Tue 06/02/2020 10:43 AM
Editor's note: This report charts key covenant trends and happenings in the secondary space in Europe in May. If you want access to any of the reports mentioned please email questions@reorg.com 

Despite the fact that the first European countries started easing their lockdown measures in the month of May, many companies continued to be affected by the financial impacts of the Covid-19 crisis, forcing them to find new solutions to address urgent liquidity issues, sometimes in a creative manner.

Covid-19 EBITDA Adjustments

As the first-quarter earnings season was in full swing this month, the first coronavirus-related EBITDA adjustments were seen in companies’ financial reports, which included two Blackstone-owned companies, Schenck Process and Cirsa. Both adjusted EBITDA upwards for losses suffered as a result of the pandemic. Schenck by €5.4 million for missed contribution margin and cost absorption, and Cirsa by €32.8 million from unprecedented year-over-year volume declines.

Apollo-owned Alteri's CBR Fashion included €10.8 million of "extraordinary" EBITDA add-backs, CVC owned Douglas made a Covid-19 adjustment to EBITDA of ~ €15mm for costs in connection with closed stores, and WFS a minor €200,000 add back for Covid-19 related cleaning costs.

The trend of Covid-19 adjustments for extraordinary losses or non-recurring costs to reported EBITDA looks set to continue. The key question is whether a company’s management will utilise Covid-19 add backs to increase their capacity under covenants to take actions that are adverse to their creditors, such as incurring more debt or leaking value out of the group.

In our weekly Covenant Conversations podcast, we had a frank discussion about the fiction and challenges of EBITDA add-backs with a seasoned credit investor.

Liquidity: State Support and Super Senior Debt

The hunt for liquidity continued last month. Early in the month, we examined how Lufthansa’s government bailout would fit within its current capital structure and the context of EU state aid framework and rules. Lufthansa has recently agreed to the conditions of €9 billion of state aid from Germany.

In the same sectoral space, we analysed the priming debt capacity of WFS, an airport ground handling service provider whose business was significantly disrupted by the pandemic.

Sub investment grade borrowers have preferred to plug liquidity needs by availing state backed support, such as NH Hotels and Naviera Armas, or by maxing out the super-senior debt capacity permitted under their existing credit documents, such as Selecta in March and CBR Fashion last month.

Super senior debt might be the only option for certain imperilled issuers. Both the UK retailer Matalan and Swissport launched amendments to their debt documents to permit the incurrence of super senior debt. Consent of only a majority of the holders of outstanding bonds was required to bring in new super senior debt. A novel (albeit unsurprising) feature in UK retailer Matalan’s new £50 million additional liquidity was that the super senior element would come pursuant to the Coronavirus Large Business Interruption Loan Scheme in the UK. Swiss ground-handling company, Swissport has also requested a majority consent to incur a €380 million new super senior facility, as bridge financing while creditors negotiate a full blown restructuring. We analysed the Swiss ground-handling company’s consent solicitation here.

In spite of the injection of super senior debt from a KKR debt fund, the Selecta’s notes trading prices collapsed in the wake of worse than expected fourth quarter results. Our analysis of Swiss vending company’s notes revealed that it had limited priming debt capacity and with a valuation significantly lower than the existing capital structure, it is likely that a more comprehensive capital structure restructuring combined with new money provision will have to take place to address the liquidity need and outsized leverage.

Covenant and calculation flex may provide or enhance debt capacity of companies beyond what investors might expect. Market speculation had it that Mclaren was seeking up to £275 million of additional funding and may “pull a J Crew” to obtain it. Our analysis of the U.K. luxury auto maker’s secured bonds confirmed that it had sufficient capacity to incur debt that could dilute the existing bondholders or leak sufficient assets to an unrestricted subsidiary and raise the debt there, if it chose to go down that controversial route. A substantial amount of such additional capacity would come from the contribution debt basket and/or investments capacity built by the equity injections received over the years.

We have written in detail about how unrestricted subsidiaries may provide creative restructuring options, or as colloquially known how secured creditors could get “J Screwed”. Mclaren’s bondholders are organising to prevent it from proceeding with a proposed new financing transaction.

In the automobile sector, we also calculated Spanish automobile supplier Gestamp’s capacity under secured notes to incur both collateral dilutive debt as well as effectively and structurally senior debt.

Payment, Insolvency and Other Defaults

For other companies, the liquidity problems led to defaults on their interest payments, such as with Takko, who announced on May 15 that it would suspend interest payments on its bonds and appointed advisors for debt negotiations. In our high-yield primer on coupon payment defaults, we discussed the consequences of coupon non-payments. Spanish gaming company Codere, had missed the coupon payment on its secured 2021s due April 30, but confirmed it would be making the pending payment towards the tail end of the 30 days grace period, thereby avoiding an event of default.

