Thu 09/23/2021 07:00 AM
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Numerous refinancing transactions in recent years, including Revlon’s success in addressing its 2021 unsecured note maturity last year with an out-of-court solution, leaves the company with an incredibly complex capital structure consisting of foreign term loans, a three-tiered ABL facility, a three-tiered “BrandCo” facility, a partially paid-down regular-way term loan and one unsecured note issuance. The following analysis is primarily focused on the potential for divergent recoveries between the BrandCo term loans and the regular-way, or “RemainCo,” term loan under a restructuring scenario. While the company has not recently suggested it is at risk of restructuring, it faces ongoing needs to refinance, with the RemainCo term loan maturing in September 2023 likely representing the next loan that Revlon will need to address.

Currently, the company’s BrandCo second lien loan is trading at 75/76.5, according to pricing from SolveAdvisors, and the RemainCo term loan is trading at 55/57. Our analysis suggests that under most assumptions, the spread between these two loans is tighter than a recovery analysis would suggest is appropriate, with the BrandCo second lien loan standing to recover par at valuations that allow for the RemainCo term loan to recover in the mid-50s.

Trading prices imply about $1.208 billion in total market value between the BrandCo second lien loan and the RemainCo term loan, with $716 million in market value attributed to the BrandCo second lien loan and $492.4 million attributed to the RemainCo term loan at recent market prices; about a 60/40 split.

In the base case under Reorg’s analysis, a lower overall recovery value is allocated to the combined loans, but a greater portion of that value is allocated to the BrandCo second lien loan relative to the RemainCo term loan. The mid-case valuation results in only $924.7 million in value being allocated to the two loans, but the split is 70/30 in the BrandCo second lien loan’s favor, resulting in a 69.3% recovery for the BrandCo second lien loan, driven by 80% of international value and 70% of North American value accruing to the BrandCo lenders, as well as by the BrandCo first lien loan’s 82% recovery from the BrandCo assets alone.

As discussed in more detail below, there are numerous complicating factors that may be contributing to this apparent mispricing, including litigation considerations and the possibility that the market views Revlon’s majority owner, Ron Perelman, as being willing to ensure the company will not undertake an in-court restructuring.

Capital Structure

Revlon’s capital structure as of June 30 is shown below:

(Click HERE to enlarge.)

A simplified corporate structure for Revlon is shown below:

(Click HERE to enlarge.)

Note that the company published a detailed corporate structure in connection with entry in 2019 into a $200 million loan from Ares Management LLC, since extinguished, which is compiled HERE.

BrandCo Collateral Overview

This analysis is primarily focused on differences in recoveries between the BrandCo loans and the RemainCo term loans, with RemainCo referring to the assets and entities that were not transferred to BrandCo at the time of the BrandCo uptier transaction, which occurred in early 2020. A summary of the key aspects of the BrandCo collateral package that differentiates those loans from the RemainCo term loans follows.

The BrandCo term loans are secured by “Specified Brand” assets that were contributed to BrandCo subsidiaries at the time of the BrandCo financing. As a result, the BrandCo facilities prime the 2016, or RemainCo, term loan with respect to the value of these Specified Brand assets.

The Specified Brand assets consist of the following brands:

  • Elizabeth Arden;

  • American Crew;

  • Certain “Select Portfolio Brands” including Almay, CND, Mitchum and the “Multicultural Group” brands including Creme of Nature, Lotta Body, and Fanci-Full; and

  • An “Owned Fragrance Portfolio.”


Remaining brands not included in the Specified Brands include primarily the Revlon brands as well as Cutex, Gatineau and SinfulColors.

Revlon and its operating subsidiaries entered into license and royalty arrangements on arm’s-length terms with the relevant BrandCo subsidiaries to provide for the company’s continued use of the “Specified Brand Assets.”

An example of these license agreements for the Elizabeth Arden brand assets can be found HERE. Each of the license agreements contemplate Revlon paying a royalty rate to BrandCo totaling 10% of the net sales of the licensed products covered by the relevant brand, subject to minimum royalties detailed in the agreement. An estimate of the value of the BrandCo brand assets is discussed in more detail below.

