European high-yield investor resistance to aggressive lending terms could be stiffened by seeing several issuers take advantage of the flexibility in deal documentation granted at the market’s peak in 2017.
The latest is German retailer CBR Fashion, which is paying a dividend to its new sponsor, just months after it changed ownership, without having to pay back holders of its €450m 5.125% bond due 2022.
In the third quarter, the company will upstream €50m of cash to sponsor Alteri Investors in the form of a shareholder loan, it said during an investor call last week.
The dividend is fairly sizeable when compared to the firm’s cash and cash equivalents of €100m and adjusted Ebitda of €62m for the first six months of 2018.
“They did it because they could,” said a fund manager. “If you were doubtful at all about what sponsors could do with these loosened covenant terms, or if you doubted they would ever use them, here’s a great example,” he added.
The fund manager was referring to a point syndicate bankers often make in defending flexibility granted to issuers in the deals they market: that they are unlikely to be used.
Other aggressive terms investors signed up for in recent times allow companies to pay dividends in technical – and sometimes actual – default without meaningful deleveraging and by investing in subsidiaries not restricted by lending terms.
But investors have shown increased resistance to aggressive terms in 2018, with the majority of deals backing buyouts having amended terms before pricing.
“The more investors get burned by documentation, the better it is for instigating some pushback,” the fund manager said.
CBR’s dividend announcement comes after former owner EQT sold the company in March 2018 to Alteri, which is backed by private equity firm Apollo.
The company was sold without taking bondholders out with a 101 put, as the bond’s terms allowed it to exercise portability without deleveraging, a point covenant analysis services had warned investors about during the sale of the bond.
High-yield investors are particularly irked by portability, as judgements about a company’s management and ownership and their strategy plays a significant role in the decision to invest in its bonds. For some, CBR’s dividend payment indeed raises doubts about the new sponsor’s strategy for the company going forward.
“From a covenant perspective in the CBR bonds, seemingly nothing has changed. The change-of-control provision is intended to give investors the opportunity to put their bonds back at the point that a third party buys the business, in the event they’re no longer happy with the ownership structure,” said Christine Tadros, head of European research at Xtract Research.
High-yield issuers also build capacity to pay dividends tied to profit levels, another risk for investors who hold portable bonds for companies that perform well.
“Alteri will have inherited whatever build-up basket capacity to make restricted payments CBR has accumulated since the issuance of the bonds,” Tadros said.
The bond was sold with obliging terms in October 2017 despite the fact that the company had restructured loan debt in 2016, following a suspended IPO a year earlier.
READING THE FINE PRINT
CBR Fashion is joining a growing list of high-yield issuers to have taken advantage of flexibility gained through recent deals.
In May, British retailer Shop Direct’s results disclosed that it paid £123m in intercompany loans during the nine months ending that month, leaving £12.3m in cash and bank balances.
The loans, which can be used to pay dividends to shareholders Barclay brothers, spooked investors – leading to a 15-point drop on the bonds, which were already under pressure given the company’s deteriorating earnings and financial metrics.
Just weeks before this, French frozen foods retailer Picard tapped a bond from December 2017 to help fund a €78m dividend payment to its shareholders led by Lion Capital, months after paying a dividend using part of the original tranche. Its pro forma cash levels came down to €70m, according to analysts at Lucror Analytics, from €148m at the end of 2017, and the dividend payment led to a one-notch rating downgrade from S&P to B.
Covenant research service firms had warned about both companies’ abilities to pay additional dividends while the bonds were being marketed.
“There’s always a lot of capacity in bond covenants, particularly in the current European high-yield bond market, so investors need to be mindful of the various permissions that are proposed in any given issuance,” Xtract’s Tadros said.
“They need to assess on a case-by-case basis whether they would be happy with a company leveraging itself up to the level permitted by its debt covenant or making payments out to the extent permitted by its restricted payments covenant,” she added.