Wed 04/28/2021 16:48 PM
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Titan International Debt Documents
Titan International Covenants Tear Sheet and Debt Document Summaries

We have updated our coverage of Titan International, a global wheel, tire and undercarriage industrial manufacturer and supplier, to include an updated covenants tear sheet, an analysis of the company’s new secured notes due 2028 and an analysis of the company’s amended ABL agreement. In this report we provide an overview of the most notable insights of those analyses and analyze a potential divestiture of Titan’s Italian undercarriage business. Continue reading for our Americas Covenants team's analysis of the Titan International liquidity restrictions 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.

Titan’s capital structure as of the end of 2020 was as follows, adjusted for the ABL amendment, which downsized ABL commitments and adjusted for a refinancing of the 2023 notes with the new 2028 notes:
Titan International capital structure

 
New Secured 2028 Notes

Last week Titan issued the $400 million of 7% senior secured notes due 2028, the proceeds of which are funding a redemption of the company’s 6.5% senior secured notes due 2023. A notice of redemption for the 2023s was delivered earlier this month, and the 2023s are expected to be redeemed on May 7. The covenant package and credit support package of the new 2028s are very similar to those of the existing 2023s, with the exception of EBITDA-based “growers” added to various covenant baskets. There was also a notable change to a certain restricted payment basket’s permitted “carry-forward,” which we discuss because initial buyers of the 2028 notes may be unaware of the change.

The existing 2023s contain an RP basket that permits $5 million of dividends per 12-month period, with carry-forward of any period’s unused amounts to the next immediately succeeding period (only). The preliminary terms of the 2028s contained that same basket, with some changes to the version in the 2023s, and then there are also some changes between the 2028s’ preliminary and final terms. Pricing term sheets generally list any changes in terms between a preliminary offering memorandum and final terms, but the changes between the 2028s’ preliminary and final terms are not reflected in the 2028s’ pricing term sheet.

Under the April 7 preliminary terms of the new 2028s, the $5 million RP basket was extended from only dividends to also include equity repurchases (which is unobjectionable). More notably, the preliminary terms of the 2028 basket also seem to have attempted to uncap the amount of permitted carry-forward. Due to an error in the drafting of that 2028 basket’s preliminary terms, it was unclear whether unused amounts could be carried forward past the immediately succeeding period. Under the April 22 indenture terms of the new 2028s, the basket was redrafted, correcting the drafting error and making it clear that carry-forward is uncapped. Presumably such change is also reflected in the April 8 final offering memorandum (which we have not reviewed).

The overall takeaway of the above is that this $5 million RP basket permits uncapped carry-forward of unused amounts. We flag the differences between the preliminary and final terms simply to alert initial buyers of the 2028 notes, as the change was not reflected in the 2028s’ pricing sheet.
Amended ABL Agreement

Titan amended its ABL agreement in February. The most notable change to the facility, besides a $25 million commitment decrease and an increase in applicable margin, was the addition of an anti-hoarding provision.

The anti-hoarding provision generally requires the ABL borrowers to prepay outstanding loans if the “Consolidated Cash Balance” exceeds $20 million. More specifically, at the end of any business day, if there are any outstanding ABL loans and cash of the ABL borrowers exceeds $20 million, then the company must prepay ABL loans in the amount of such excess (or, if the amount of ABL loans is lesser, such lesser amount). If the agreement’s cash dominion provisions are also in effect, then the $20 million test is instead $0, and if a default exists after such a prepayment and any LC obligations exist, the company must also cash collateralize the LC obligations.

In tandem with the ABL agreement’s existing cash dominion provisions, a quarterly tested availability-based 1.00x springing FCCR covenant (the ratio was about 0.8x as of year-end 2020 but not tested) and various availability-based blockers on restrictive covenant baskets, the February 2021 addition of the anti-hoarding provision places further potential restrictions on the company’s U.S. operations’ access to liquidity.