The BrandCo loans are referred to as consisting of first lien, second lien and third lien tranches, or the BrandCo 1L/2L/3L tranches. This tranching of priorities is only with respect to the BrandCo assets; that is, there is a BrandCo collateral waterfall whereby the 1L tranche recovers in full from the BrandCo assets before the 2L tranche can recover any value from those assets, as governed by a 1L/2L/3L intercreditor agreement.

This priority structure is not in place, however, for any of the other collateral securing the BrandCo and RemainCo term loans. For all RemainCo collateral, all the term loans - both BrandCo and RemainCo - have a pari passu security interest in the collateral, as governed by a first lien pari passu intercreditor agreement. Put another way, the BrandCo term loans are guaranteed and secured on a pari passu basis with the RemainCo term loan facility on the RemainCo term loan collateral. This RemainCo collateral is generally described as follows:
“The obligations of Revlon, Products Corporation and the subsidiary guarantors under the 2016 Term Loan Facility are secured by pledges of the equity of Products Corporation held by Revlon and the equity of the Restricted Group held by Products Corporation and each subsidiary guarantor (subject to certain exceptions, including equity of first-tier foreign subsidiaries in excess of 65% of the voting equity interests of such entity) and by substantially all tangible and intangible personal and real property of Products Corporation and the subsidiary guarantors (subject to certain exclusions). The obligors and guarantors under the 2016 Term Loan Facility and the 2016 Revolving Credit Facility are identical. The liens securing the 2016 Term Loan Facility on the accounts, inventory, equipment, chattel paper, documents, instruments, deposit accounts, real estate and investment property and general intangibles (other than intellectual property) related thereto (the ‘Revolving Facility Collateral’) rank second in priority to the liens thereon securing the 2016 Revolving Credit Facility. The liens securing the 2016 Term Loan Facility on all other property, including capital stock, intellectual property and certain other intangible property (the ‘Term Loan Collateral’), rank first in priority to the liens thereon securing the 2016 Revolving Credit Facility, while the liens thereon securing the 2016 Revolving Credit Facility rank second in priority to the liens thereon securing the 2016 Term Loan Facility.”

Finally, the BrandCo loans are secured by a “34% equity pledge of any Non-Guarantor subsidiaries directly owned by a Guarantor” in addition to the pledge of 65% of the equity of first-tier foreign subsidiaries provided to the RemainCo term loan and the BrandCo loans on pari passu basis, suggesting that the BrandCo loans have a priority lien on 34% of Revlon’s foreign subsidiary assets, relative to the RemainCo term loan.

The summary of terms for the BrandCo facilities, which reinforces the above summary of the BrandCo collateral, was included in a lender presentation dated April 14, 2020, and is shown below:

Additional documentation for the BrandCo loans, including credit agreements, security agreements, stock pledge agreements and additional license agreements, is included as exhibits to the Revlon 10-Q for the second quarter of 2020.

Financials / Valuation

Revlon Valuation

Determining a reasonable valuation for Revlon is difficult. Comparable companies, for the most part, trade at a significant premium to the company’s valuation as measured through its equity market capitalization, driven in no small part by the fact that most of Revlon’s competitors are exhibiting top-line growth, while Revlon’s revenue has declined since the Elizabeth Arden acquisition in 2016. Among the company’s disclosed competitors, Coty trades at 15.3x LTM EBITDA and e.l.f. Beauty trades at 23.8x LTM EBITDA.

Further, determining a consolidated value of Revlon is challenging, given the significant divergences within Revlon’s own capital structure. Revlon has a multi-hundred-million-dollar market capitalization despite its secured debt trading in the 70s and unsecured debt in the 40s. Much of this apparent disparity in capital structure pricing can be attributed to Ron Perelman’s significant ownership of Revlon equity, and the perception that he will not allow the company to fail.

Ultimately, we rely largely on trading prices in determining a starting point for Revlon’s valuation and show recoveries across a relatively wide valuation range, yielding an estimated Revlon enterprise value of $1.919 billion in the low case and $2.894 billion in the high case.

BrandCo Valuation

In connection with the BrandCo financing, Revlon provided summary financials for its BrandCo brands for 2017, 2018 and 2019, as shown below. Certain of the financials below are calculated based on the information provided by the company.

