GTT Communications, Inc.
New Coverage/Tear Sheet: Asset Sales Could Help Alleviate GTT Communications’ Decreasing Cushion Under Credit Agreement’s Secured Leverage Maintenance Covenant; Company Hires Advisors for Noncore Asset Sales
Mon 08/12/2019 13:12 PM
Relevant Items:
GTT Communications Covenants Tear Sheet and Debt Document Summaries on Reorg Analysis Page
GTT Communications Debt Documents
After the closing of GTT Communications’ $2.3 billion acquisition of Interoute, an operator of fiber networks and cloud networking platforms in Europe, which was partially financed with the proceeds of a term loan and revolving credit facility (the “Credit Agreement”) that provided a €750 million EMEA term loan, a $1.77 billion U.S. term loan and a $200 million revolving credit facility, GTT Communications' net secured leverage increased to 7.22x as of Dec. 31, 2018, from 2.7x as of Dec. 31, 2017, and its net total leverage increased to 8.9x from 5.3x.
As the company contends with difficulties related to the integration of the acquisition and generating organic sales growth, it announced last Thursday, along with second-quarter earnings, that it had hired advisors to assist with potential noncore asset sales in an effort to reach its targeted goal of between 3x and 4x net leverage. GTT reported that revenue, pro forma for the Interoute acquisition, dropped 6% year over year for the three-month period ended June 30.
On Aug. 8, the company entered into an amendment to the Credit Agreement that delayed the step-down of the Credit Agreement’s financial maintenance covenant; as a condition to the amendment, GTT agreed that, until March 31, 2021, it would not pay dividends or designate or invest in unrestricted subsidiaries and would limit incremental debt incurrence.
Although GTT Communications’ debt documents do not restrict the company from purchasing its senior unsecured notes in the open market, and although the company can likely use a portion of asset sale proceeds to indirectly fund additional purchases of the unsecured notes, a secured leverage maintenance covenant under the Credit Agreement could incentivize the company to prepay secured debt rather than capture the discount of the 2024 Notes’ distressed trading price.
With the release of second-quarter earnings on Aug. 8, the company’s 2024 Notes dropped from the mid-70s area before the report to the low 60s as of today, according to TRACE.
On Feb. 26, 2018, GTT Communications announced that it was acquiring Interoute, an operator of fiber networks and cloud networking platforms in Europe, for approximately $2.3 billion. In its announcement, the company noted:
As stated on the second-quarter call last week, the company is currently facing a number of headwinds, most notably including:
GTT Communications’ capital structure, as of June 30, is illustrated below for reference.
Although the company’s net secured leverage and net total leverage have decreased to 5.8x and 7x, respectively, as of June 30, on its-second quarter earnings call, management stated:
As an initial matter, because the Credit Agreement only restricts GTT Communications from prepaying junior lien and payment subordinated debt, the company is not restricted from purchasing its 7.875% senior notes due 2024 (the “2024 Notes”) in the open market. Nevertheless, after a recent amendment to the Credit Agreement, its ability to fund such purchases is somewhat limited.
In this article, we discuss GTT Communications’ ability to reduce its leverage, including by selling assets and by funding open-market purchases of the 2024 Notes with secured debt.
The Credit Agreement and the 2024 Notes generally permit GTT Communications to sell assets, as long as such sales are consummated at fair market value, 75% of the consideration consists of cash, and the proceeds are used for specified purposes, including reinvesting in the business.
Although the 2024 Notes permit GTT to use asset sale proceeds to repay any senior debt, regardless of whether it’s secured or unsecured, the Credit Agreement generally requires the company to prepay outstanding term loans.
As such, the company is likely unable to directly use asset sale proceeds to purchase the 2024 Notes in the open market and capture the discount of their current trading price. While the company could use asset sale proceeds to fund capex and use the cash that had been earmarked for its capex budget to fund purchases of the 2024 Notes, a secured leverage maintenance covenant under the Credit Agreement could incentivize the company to prepay secured debt rather than capture the discount of the 2024 Notes’ distressed trading price.
The Credit Agreement includes a secured leverage financial maintenance covenant for the benefit of the revolving lenders that is in effect only if revolving usage exceeds 30% (or $75 million); given $85 million of outstanding revolving borrowings, the maintenance covenant has likely been triggered.
On Aug. 8, the company entered into an amendment to the Credit Agreement that, as illustrated above, loosened the maintenance covenant and pushed out the dates when the maintenance covenant begins stepping down.
On the basis of our calculations, assuming constant outstanding debt and cash, GTT Communications can likely incur an additional $327 million of secured debt and remain in compliance with the 6.5x secured leverage test ($162 million assuming a fully drawn revolver); however, assuming constant outstanding debt and cash, if GTT Communications’ EBITDA declines by $50 million or, whenever the maintenance covenant steps-down to 6.25x, by $34 million, it could have difficulty remaining in compliance with the covenant.