Company-reported LTM adjusted EBITDA at year-end 2020 was $54 million, up from $38 million at year-end 2019 but down from $119 million at year-end 2018.
Potential Divestiture of ITM Business

In 2016, Titan formed a special committee of its board of directors and engaged Goldman to explore a sale of its Italian subsidiary Italtractor ITM SpA (“ITM”), but that sale never occurred.

ITM designs, manufactures and distributes steel track and undercarriages for the construction, mining and agricultural markets. It is a part of Titan’s earthmoving / construction segment (“EMC”), which manufactures rims, wheels, tires and undercarriage systems and components for various types of off-the-road equipment, including skid steers, aerial lifts and cranes. During 2020 the EMC segment generated net sales of approximately $510 million and gross profit of approximately $58 million (of which the ITM subsidiary was a portion).

In February 2019, Titan announced that it had again engaged advisors to evaluate strategic alternatives for ITM. And on the company’s March 2019 earnings call, management stated that it was considering a public listing of the ITM business on the London AIM market.
“As we announced last week, we are now once again evaluating strategic alternatives for ITM. We’ve engaged advisors to assist us with their process and this does now include the option of a public listing in Europe. I firmly believe that based on ITM's performance in the past couple of years, ITM is now worth a much higher value than the offers we received in 2016. We are not declaring ITM a non-core asset and it's not a foregone conclusion that we'll dispose of this business. But I want to add that ITM can be split apart from Titan without major disruption or cost. Regardless of our announcements, we continue to believe that ITM is an excellent business with a strong future. However, we also firmly believe it's in the best interest of our shareholders to evaluate our strategic options at this time.”

In May 2019, the company stated that it had engaged financial advisor Shore Capital and “continue[d] to make positive progress as [they] move through the diligence phase of this alternative.” By August 2019 the listing was shelved.
“‘Earlier this year we announced that we were evaluating strategic alternatives with respect to ITM, our undercarriage business, and that we had engaged a financial advisor to assist us in carrying out this evaluation,’ commented Maurice Taylor, Chairman of the Board. ‘We noted that one of the potential alternatives was a public listing of ITM's shares within Europe. Although we recently pursued a listing of ITM’s shares on the AIM market of the London Stock Exchange, our Board of Directors has determined to postpone the AIM Listing. ITM’s business has performed very well in recent years and during the first half of 2019 with full year 2018 revenue of nearly $450 million. Based on this strong performance, Titan’s Board and our advisor expected an IPO valuation in excess of $300 million. The recent softer conditions of the financial markets in Europe due to Brexit and continued global trade concerns have impacted our ability to obtain a valuation at a suitable level. We continue to believe that ITM has a strong future of continued growth and Titan will execute a plan that is in the best interests of our shareholders’” (emphasis added).

More recently, on the company’s August 2020 earnings call, management suggested that it was again considering a divestiture of the ITM business:


“Titan has other non-core assets that we'll sell at a fair price and the largest non-wheel/tire asset is ... our tractor wheel business at ITM. We believe, over the next 18 months, Titan will have the opportunity to either sell or to spin off ITM” (emphasis added).

“We have spent time in the last two years building ITM's business up, especially into the aftermarket. And now everything, of course, with the situation with the COVID-19 worldwide has knocked everything down. But we believe what's going to happen is that the infrastructure, both in Europe and in the U.S., will come to start moving right after the election, no matter who the heck wins the damn thing. We expect this business to grow, both in the sales of the OEs and our aftermarket business. We believe that we'll increase its revenue up to around $500 million. Before this period and the shutdown, it was bouncing right around the $400-plus million. We believe that will bring to Titan between a total value of $300 million to $400 million” (emphasis added).


Below, we analyze the permissibility under Titan’s ABL and 2028 notes of an asset sale or spinoff of the ITM subsidiary.