 

The above financials do not accurately reflect the value of the BrandCo entities themselves as they are a summary of the contribution from the brands to Revlon’s overall operations, rather than of the cash flow for the BrandCo entities themselves. Therefore, we estimate the cash flow for the BrandCo entities based on the underlying license agreements and calculate an implied valuation as shown below:

(Click HERE to enlarge.)

This valuation relies heavily on the assumptions and techniques used in an expert report provided by Navigant Consulting, as advisor to the J. Crew term loan plaintiffs in their 2017 litigation with the company regarding, among other things, the valuation of the J. Crew brand that was transferred out of the term loan credit group. In this expert report, Navigant estimates the value of the brand at issue based on a “Relief From Royalty” methodology, as shown HERE. Navigant notes that the “key considerations to this method are the royalty rate, the revenue projections, and the discount rate.” In J. Crew’s case, Navigant uses an 8% royalty rate, a 0% long-term growth rate and a 10.8% discount rate.

Reorg uses a 8% royalty rate in determining Revlon brand valuation, which is in line with the median royalty rate for luxury and cosmetics companies calculated by Navigant in its expert report but below the 10% charged by the BrandCo entities in the license agreements.

We use a long-term growth rate of 2.6%, largely driven by expectations that the Elizabeth Arden brand will continue to grow over time and partially offset by declines in the owned fragrance portfolio. However, the long-term growth rate and the explicit growth rates included in the brand valuation are highly illustrative, given the limited brand-level data provided by Revlon and the lack of data post-2019. Finally, a 10% discount rate is used, yielding a valuation of the BrandCo assets of $890.4 million.

Within the waterfall, a multiple-driven valuation model is used for simplicity, centered on the $890.4 million calculated valuation, as shown below:

International vs. North America Value Allocation

As noted above, the BrandCo loans have additional equity pledges from first-tier nonguarantor subsidiaries, in excess of the stock pledged to the RemainCo term loan. For the most part, these nonguarantor subsidiaries are foreign entities and make up the company’s international operations, making the allocation of value to Revlon’s international business a key piece of a recovery analysis.

Revlon provides revenue by product segment across its North America and international regions and also provides segment profit. Based on the aggregate segment profit margins, we estimate segment profit in North America and internationally, as well as calculating revenue share in North America and internationally.

As shown above, in all cases the allocation of revenue and estimated segment profit suggests a slightly greater share of value from North America compared with the international segment. Based on the average of revenue and segment profit in 2019 and 2020, we estimate a value split of 53.2%/46.8% between the North American and international segments.

After calculating a total enterprise value, or TEV, for Revlon, allocating certain of that value to the BrandCo brands and splitting the remaining value between the North American and international business segments, we arrive at the valuation summary shown below:

Recovery Analysis

In line with the valuation above, our recovery analysis breaks the Revlon entities into three groups. These are the BrandCo assets and related claims; the international assets and claims; and the RemainCo, or North American, assets and claims.

As noted above, the BrandCo assets are allocated across the BrandCo loans based on a three-tiered waterfall, with the 1L recovering most or all of the BrandCo asset value under most assumptions.

Note that the BrandCo credit agreement includes language providing for a make whole upon default, detailed in section 2.19 of the BrandCo credit agreement, which we calculate to provide for a 19.2% increase in the BrandCo 1L claim amount as of today. This make whole claim increases the BrandCo 1L claim amount to $1.107 billion from our calculation of BrandCo 1L currently outstanding of $929.2 million. Our recovery model includes a toggle allowing for the exclusion of the make whole amount.

For each of the RemainCo and international recovery calculations, we assume that the ABL claims and foreign term facility claims have effective priority claims and therefore deduct their claim amounts from the RemainCo and international valuation estimates before allocating the remaining value across the other creditors.

As noted earlier the BrandCo claims have additional equity pledges from first tier nonguarantor subsidiaries, resulting in the BrandCo and RemainCo lenders sharing in 66% of value in nonguarantor subsidiaries and the BrandCo lenders having the sole claim against the remaining 34%. We assume the value allocated to the international operations sits entirely within nonguarantor subsidiaries, and therefore, all of the international value is subject to this split. Note that the equity pledges are detailed by entity in exhibits to the term loan guarantee and collateral agreement and the first lien BrandCo stock pledge agreement.