U.S. car rental company Hertz’s Chapter 11 filing caused an event of default and automatic acceleration of its euro-denominated bonds. It subsequently received the required majority approval from holders of such euro-denominated bonds for a temporary event of default waiver until Sept. 30, a recission of the acceleration as well as consent for amendments to other terms in the indentures. Our distressed debt analysts examined Hertz’s financials, capital structure and the Chapter 11 filing in a webinar.

Another type of default becoming more prevalent could be found for Hema, which announced on May 26 that it would postpone the publication of its 2019 annual report using a reporting extension provided under Dutch law. However, this extension clashes with the retailer’s senior secured 2022 and senior 2023 bond documents. Hema’s bondholders’ ability to accelerate on a reporting breach could be compromised by the flexibility in the documentation.

Pizza Express also solicited consents of its senior secured and senior unsecured bondholders to defer the publication of its annual and quarterly reports, and waive any related defaults. The deadline for the consent solicitation has been extended twice.

As mentioned in our articles on financial information undertakings in the Navigating Uncertainty Series, it is now more important than ever to receive frequent and up-to-date financial information, as delayed delivery may enable financial health of borrowers to be disguised.

Debt Negotiations, Covenant Waivers, RCF Drawdowns

While many companies were forced to draw on their revolving credit facilities again to solve urgent liquidity problems this month, as shown in Debt Explained’s RCF Tracker, some credits came at risk of breaking their covenants and had to turn to lenders for covenant holiday or waiver discussions.

Companies that were successful in negotiating waivers included French equipment rental firm Loxam, which obtained a waiver from its RCF lenders entailing a covenant suspension on its financial debt ratio until and including March 31, 2021, and London-headquartered gaming company International Game Technology, waiving the net leverage covenant from June 30 to June 30, 2021. For IGT, its group lenders also agreed that any impact arising from the virus including lockdowns and quarantines shall not constitute a material adverse effect and any consequence of the virus on the business shall not constitute an event of default. As mentioned in our Navigating Uncertainty article on material adverse change clauses, these controversial provisions have come under increased scrutiny due to the Covid-19 crisis.

“Super Schemes”: UK Restructuring Law Change

U.K. hotel chain Travelodge facing severe cash flow issues as a consequence of the Covid-19 crisis, launched a successful consent solicitation to holders of its 2025 notes to approve an amendment allowing it to either enter into a company voluntary arrangement (CVA) with landlords or a restructuring plan with landlords and unsecured creditors under U.K. government’s proposed cross-class cramdown restructuring plan, or the “super scheme”. Travelodge could be the first UK company to use the “super scheme,” to implement a rent reduction and compromise its 2025 notes. Reorg and Skadden Arps will be discussing the new “super scheme” and its implications for a cross-border restructuring toolkit in a webinar on June 4.

Acquisitions and Joint Ventures

While M&A deal making has taken a coronavirus hit in the past few months, there was a spot of activity in the telecoms sector in May. Liberty Global and Telefonica announced a 50:50 JV between their UK subsidiaries Virgin Media and O2, expected to close in mid-2021. Our analysis of Virgin Media’s senior secured and senior notes showed that a contribution of Virgin Media’s assets to the proposed JV would be permitted.

UK consumer loans provider Amigo received a proposal from a potential acquirer. Our analysis confirmed that Amigo would likely be able to take advantage of its change of control portability exception (as per 12/31/19 numbers), as the fine print of its bonds allowed all of the securitisation debt to be excluded when calculating the net leverage portability test. Without this documentary exclusion, portability would not be available - a reminder that thorough review of the documentation is always necessary to get the correct conclusion.

Covenant Conversation Podcasts

Reorg continued its weekly Covenant Conversations in May on the following topics:

May 26: The Fiction and Challenges of EBITDA Add-Backs: A Conversation with JO Hambro Capital Management’s head of credit Lale Topcuoglu

May 19 : Covenant Conversations: Issuers Capitalizing on Low Trading Prices Through Distressed Debt Exchange Offers

May 12: How to Use Covenants Creatively in Stressed Situations: A Conversation with Morrison Foerster’s partners: Benoit Lavigne and Matthew Dunlap

May 5: The Changing Covenant Landscape in Mid-Market Financings: A Conversation with Goodwin Proctor’s partner: Kristopher Ring

This article is an example of the content you may receive if you subscribe to a product of Reorg Research, Inc. or one of its affiliates (collectively, “Reorg”). The information contained herein should not be construed as legal, investment, accounting or other professional services advice on any subject. Reorg, its affiliates, officers, directors, partners and employees expressly disclaim all liability in respect to actions taken or not taken based on any or all the contents of this publication. Copyright © 2020 Reorg Research, Inc. All rights reserved.
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