Asset sale analysis - A divestiture of the ITM subsidiary that is structured as an asset sale could generally be structured in one of two forms, either (1) a plain-vanilla asset sale by the restricted group or (2) a “two-step” asset sale in which the company first deposits the ITM subsidiary in an unrestricted subsidiary and then that unrestricted subsidiary sells ITM. Under either of those asset sale structures, a sale of ITM’s equity via a public listing would be an asset sale (the sale of the equity in a subsidiary).

Plain-vanilla asset sale structure - A plain-vanilla asset sale (i.e., not a “two-step” transaction) most likely would not trigger the ABL’s asset sale covenant and related mandatory prepayment provisions. The ABL’s asset sale covenant applies only to dispositions of assets of an ABL borrower, which includes the topco, Titan and certain other U.S. subsidiaries but does not include any foreign subsidiaries. Therefore, the ABL’s asset sale covenant would not apply to a sale of a foreign subsidiary unless it was a sale of assets (equity) directly held by an ABL borrower.

Even if the ABL’s asset sale covenant did apply to a sale of ITM, the covenant permits uncapped asset dispositions unless availability is less than 25% of commitments. Availability as of year-end 2020, pro forma, was $50.9 million, and 25% of commitments under the amended ABL agreement totals $25 million. Moreover, assuming the asset sale covenant did apply, and assuming that at the time of an ITM sale Titan cannot satisfy that availability-based test, the asset sale sweep of the ABL’s mandatory prepayment provisions applies only to dispositions of ABL borrower base collateral (U.S. domestic receivables and inventories), which does not include any assets of ITM, a foreign subsidiary.

Under the secured 2028 notes, their asset sale covenant would be triggered only if the sale concerns a fair market value of $25 million or more, because the de minimis carve-out to the indenture’s “asset sale” definition permits any sales of non-collateral with a FMV of less than $25 million. Because an ITM sale would most likely be for more than $25 million ($300 million-plus valuation), the notes’ asset sale covenant would generally require that the net proceeds be reinvested in the business, used to repay credit facilities or used to make an asset sale par offer to noteholders.

“Two-step” asset sale structure - If the company structured a sale of ITM in a “two-step” transaction, the answer would be the same under the ABL. That is because the ABL agreement does not contain the concept of restricted and unrestricted subsidiaries. Instead, the ABL’s restrictive covenants generally apply only to ABL borrowers (which are all U.S. entities).

The company would need to, however, locate sufficient “investment” capacity under the 2028 notes to transfer ITM into an unrestricted subsidiary or otherwise designate ITM as an unrestricted subsidiary.

The 2028 notes’ RP covenant contains the following notable carve-outs that can be used to make investments in unrestricted subsidiaries:

  • An RP buildup basket, which builds from April 1, 2020, by 50% of cumulative consolidated net income (subject to typical adjustments), with a $50 million starter amount and basket usage subject to satisfying a 2.00x fixed charge coverage ratio test;

  • A general RP basket, sized at $100 million and which is prohibited from being combined with other baskets;

  • A general investment basket, sized at the greater of $100 million and 1.8x adjusted EBITDA (an estimated $97.3 million); and

  • A “Permitted Business” investment basket, sized at 15% consolidated net tangible assets (“CNTA”) (an estimated $116 million).


At the time of a sale of the ITM subsidiary, the RP buildup basket may contain insufficient accessible capacity to effect a two-step asset sale, for two reasons. First, the RP buildup basket’s 50% CNI test builds from the beginning of the current 2021 financial quarter, so that component of the basket currently contains no capacity. Second, although the basket contains a $50 million starter amount, use of the starter amount (as well as any CNI amount) is subject to satisfying a 2.00x FCCR test, and that ratio was an estimated 1.7x as of year-end 2020, pro forma for the recent refinancing. Therefore, in order to access the $50 million starter amount, Titan would likely need to improve its fixed charge coverage ratio (pro forma for the disposition).