Generally speaking, we assume there are no general unsecured claims outstanding other than the unsecured bond claims. This assumption improves recoveries for lenders from the international assets, as any unsecured claims at nonguarantor foreign entities would likely recover value before it flowed to the lenders via their equity pledges.

The RemainCo waterfall is shown below:

Value available to creditors from the RemainCo assets, after full repayment of the ABL claims, is allocated between BrandCo and RemainCo secured creditors based on their pro rata share of the claims pool. The BrandCo and RemainCo lenders are pari passu secured creditors and therefore recover their pro rata share without adjustment.

Note, however, that the share of the claims pool is calculated based on the full amount of BrandCo claims and RemainCo claims outstanding, irrespective of any recovery from other sources, based on the premise that the BrandCo creditors are entitled to a full face claim against any entity which guarantees their loans. The BrandCo claims total $2.056 billion (after inclusion of the 1L make whole amount), and the RemainCo term loan claims total $879.3 million, resulting in a $2.935 billion secured claims pool and a 70%/30% allocation of value to BrandCo and RemainCo secured claimants.

The recovery model includes a toggle allowing for the BrandCo claims amount to be reduced if a tranche of the BrandCo loans recovers in full from the BrandCo assets. Adjusting this toggle results in international and RemainCo value being allocated between BrandCo and RemainCo creditors based on a 52%/48% split in the event that there is sufficient value at BrandCo to repay the BrandCo 1L in full. In all scenarios, the model adjusts recoveries such that no creditor recovers in excess of their claim amount, even if their recoveries from the various sources of value suggest that they could do so.

Summary recoveries under our assumptions are shown below:

The recovery model and supporting calculations are available for download in Excel HERE.

Citibank Mistaken Transfer Litigation

Against the capital structure backdrop discussed above, issues remain regarding both the accidental payment of certain of the company’s term loans and the fundamental legality of the BrandCo transactions.

A fulsome discussion of Citibank’s mistaken payment of funds to lenders under the RemainCo term loan is beyond the scope of this article. However, in February 2021, Judge Jesse Furman of the U.S. District Court for the Southern District of New York ruled that lenders who received mistaken transfers from Citibank in August 2020 could keep the money. That ruling has been appealed to the Second Circuit.

If Judge Furman’s decision is upheld on appeal, then Ctibank may have the ability to assert a subrogation claim and step into the shoes of the RemainCo lenders it mistakenly paid off. Regarding this possibility, Revlon says the following: “Citi has appealed the Citi Decision. Citi has also asserted subrogation rights, but, as yet, there has been no determination of those rights (if any) under the 2016 Facility and Revlon has not taken a position on this issue. In these circumstances, it is the current intention of the Company to continue to make the scheduled payments under the 2016 Facility as if the full amount of the 2016 Facility remains outstanding.” Citibank has likewise asserted that it has “rights as a creditor related to the Revlon loan.”

Reorg has discussed the possibility of subrogation and the related legal considerations in more detail HERE and HERE.

If Citibank were unable to successfully step into the lenders’ shoes and the RemainCo claim were reduced by the $504 million at issue, recoveries for otherwise impaired creditors would improve across the board, as shown below:

Prior to the mistaken payment by Citibank, certain lenders under the RemainCo term loan directed UMB, as administrative agent to the loan, to sue Revlon, Jefferies, Ares and the lenders under the BrandCo facility. UMB sought through its complaint to rescind the BrandCo credit agreement, unwind the BrandCo refinancing transaction (including reversal of all IP transfers and return of all proceeds), declare the company in breach of the credit agreement, and award damages to compensate the dissenting lenders “for the loss of the liens on collateral securing payment of their loans under the 2016 credit agreement.”

UMB later voluntarily dismissed the BrandCo refinancing lawsuit without prejudice. The voluntary dismissal occurred after the court denied UMB’s request for a 60-day extension to serve the complaint on Revlon. UMB had requested the extension of the service deadline in early October 2020, saying that its lawsuit should not proceed before the resolution of Citibank’s clawback action in connection with the funds that it mistakenly transferred to term lenders. If Citibank were to win on appeal and retrieve the mistaken transfers, returning the defendants to their position as lenders under the RemainCo term loans, it is possible this suit challenging the BrandCo transactions could be reinitiated, though no indication has been given that such a strategy is under consideration.

--Nick Williams
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