However, as a condition to revolving lenders agreeing to loosen the maintenance covenant, as illustrated below, GTT Communications agreed to limit certain activities through the quarter ending March 31, 2021, that had been permitted under the Credit Agreement.
Pursuant to the amendment, GTT Communications’ incremental debt capacity was reduced by $275 million, it is restricted from paying dividends and designating, and investing in, unrestricted subsidiaries and its ability to make investments is now subject to a liquidity test.
Nevertheless, the company is still likely permitted to incur $290 million of additional pari debt, including $250 million of pari incremental debt and $40 million of pari debt using capacity under general debt and liens baskets. Although the company can also incur $80 million of junior lien debt under the general debt basket, the maintenance covenant likely restricts the company from incurring $327 million of additional secured debt, including additional draws on the revolver.
The 2024 Notes were issued in December 2016, and the negative covenants under the notes provide capacity based on the greater of a fixed amount and a percentage of total assets; according to the company’s 10-K for the 2016 fiscal year, its total assets were valued at about $953 million. Since the 2024 Notes were issued, the company has acquired Hibernia (to add a strategic transatlantic fiber network), Global Capacity (to add scale and low-cost last-mile access) and Interoute.
At the end of 2017, the company’s total assets were valued at around $1.8 billion and, at the end of 2018, at around $4.5 billion.
Because of the significant increase in the company’s total assets, as illustrated below, the 2024 Notes provide the company with significantly more flexibility than the Credit Agreement to pay dividends and make investments; however, under the 2024 Notes, the company is permitted to incur only $234 million of additional secured debt.
GTT Communications Covenants Tear Sheet and Debt Document Summaries on Reorg Analysis Page
GTT Communications Debt Documents
Executive Summary
After the closing of GTT Communications’ $2.3 billion acquisition of Interoute, an operator of fiber networks and cloud networking platforms in Europe, which was partially financed with the proceeds of a term loan and revolving credit facility (the “Credit Agreement”) that provided a €750 million EMEA term loan, a $1.77 billion U.S. term loan and a $200 million revolving credit facility, GTT Communications' net secured leverage increased to 7.22x as of Dec. 31, 2018, from 2.7x as of Dec. 31, 2017, and its net total leverage increased to 8.9x from 5.3x.
As the company contends with difficulties related to the integration of the acquisition and generating organic sales growth, it announced last Thursday, along with second-quarter earnings, that it had hired advisors to assist with potential noncore asset sales in an effort to reach its targeted goal of between 3x and 4x net leverage. GTT reported that revenue, pro forma for the Interoute acquisition, dropped 6% year over year for the three-month period ended June 30.
On Aug. 8, the company entered into an amendment to the Credit Agreement that delayed the step-down of the Credit Agreement’s financial maintenance covenant; as a condition to the amendment, GTT agreed that, until March 31, 2021, it would not pay dividends or designate or invest in unrestricted subsidiaries and would limit incremental debt incurrence.
Although GTT Communications’ debt documents do not restrict the company from purchasing its senior unsecured notes in the open market, and although the company can likely use a portion of asset sale proceeds to indirectly fund additional purchases of the unsecured notes, a secured leverage maintenance covenant under the Credit Agreement could incentivize the company to prepay secured debt rather than capture the discount of the 2024 Notes’ distressed trading price.
With the release of second-quarter earnings on Aug. 8, the company’s 2024 Notes dropped from the mid-70s area before the report to the low 60s as of today, according to TRACE.
Background
On Feb. 26, 2018, GTT Communications announced that it was acquiring Interoute, an operator of fiber networks and cloud networking platforms in Europe, for approximately $2.3 billion. In its announcement, the company noted:
“At closing, after funding the acquisition with a combination of debt and equity, the expected ratio of total net debt to Adjusted EBITDA will be approximately 5.0-5.5:1, using pro forma combined Adjusted EBITDA plus expected cost synergies. After closing, over time, GTT expects to reduce the ratio of total net debt to Adjusted EBITDA to its long-term target range of 3.0-4.0:1.”
As stated on the second-quarter call last week, the company is currently facing a number of headwinds, most notably including:
- Difficulty in expanding its sales force: “This was a challenging quarter for us, as we have not yet returned to organic rep-driven growth … to return to positive net installs and organic rep-driven growth, we need a larger sales force to drive a larger volume of sales and installs to outpace our churn at the mid-1% level.”
