documents, while Claire’s transfers enabled the unrestricted subsidiary to incur debt that Claire’s was restricted from incurring under its debt documents.
The Term Loan and 2025 Notes likely permit Staples to make at least $2.25 billion of investments in unrestricted subsidiaries, plus additional amounts equal to the lesser of the company’s retained excess cash flow or 50% of consolidated net income since the acquisition, assuming Sycamore’s $1.6 billion equity contribution was designated as an Excluded Contribution.
As Reorg Covenants has previously covered, J.Crew’s transfers ultimately resulted in J.Crew repaying certain lenders’ terms loans at par and converting their outstanding term loans into a new “class” of term loans that would receive a higher interest rate and an accelerated repayment schedule. Because the Term Loan permits Staples to purchase term loans on a non-pro rata basis and explicitly permits Staples to favor certain term lenders over other term lenders, the Term Loan would likely not restrict Staples from consummating a similar J.Crew-like coercive exchange.
Additionally, the Term Loan and 2025 Notes allow for $1.475 billion and $2 billion respectively of additional secured debt. Other key covenants as well as differences between the term loan and the 2025 notes that are not discussed in this analysis but are summarized below.
For a complete overview of the terms and provisions in the term loan, click HERE, and in the 2025 Notes, click HERE.
Background
On Sept. 14, Essendant Inc., a national distributor of workplace items, announced that it was being acquired by Staples Inc. (“Staples”) in a deal valued at $996 million, including net debt.
Staples was acquired in September 2017 by Sycamore Partners for about $6.9 billion. As part of the acquisition, Sycamore separated Staples’ U.S. retail business, the Canadian retail business and the North American B2B distribution business (“NAD”) into three separate entities, with the Staples name remaining with the NAD. This piece focuses on the NAD financing.
Staples’ capital structure as of April 29, 2017, pro forma for the acquisition, is illustrated below for reference. Note that because Staples is a private company, this analysis is based on Staples’ financials as of April 29, 2017, which are the most recent financials we have reviewed.
As illustrated above, in connection with the acquisition, Staples entered into a $2.7 billion senior secured term loan facility (the “Term Loan”) and a $1.2 billion asset-based revolving credit facility (the “ABL Facility”) and issued $1 billion of 8.5% senior notes due 2025 (the “2025 Notes”).
The Term Loan, ABL Facility and 2025 Notes are each guaranteed by Staples’ material domestic restricted subsidiaries and are secured by equity of Staples, each of the guarantors, 65% of the voting stock and 100% of the non-voting stock of foreign subsidiaries directly owned by Staples or the guarantors. In addition, (i) the Term Loan is secured by a first lien on all or substantially all of Staples’ and the guarantors’ tangible and intangible personal property, including intellectual property, and a second lien on the ABL collateral, and (ii) the ABL is secured by a first lien on accounts, inventory, deposit accounts and related assets and a second lien on the Term Loan collateral. Notably, however, the Term Loan is not secured by Staples’ real property.
As Reorg Covenants has previously discussed, as part of a series of restructuring transactions, J.Crew and Claire’s transferred portions of their intellectual property to newly created unrestricted subsidiaries and entered into licensing agreements under which they paid the unrestricted subsidiaries royalty payments for continued use of the transferred IP.
J.Crew’s transfers enabled the unrestricted subsidiary to prepay debt that J.Crew was restricted from prepaying under its debt documents, while Claire’s transfers enabled the unrestricted subsidiary to incur debt that Claire’s was restricted from incurring under its debt documents.
More recently, PetSmart transferred portions of equity of its Chewy subsidiary to both an unrestricted subsidiary and to its parent company Argos Holdings Inc. While the purpose of such transfers remains unclear, the effect was to release the liens on Chewy’s assets that secured PetSmart’s term loan and secured notes.
As illustrated in Staples’ balance sheet below, pro forma for the acquisition, 47% of its non-current assets (or $2.986 billion) that secure the Term Loan consisted of intangible assets, and 34% (or $2.157 billion) consisted of goodwill. Only 14% (or $893 million) of Staples’ non-current assets consisted of plant, property and equipment.
Although the Offering Memorandum did not disclose the value of Staples’ intellectual property that secures the the Term Loan, the value of the IP could be significant, because such intellectual property is included in Staples’ $2.986 billion of intangible assets.
Although Staples’ financials have not materially declined since the acquisition, and although Staples likely would not need to pursue similar transfers in the foreseeable future, given how much of the collateral securing the term loans consists of intellectual property, in this piece, we analyze Staples’ ability to consummate transfers similar to those consummated by J.Crew, Claire’s and PetSmart. Note that because we have not been provided a copy of Staples’ ABL facility, our analysis focuses on restrictions under the Term Loan and 2025 Notes.
Investments in Unrestricted Subsidiaries
The following table illustrates Staples’ ability to make investments in unrestricted subsidiaries under the Term Loan and the 2025 Notes. We analyze these baskets below.
Similar to PetSmart’s debt documents, the Term Loan and 2025 Notes only restrict Staples and the restricted subsidiaries from prepaying debt that is subordinated in right of payments to the term loans and the 2025 Notes. As such, Staples likely would not need to rely on an unrestricted subsidiary to prepay debt that it is unable to prepay, given that it is currently not restricted from prepaying any of its outstanding debt.
In addition, in order to finance Staples’ acquisition, as disclosed in the Offering Memorandum, Sycamore Partners made a $1.6 billion cash equity contribution to Staples (the “Equity Contribution”).
Although the Term Loan’s Available Amount basket and the 2025 Notes’ Builder Basket (which we discuss below) likely do not include the Equity Contribution, the Term Loan and 2025 Notes include baskets that permit Staples to pay dividends, prepay certain outstanding debt and make investments not to exceed the amount of Excluded Contributions Staples has received.
