Mon 05/24/2021 14:01 PM
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Relevant Items:
Steel Connect Covenants Tear Sheet, Debt Document Overview
Steel Connect Debt Documents

Steel Connect Inc. is a holding company with two subsidiaries: direct marketing business ModusLink Corp. and supply management company IWCO Direct Holdings Inc. Continue reading for our Americas Covenants team's analysis of the Steel Connect debt documents and Request a Trial for access to the linked debt documents, tear sheets, and summaries as well as our coverage of thousands of other stressed/distressed debt situations.

Corporate-level debt consists of $15 million of unsecured convertible notes without any guarantees, while ModusLink has a $12.5 million revolver and IWCO Direct Holdings has a $25 million revolver and $393 million term loan at its subsidiary Instant Web LLC. Steel Connect does not guarantee or secure any of the OpCo debt, but such debt is secured and guaranteed by the respective subsidiary operating groups with customary exceptions.

On Nov. 19, 2020, Steel Partners Holdings LP, itself a publicly listed diversified holding company that owns 48.7% of Steel Connect through various subsidiaries, delivered a preliminary, non-binding proposal to Steel Connect’s board of directors to acquire all the outstanding shares of common stock not already owned by Steel Partners and its affiliates. As of March 10, 2021, Steel Connect reported in its most recent quarterly filing that it has not made a decision on the proposal. Steel Partners and its non-operating company affiliates are permitted holders under the debt of Steel Connect’s OpCos, and the consummation of the transaction would not likely constitute a change of control under such debt. The transaction would, however, trigger a change-of-control put under Steel Connect’s unsecured convertible notes.

The company’s capital structure as of Jan. 31 is as follows:

 
Steel Connect’s Unsecured Convertible Notes

Steel Connect’s $15 million 7.50% convertible notes due 2024 were issued to SPH Group Holdings LLC, a subsidiary of Steel Partners, and are not publicly traded. They are unsecured and lack any guarantees. They also lack financial maintenance and negative covenants. However, unlike the debt at the OpCo level, the notes do contain a change-of-control provision that would be triggered by Steel Partners’ proposed acquisition of Steel Connect.

So long as an affiliate of Steel Partners is the holder of the convertible notes due 2024, any affiliate(s) of Steel Partners may own up to 65% of the voting power of Steel Connect (if any other person or group holds the notes, then the threshold drops to 50%). Steel Partners’ expression of interest was for the acquisition of the remaining shares outstanding in full, and as such, would trigger the right of the noteholder to require Steel Connect to repurchase the notes at par. Given that an affiliate of Steel Partners is the noteholder, the notes might not be put for repurchase under the proposed transaction.
OpCo Debt: ModusLink’s ABL Revolver

ModusLink has a $12.5 million ABL revolver maturing in 2022 which was undrawn as of Jan. 31. The change-of-control provisions in the revolver explicitly exempt Steel Partners and its affiliates from the trigger. The facility is guaranteed by certain subsidiaries of ModusLink and secured by the assets of ModusLink and its subsidiary guarantors, including the equity of domestic subsidiaries and ModusLink itself. The revolver does contain financial maintenance and negative covenants. There is no restricted/unrestricted subsidiary distinction, and the covenants apply to ModusLink and its subsidiaries.

Financial covenants and liquidity - Until July 31 or such earlier date when ModusLink has exhausted its restricted payments basket to make $50 million in distributions to Steel Connect, ModusLink must maintain at least $3 million in liquidity. As of Jan. 31, the borrowing base under the undrawn ABL revolver was $8.8 million. It is unclear how much cash was kept at ModusLink as of such date. ModusLink must also maintain a monthly fixed charge coverage ratio, or FCCR, of 1.0x. We estimate the interest coverage ratio to be approximately 2.7x.

Debt and liens - We estimate that ModusLink can incur $6 million in secured debt, $500,000 in unsecured debt and unlimited unsecured subordinated debt. It can also incur an additional $2 million in contingent obligations.

Restricted payments, investments and prepayments - As noted above, ModusLink has a basket to make special distributions to Steel Connect totaling $50 million. This basket expires on July 31. Any use of this basket during fiscal year 2021 supersedes and prevents the use of the dividends basket, which permits $2 million in distributions annually. A third basket, unaffected by use of the special distributions basket, permits up to $125,000 per month to be paid to Steel Connect for management and related fees. Unlimited intercompany advances from loan parties to non-loan parties are permitted, but this is not particularly concerning because all subsidiaries are subject to the negative covenants. There is also a $50 million basket for permitted acquisitions, with a sublimit of $10 million for foreign acquisitions. This is important because the security package generally excludes the equity of foreign subsidiaries, as is customary. ModusLink does not have the ability to prepay debt which has been subordinated in any way.
OpCo Debt: Instant Web’s RCF and Term Loan

Instant Web LLC is a subsidiary of IWCO Direct Holdings Inc., one of Steel Connect’s two main subsidiaries. It has an undrawn $25 million cash flow revolver and a $393 million term loan, of which $369 million remains outstanding. The change-of-control provision in the facility exempts SPH Group Holdings LLC, a subsidiary of Steel Partners, from the change-of-control trigger, and Steel Partners’ proposed transaction would not result in an event of default or mandatory prepayment.

The revolver and term loan are guaranteed by certain of Instant Web’s subsidiaries and secured by substantially all the assets of the borrower and guarantors, as well as the equity of IWCO Direct Holdings’ subsidiaries. As with the debt at its sister subsidiary, Instant Web’s facility does not distinguish between restricted and unrestricted subsidiaries, and the covenants apply to the borrower, IWCO Direct Holdings and its subsidiaries.

Financial covenants and liquidity - The credit agreement has a net leverage ratio that is tested quarterly only when average liquidity for the last 10 consecutive days of the applicable calendar quarter is less than $14.5 million. The ratio requirement decreases over the life of the facility and currently stands at 5.0x. We estimate the net leverage ratio to be between 3.3x (assuming the entire cash balance was held by IWCO Direct Holdings) and 4.3x (assuming no cash balance was held by IWCO Direct Holdings) as of Jan. 31. The availability under the undrawn cash flow revolver was $25 million. It is unclear how much cash was kept at IWCO Direct Holdings or Instant Web as of such date.

Debt and liens - We estimate IWCO Direct Holdings can incur $10 million in secured debt, $1 million in unsecured debt and unlimited unsecured subordinated debt.

Restricted payments, investments and prepayments - The credit agreement for Instant Web’s facility is much more restrictive than ModusLink’s ABL revolver. We estimate that as of Jan. 31, IWCO Direct Holdings can make $5.5 million in restricted payments and $34 million in investments. This includes $500,000 in distributions and investments outside the loan parties but within the IWCO Direct Holdings subsidiary group. As these subsidiaries are still subject to the negative covenants and themselves are unable to distribute outside of the group, the danger of value leakage is minimized. IWCO Direct Holdings also has a basket to make $5 million per fiscal year in restricted payments to Steel Connect for management fees and other related operational expenses. While this basket is larger than ModusLink’s management fees basket, Instant Web’s facility lacks a general dividends basket completely. Instant Web has a general investment basket of $3.5 million and a permitted acquisitions basket of $30 million.

--Richard Barbour II
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