Frontier Communications Cleansing Materials Contemplate Restructuring With Senior Unsecured Noteholders Taking 100% of Predilution Reorganized Equity, Senior Classes Paid in Full or Reinstated; Management Advocates for Restructuring to Allow for Increased Reinvestment in the Business

Relevant Document:
8-K

In an 8-K released this morning, Frontier Communications released cleansing materials and stated that it has been engaged in discussions since January 2020 with certain holders of the company’s senior unsecured notes “with respect to potential deleveraging or restructuring transactions” that may include a chapter 11 filing. The company has entered into confidentiality agreements with such noteholders. Those discussions now appear to contemplate a chapter 11 bankruptcy filing in the coming weeks, as outlined further in the cleansing materials.

On March 16, the company announced that it entered into a 60-day grace period, electing to defer interest payments due March 16 on certain of its senior unsecured notes.

Included in the cleansing materials is a presentation provided by Frontier management to certain senior unsecured noteholders, dated January 2020, in which management states, “An overleveraged capital structure coupled with operational challenges limits the Company’s ability to invest in critical areas to maintain and grow the business in the face of intense competition and general secular decline.” From its business plan review, management states its belief that “it is in the Company’s and the stakeholders’ best interests to begin restructuring negotiations now,” as the company believes that a debt-oriented liability management transaction alone would be unlikely to achieve sufficient deleveraging to allow the company to re-access capital markets and/or adequately reinvest in the business.

The cleansing materials also include three term sheet proposal drafts dated March 26 from each of the company, a group of senior unsecured noteholders represented by Milbank and Houlihan Lokey, and another group of senior unsecured noteholders represented by Akin Gump and Ducera Partners. Under each of the term sheets, senior unsecured notes claims would receive 100% of pre-dilution reorganized Frontier equity, $750 million (subject to adjustment) in takeback debt and “excess cash.” All of the term sheets contemplate a chapter 11 filing by mid-April, within the 60-day grace period triggered by the company’s March 16 decision to defer approximately $322 million in interest payments on certain of its senior unsecured notes.

A summary chart of the key terms of the various proposals is provided further below.

Illustrative Transaction Summary

In the company’s presentation to senior unsecured noteholders dated January 2020, it provides an illustrative transaction summary for a pro forma restructuring, resulting in 2.48x estimated net leverage at emergence (down from 4.9x as of Sept. 30, 2019). Note that the company’s proposed restructuring term sheet dated March 2020 (discussed in the next section in greater detail) provides for certain modifications from the terms outlined in the January 2020 presentation.
 

• First priority debt residing at parent Frontier Communications Corp., consisting of $749 million outstanding on its revolving credit facility, $1.7 billion senior secured term loan B and approximately $1.7 billion senior secured first lien notes and industrial development revenue bonds would be unimpaired. First-priority debt would receive no pro forma equity ownership in reorganized Frontier.
   
  • The revolver would be paid in full through a cash distribution at emergence;
     
  • The term loan B would receive $1.7 billion of new first lien debt, equivalent to the amount of its claim; and
     
  • First lien notes and industrial development revenue bonds would receive approximately $1.7 billion of new first lien debt, equivalent to the amount of its claim.
     
• Second priority debt residing at Frontier Communications Corp., consisting of $1.6 billion of senior secured second lien notes, would also be unimpaired, receiving $1.6 billion of new second lien debt in addition to accrued interest at emergence. Second lien notes would receive no pro forma equity ownership in reorganized Frontier.
   
• $856 million of debt residing at certain subsidiaries of Frontier Communications Corp. would also be unimpaired, receiving $856 million of new subsidiary debt in addition to accrued interest at emergence. Subsidiary debt would receive no pro forma equity ownership in reorganized Frontier.
   
• $10.9 billion of senior unsecured notes would receive $1.1 billion of cash distributed at emergence (pro forma for accrued interest paid to second lien notes and subsidiary debt), in addition to a to-be-determined pro forma equity ownership percentage in reorganized Frontier.
   
• Frontier common share holders would receive a to-be-determined pro forma equity ownership percentage in reorganized Frontier.

   
The table below provides an illustrative pro forma capitalization, including an undrawn superpriority DIP facility and an undrawn new exit facility which is assumed to replace the existing revolving credit facility.
 
Term Sheet Proposals

As noted above, the cleansing materials include three term sheet proposal drafts dated March 26 from each of the company (term sheet HERE), the Milbank/Houlihan unsecured notes group (term sheet HERE) and the Akin/Ducera unsecured notes group (term sheet HERE). Proposed claim treatments are generally similar across the term sheets, though the Milbank/Houlihan group calls for consent premiums for RSA parties payable in new common stock, whereas the Akin/Ducera group term sheet includes a similar premium construct payable in cash. Other open items are whether second lien notes would receive cash interest during the cases and the allowed amount of parent litigation claims.