Under both the Term Loan and the 2025 Notes, the definition of “Excluded Contribution” includes “net cash proceeds … received by [Staples] from … contributions to its common equity capital,” as long as such contributions have been designated as an Excluded Contribution pursuant to an Officer’s Certificate.
As such, to the extent Staples designated the Equity Contribution as an Excluded Contribution, it may have an additional $1.6 billion of capacity under the Term Loan and 2025 Notes to pay dividends, prepay certain outstanding debt and make investments.
Term Loan
As illustrated in the Term Loan Summary, Staples can make investments in unrestricted subsidiaries under the Term Loan using an Available Amount basket that is based on retained excess cash flow, plus other typical amounts, including the Equity Contribution, plus $150 million. Although Staples must ensure that no Event of Default is occuring in order to access the Available Amount, it is not required to meet a leverage test.
Staples’ 3.5x leverage ratio likely restricts it from making investments from the Term Loan’s leverage-based investments basket that requires meeting a 3x leverage test.
Staples is also permitted to make at least $500 million of additional investments in unrestricted subsidiaries under the Term Loan, including $100 million under a general investments basket, $250 million under a basket for investments in unrestricted subsidiaries and $150 million under a shared prepayments and investments basket. It can make an additional $150 million of investments using capacity under a general restricted payments basket, but any such investments would reduce Staples’ dividend capacity.
2025 Notes
As illustrated in the 2025 Notes Summary, the 2025 Notes permit Staples to make investments in unrestricted subsidiaries using the Builder Basket if it can meet a 2x fixed charge coverage ratio (“FCCR”) and if no Event of Default is occuring. While both the Builder Basket and Available Amount include a $150 million starter basket, whereas the Available Amount is based on retained excess cash flow, the Builder Basket is based on 50% of consolidated net income.
Staples’ approximately 4x FCCR likely permits it to make investments from the Builder Basket.
Staples’ 3.5x leverage ratio likely restricts it from making investments from the 2025 Notes’ leverage-based investments basket that requires meeting a 3x leverage test.
Staples is also permitted to make at least $550 million of additional investments in unrestricted subsidiaries under the 2025 Notes, including $150 million under a general investments basket, $150 million under a basket for investments in unrestricted subsidiaries and $250 million under a basket for investments in similar businesses. It can make an additional $150 million of investments using capacity under a general restricted payments basket, but any such investments would reduce Staples’ dividend capacity.
The 2025 Notes do not include a proceeds basket.
Total Investments Capacity
Assuming Staples wants to preserve the ability to pay dividends under general restricted payments baskets, the Term Loan and 2025 Notes likely permit Staples to make at least $650 million of investments in unrestricted subsidiaries (which includes the $150 million starter basket under the Available Amount, plus additional amounts equal to the lesser of the company’s retained excess cash flow or 50% of consolidated net income since the acquisition. To the extent Sycamore’s $1.6 billion equity contribution made as part of the acquisition financing was designated an Excluded Contribution, Staples may be permitted to make $1.6 billion of additional investments in unrestricted subsidiaries.
Coercive Exchanges and Voluntary Prepayments
As Reorg Covenants has previously covered, J.Crew’s transfers ultimately resulted in J.Crew repaying certain lenders’ terms loans at par and converting their outstanding term loans into a new “class” of term loans that would receive a higher interest rate and an accelerated repayment schedule. As discussed, J.Crew’s ability to consummate these transactions likely hinged on its ability under the term loan to purchase the term loans on a non-pro rata basis and its ability to amend provisions governing sharing of payments made to the lenders.
Unlike J.Crew’s term loan, whereby J.Crew arguably was not permitted to purchase term loans on a non-pro rata basis, Staples’ Term Loan explicitly provides that:
“[A]ny Borrower Party may … purchase outstanding Term Loans on a non-pro rata basis through open market purchases[.]”
In our coverage of PetSmart and American Tire Distributors, we discussed how PetSmart’s and ATD’s term loans likely permitted coercive exchanges, given that PetSmart and ATD were permitted to purchase term loans on a non-pro rata basis and that amendments to the pro rata sharing provisions could be amended by a majority of lenders. Under those agreements, we concluded, the term loans would likely not restrict PetSmart or ATD from creating a different “class” of term loans with better terms, including higher pricing and an accelerated repayment schedule, than the initial term loans.
While, as discussed in the Term Loan Summary, Staples’ Term Loan also permits the pro rata sharing provisions to be amended by a majority of lenders, Staples would likely be permitted to consummate coercive exchanges even if amendments to the pro rata sharing provisions did require consent from all affected lenders.
If Staples makes a voluntary prepayment of the term loans, the Term Loan provides that:
“Each [voluntary] prepayment in respect of any Term Loans … may be applied to any Class of Term Loans as directed by the Borrower. … For the avoidance of doubt, [Staples] may (i) [voluntarily] prepay Term Loans of any Term Loan Class without any requirement to prepay [incremental term loans or extended term loans] that were converted or exchanged from such Term Loan Class and (ii) [voluntarily] prepay [incremental term loans or extended term loans] without any requirement to prepay any Term Loans that were converted or exchanged for such [incremental term loans or extended term loans].”
Because the Term Loan explicitly permits Staples to create a different “class” of term loans with better terms, including higher pricing and an accelerated repayment schedule, in order to consummate a coercive exchange, an amendment to the pro rata sharing provisions would likely not be necessary.
Taken together, because the Term Loan permits Staples to purchase term loans on a non-pro rata basis and explicitly permits Staples to favor certain term lenders over other term lenders, the Term Loan would likely not restrict Staples from consummating a J.Crew-like coercive exchange.
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