Assuming the RP buildup basket could not be accessed, and considering that the $100 million general RP basket could not be combined with the RP buildup basket (at least not concurrently), the maximum amount of capacity for an unrestricted subsidiary transaction could potentially be $216 million: capacity under the general investment basket of $100 million under the Permitted Business investment basket of $116 million.

The indenture defines Permitted Business broadly, as is customary.
“‘Permitted Business’ means (i) the business conducted by or proposed to be conducted by, the Company and its Restricted Subsidiaries on the Issue Date and (ii) businesses that are reasonably similar, ancillary or related to, or a reasonable extension or expansion of, the business conducted by the Company and its Restricted Subsidiaries on the Issue Date.”

Although defined broadly, use of a Permitted Business investment basket for an unrestricted subsidiary transaction is potentially subject to challenge. For example, travel commerce company Travelport previously faced litigation from its noteholders for use of such a basket to effect unrestricted subsidiary transactions, but that litigation settled before the court ruled on the issue.

Whether the above investment baskets, standing alone or in some combination, are sufficient to sell ITM in a “two-step” transaction structure would depend entirely on the fair market value of the divested ITM subsidiary. According to the company disclosure further above, ITM has a fair market value of greater than $300 million.

Spinoff analysis - If Titan spun off the ITM subsidiary to Titan’s existing shareholders, the ABL agreement likely would not restrict that transaction. Similar to the ABL’s asset sale covenant, the ABL’s restricted payment covenant is subject to an availability-based test, which permits uncapped RPs unless availability is less than 25% of commitments (the same test as the ABL asset sale covenant).

How a spinoff would potentially be structured under the 2028 notes’ RP covenant is less clear. Typically, under a high-yield RP covenant, spinoffs are structured by first transferring the to-be-spun entity into an unrestricted subsidiary (or “designating” that entity as unrestricted) and then, under the RP covenant, relying on a customary high-yield RP carve-out that permits uncapped distributions of the assets or equity of unrestricted subsidiaries. The RP covenant of the 2028 notes, however, lacks such a carve-out. Therefore, to spin off the ITM subsidiary to Titan’s shareholders, the company could not rely on investment capacity (i.e., asset transfer / designation capacity) and would instead, in the absence of that customary RP carve-out, be required to entirely locate RP capacity (i.e., capacity for distributions to Titan’s shareholders) to effect the spinoff.

The 2028 notes’ two most notable RP carve-outs to effect a spinoff of ITM are the RP buildup basket and the $100 million general RP basket (each discussed above). Assuming the RP buildup basket could not be accessed, that leaves only $100 million of spinoff capacity.

Whether those baskets would be sufficient to spin off ITM would, similar to the analysis further above, depend entirely on the fair market value of the divested ITM subsidiary, and previously Titan disclosed that ITM had a fair market value of approximately $300 million plus.

Amendment / retirement analysis - If, at the time of any divestiture of ITM, the 2028 notes contain insufficient capacity for the divestiture, the company would either need to obtain an amendment to the 2028 notes, retire the 2028s or comply with the 2028 notes’ asset sale covenant’s application-of-proceeds provisions.

Amendments to the 2028 notes require a majority of the 2028 balance ($400 million outstanding at issuance), and the notes contain a payments for consent covenant, which generally requires that if the company offers a consent fee to some 2028 noteholders then it must offer that fee to all noteholders.

As to redemption, because the 2028 notes were issued only last week, their call schedule does not become effective until 2024. Until then an optional redemption of the 2028s is subject to a T+50 make whole (and equity claw with a 107% claw price, which can be used to redeem $160 million of the notes). Therefore, redemption is likely cost prohibitive.

If the 2028 notes need to come out, the company could instead simply comply with the 2028 notes’ asset sale covenant. Generally speaking, proceeds of an ITM sale that are not reinvested in Titan’s business or used to repay credit facilities would be required to be used to make an asset sale par offer to noteholders. The notes currently trade slightly above par, and if the notes trade above par at the time of an ITM sale, noteholders may prefer to reject such a par offer.
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