A comparison of key terms and proposed claims treatment is below:
 

Additional notes on the proposed treatment of unsecured notes claims include the following:
 

• “Excess cash” is defined in the notes groups’ term sheets as unrestricted balance sheet cash in excess of $150 million on the plan effective date, including net after-tax cash proceeds from the PNW sale and less potential costs related to regulatory settlements and other restructuring related payments due on the plan effective date, including any required repayments of debt.
   
• The “takeback debt” would be issued “solely for the purpose of distribution to Senior Noteholders pursuant to the Plan.”
   
• Consent premiums:
   
  • “Consent premium equity” is defined in the Milbank/Houlihan group term sheet as an unspecified amount of new common stock “issued at plan value” on the plan effective date to be paid to accredited investor and qualified institutional buyer noteholders who have become consenting noteholders as of an unspecified “consent date.”
     
  • The Akin/Ducera group term sheet provides that each consenting noteholder would agree to reduce the amount of its applicable senior notes claims on a dollar-for-dollar basis in an amount equal to received cash “RSA consent premiums.” Consenting holders of (i) CTF notes would receive a pro rata share (based on aggregate CTF notes) of “$[315] million,” and (ii) non-CTF notes would receive a pro rata share (based on aggregate non-CTF notes) of “$[99] million,” payable on the earlier of the consummation of the PNW sale and the plan effective date. Payment would be subject to the company having $150 million in balance sheet cash at the time of payment and “the then current forecast reflecting $150 million in balance sheet cash through the Plan Effective Date.”

The takeback debt, unless otherwise agreed to by the company and the required consenting noteholders, has the following terms in the company’s term sheet:
 

• Principal amount: “Up to” $750 million, subject to downward adjustment by consenting noteholders holding at least 66-2/3% of the aggregate outstanding principal amount of senior notes that are subject to the RSA, the “determining noteholders,” with such determination to be made no later than 30 days before the occurrence of the plan effective date.
   
  • At any time prior to the plan effective date, the determining noteholders may “elect that there will be no Takeback Debt.”
     
  • Alternatively, the takeback debt “may be replaced with cash proceeds of third-party market financing that becomes available prior to the Plan Effective Date,” provided that the third-party market financing must contain terms no worse than those contemplated for the takeback debt.
     
• Interest rate: No more than 250 basis points higher than the interest rate of the most junior secured debt facility to be entered into on the plan effective date.
   
• Maturity: No less than one year outside of the longest-dated debt facility to be entered into on the plan effective date.
   
• Security: To be mutually agreed upon and determined by the required consenting noteholders and the company parties no later than 30 days before the confirmation of the plan.
   
• All other terms would not be more restrictive than those in the indenture for the second lien notes.

Additional key terms in the company’s term sheet are as follows:
 

• DIP facility: The debtors would use “commercially reasonable best efforts” to obtain a superpriority secured DIP facility with an option for conversion into an exit facility on terms “including as to [a currently empty placeholder] amount” that is “reasonably acceptable” to the company and required consenting noteholders. DIP proceeds would be used in whole or in part to repay “some or all” of the debtors’ existing secured debt.
   
• Exit facilities: The debtors’ term sheet calls for a similar undertaking as the DIP process to obtain “one or more third-party” exit facilities, which would remain undrawn (excluding any required letters of credit) on the effective date.
   
• Placeholders for new board of directors and management incentive plan details.
   
• PNW sale: The debtors would “promptly file a motion after the Petition Date to assume” the May 28, 2019, purchase agreement, as amended, “and close the sale (the "PNW Sale") as soon as reasonably practicable.”
   
• Reorganized Frontier new common stock: Listing on a “recognized U.S. stock exchange” would be determined by the required consenting noteholders and the company prior to the plan effective date. Any such listing would occur “as promptly as reasonably practicable on or after the Plan Effective Date.”
   
• Release and exculpation provisions in favor of the company, the consenting noteholders, indenture trustees and a broad range of affiliates and related parties.

The noteholder group term sheets contain “pension/OPEB” and “labor” provisions not found in the company’s term sheet. The Milbank/Houlihan group provision is more general on these points, providing that the company and the consenting noteholders “shall confer regarding potential cost savings and concessions under the Company Parties' pension/OPEB plans and determine in good faith whether to pursue further concessions,” provided that, upon the RSA effective date, the finance committee of the board, “in consultation with” the required consenting noteholders, would be charged with overseeing and making decisions on behalf of the company with respect to “any negotiations regarding the ‘freeze’ of the Company Parties' pension/OPEB plans.”

The Akin/Ducera group would commit the company, upon the chapter 11 filing, to “promptly” “begin formal negotiations with the relevant authorized representatives” to achieve potential savings or other concessions relating to workforce obligations. The term sheet further provides that “[t]o the extent necessary and if requested by the Required Consenting Noteholders, the Company Parties shall commence the processes required under sections 1113 and/or 1114 of the Bankruptcy Code,” the sections of the code that govern modification of collective bargaining agreements and retiree benefits, respectively.