- Larger customer refunds than expected: “The sequential revenue decline was driven by several factors, including … credits issued to clients to resolve disputed amounts associated with Interoute billing integration. Issuing dispute credits as a result of billing integration is not uncommon, but the magnitude is larger and the time frame is longer than we normally see.”
GTT Communications’ capital structure, as of June 30, is illustrated below for reference.
Although the company’s net secured leverage and net total leverage have decreased to 5.8x and 7x, respectively, as of June 30, on its-second quarter earnings call, management stated:
“In addition, we have engaged an adviser to explore divesting nonstrategic assets that we have acquired over the past several years as we focus on our cloud networking services. The main use of proceeds from any asset sale will be to pay down debt … we remain committed to reducing leverage over the next few years to our long-term target of 4x or less through growth in adjusted EBITDA, cash flow generation, potential asset sales and delevering acquisitions” (emphasis added).
As an initial matter, because the Credit Agreement only restricts GTT Communications from prepaying junior lien and payment subordinated debt, the company is not restricted from purchasing its 7.875% senior notes due 2024 (the “2024 Notes”) in the open market. Nevertheless, after a recent amendment to the Credit Agreement, its ability to fund such purchases is somewhat limited.
In this article, we discuss GTT Communications’ ability to reduce its leverage, including by selling assets and by funding open-market purchases of the 2024 Notes with secured debt.
Asset Sales and Mandatory Prepayments
The Credit Agreement and the 2024 Notes generally permit GTT Communications to sell assets, as long as such sales are consummated at fair market value, 75% of the consideration consists of cash, and the proceeds are used for specified purposes, including reinvesting in the business.
Although the 2024 Notes permit GTT to use asset sale proceeds to repay any senior debt, regardless of whether it’s secured or unsecured, the Credit Agreement generally requires the company to prepay outstanding term loans.
As such, the company is likely unable to directly use asset sale proceeds to purchase the 2024 Notes in the open market and capture the discount of their current trading price. While the company could use asset sale proceeds to fund capex and use the cash that had been earmarked for its capex budget to fund purchases of the 2024 Notes, a secured leverage maintenance covenant under the Credit Agreement could incentivize the company to prepay secured debt rather than capture the discount of the 2024 Notes’ distressed trading price.
Amendment No. 1 and Funding Open-Market Purchases
The Credit Agreement includes a secured leverage financial maintenance covenant for the benefit of the revolving lenders that is in effect only if revolving usage exceeds 30% (or $75 million); given $85 million of outstanding revolving borrowings, the maintenance covenant has likely been triggered.
On Aug. 8, the company entered into an amendment to the Credit Agreement that, as illustrated above, loosened the maintenance covenant and pushed out the dates when the maintenance covenant begins stepping down.
On the basis of our calculations, assuming constant outstanding debt and cash, GTT Communications can likely incur an additional $327 million of secured debt and remain in compliance with the 6.5x secured leverage test ($162 million assuming a fully drawn revolver); however, assuming constant outstanding debt and cash, if GTT Communications’ EBITDA declines by $50 million or, whenever the maintenance covenant steps-down to 6.25x, by $34 million, it could have difficulty remaining in compliance with the covenant.
However, as a condition to revolving lenders agreeing to loosen the maintenance covenant, as illustrated below, GTT Communications agreed to limit certain activities through the quarter ending March 31, 2021, that had been permitted under the Credit Agreement.
Pursuant to the amendment, GTT Communications’ incremental debt capacity was reduced by $275 million, it is restricted from paying dividends and designating, and investing in, unrestricted subsidiaries and its ability to make investments is now subject to a liquidity test.
Nevertheless, the company is still likely permitted to incur $290 million of additional pari debt, including $250 million of pari incremental debt and $40 million of pari debt using capacity under general debt and liens baskets. Although the company can also incur $80 million of junior lien debt under the general debt basket, the maintenance covenant likely restricts the company from incurring $327 million of additional secured debt, including additional draws on the revolver.
The 2024 Notes
The 2024 Notes were issued in December 2016, and the negative covenants under the notes provide capacity based on the greater of a fixed amount and a percentage of total assets; according to the company’s 10-K for the 2016 fiscal year, its total assets were valued at about $953 million. Since the 2024 Notes were issued, the company has acquired Hibernia (to add a strategic transatlantic fiber network), Global Capacity (to add scale and low-cost last-mile access) and Interoute.
At the end of 2017, the company’s total assets were valued at around $1.8 billion and, at the end of 2018, at around $4.5 billion.
Because of the significant increase in the company’s total assets, as illustrated below, the 2024 Notes provide the company with significantly more flexibility than the Credit Agreement to pay dividends and make investments; however, under the 2024 Notes, the company is permitted to incur only $234 million of additional secured debt.
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