Business Operations, Projected Financials

The company’s finance committee, initially formed in December 2018 and reconstituted in June 2019, led a 12-month process to evaluate restructuring alternatives and develop a “granular” business plan. Included in the table below, the company provides a comparison of estimated adjusted EBITDA in 2022 under a “business as usual” case where operational trends from 2018 continue, versus the finance committee base case, which incorporates certain operational initiatives. The company estimates a $421 million uplift in 2022 adjusted EBITDA and a $315 million uplift in 2022 operating cash flow resulting from the finance committee operational improvements, compared with the “business-as-usual” case.
   
While the company estimates an uplift in adjusted EBITDA resulting from the finance committee’s operational improvements compared with a “business as usual” case, the company acknowledges that due to expected elevated churn in its subscriber base and the expiration of Connect America Fund Phase II, or CAF II, cash flows, the company’s base case business plan projects a material reduction in revenue, adjusted EBITDA, and unlevered free cash flow in every year through the projection period ending in 2024.
 

• Revenue is projected to fall to $5.6 billion in 2024 from an estimated $8.2 billion in 2019;
   
• Adjusted EBITDA is projected to fall to $2.1 billion in 2024 from an estimated $3.4 billion in 2019;
   
• Unlevered FCF is projected to fall to $741 million in 2024 from an estimated $1.8 billion in 2019; and
   
• Net leverage is expected to increase to 9.1x in 2024 from an estimated 5x in 2019. The company acknowledges that its Form 10-K for 2020, which would be filed in early 2021, “may contain [a] going concern qualification.”

     
Because of the material reduction in revenue, EBITDA and FCF under the base case, the company presents an alternative case for reinvesting in the business to provide “longer term value in the 8 to 10 year horizon with re-rating and value uplift occurring earlier in the cycle as business and asset mix shifts.” The table below outlines both revenue and adjusted EBITDA increases under the reinvestment case compared with the finance committee’s base case. Under the reinvestment case, capex in 2024 is estimated to be approximately $1.9 billion, compared with $986 million under the base case. As a result, the company projects:
 

• 2024 revenue under the reinvestment case would increase to $6.2 billion, compared with $5.6 billion in the base case; and
   
• 2024 adjusted EBITDA under the reinvestment case would increase to $2.5 billion, compared with $2.1 billion in the base case.

   
The company outlines a strategy to shift its mix toward its fiber assets and away from its legacy assets. In 2019, the company’s revenue mix was estimated to be 34% fiber and 66% legacy. Under the company’s reinvestment case, it would shift the revenue mix by 2024 to 47% fiber and 53% legacy, and further shift the revenue mix by 2031 to 66% fiber and 34% legacy.
 
In the table below, the company provides projections for pro forma net leverage and operating liquidity through 2024, in both the finance committee’s base case and the reinvestment case, assuming the aforementioned reorganized capital structure.
   
Preliminary FY’19 Results

The company provided preliminary results for fiscal year 2019, shown in the table below, with total revenue down 5.9% year over year.
   
Other Considerations

The cleansing materials include various other operational metrics and other considerations, including the following items.

Tax Considerations

The company said it expects to have approximately $656 million of pre-emergence net operating losses, or NOLs, as of Dec. 31, 2020, taking into account a gain from the anticipated sale of its northwest operations to WaveDivision Capital (announced in May 2019 for $1.352 billion in cash proceeds). The company states that recently proposed tax regulations, if applicable in their current form, would “dramatically limit” the company’s ability to use post-emergence NOLs.

The company states that effectuating the restructuring transaction as a taxable sale - a so-called Bruno’s transaction - would allow the company to utilize its NOLs prior to emergence, while maintaining its historic operating asset tax basis. Under the Bruno’s transaction in the company’s aforementioned base case, the company projects $37 million of aggregate cash income tax liabilities for 2020 through 2024; in contrast, under a traditional deleveraging transaction, the aggregate cash income tax liabilities are estimated to be $267 million for 2020 through 2024. The company notes that it would not expect the Bruno’s transaction to delay the restructuring process, as compared with a traditional deleveraging transaction structure.

Additionally, the company outlines potential tax considerations for an illustrative “propco/opco” structure, compared with the aforementioned Bruno’s transaction, whereby Frontier would be separated into an operating company and a property company, which “could be accomplished in a bankruptcy restructuring without any transfer taxes.” However, according to the company, the separation itself would be a taxable transaction for income tax purposes and would exhaust all of the company’s NOLs. The company states that because its current tax model forecasts minimal cash income taxes under the Bruno’s structure, the incremental costs and potential delays associated with a propco/opco separation would likely outweigh “by a significant amount” any potential tax benefits.

Pending Divestiture of Northwest Operations

As of the management presentation date of January 2020, the company stated that the sale of the company’s operations in Washington, Oregon, Idaho and Montana to WaveDivision Capital, which was announced in May 2019, was expected to be completed by March 2020. The table below illustrates the pro forma impact of the divestiture through 2024. In 2024, the divestiture is expected to negatively impact EBITDA by $42 million.
   
Condensed Organizational Chart

The company provided a condensed organizational chart, illustrating which of its entities are counterparties to the company’s collective bargaining agreements, among other agreements.