Leveraged finance markets have seemingly breathed life into private equity in recent months, but beneath the surface, trouble lives on. Sponsor-backed companies with highly leveraged balance sheets have spent much time and energy working through restructurings, with mixed results. The weaker ones have failed, and defaults and bankruptcies have spiked. Others may be postponing the inevitable.
Relatively healthy companies can pay down debt from cash flow, operations, asset sales or initial public offerings, or they refinance debt through high-yield markets if bank credit isn't accessible. Scores of companies have relied on amendments to debt agreements to get more flexible covenants and/or extend maturities. Unluckier ones are forced into in- or out-of court restructurings.
The overhang of leverage -- estimated at between $800 billion to $1 trillion in leveraged loans and high-yield bond debt maturing in the next five years -- is gargantuan enough that everyone will likely compete for a limited supply of credit between 2012 and 2014. Fitch Ratings Inc., in a recent study, analyzed nine LBO'd companies representing more than $100 billion in total debt.
At the risk of oversimplifying, Fitch says the companies -- which include Freescale Semiconductor Inc., HCA Inc., Toys "R" Us Inc. and Univision Communications Inc. -- have adequate cash and credit positions that more than cover maturities through 2012, with the exception of Univision, whose credit facility is almost fully drawn.
The Spanish-language broadcaster, which a group of PE investors bought in 2007 for $13.7 billion, has been divesting businesses and taken steps to boost cash flows. But its margin of safety is tight. It obtained an amendment from creditors increasing the leverage covenant to 11.25 times Ebitda, from 10.75 times. This gives it some runway, but Fitch says banks could reprice the existing facility, thus offsetting any upside from cash flow increases over the next few years.
Fitch recommends companies be more proactive. "In no instance does Fitch expect a company to generate the cash required to pay down its bank loans at maturity," it says. So companies will have to refinance most, if not all, of the maturing debt.
Some 340 companies have had amendments to debt agreements this year, according to Standard & Poor's Leveraged Commentary & Data. Of these about 35% were sponsor-backed. There have been roughly 170 amendments that aimed for covenant relief and about 98 amendments for maturity extensions. Sponsors were involved in about a third of the cases in both.
In every instance, however, amendments will have raised rates or introduced LIBOR floors. But these generally did not deleverage the companies.
"The reality is your costs go up, but it doesn't help the financial health of the company per se because you're not reducing debt and the cost of debt," says Jeffery Gelles, managing general partner at GLC Advisors & Co. LLC, a San Francisco restructuring advisory firm. "What you're doing is buying time."
To a lesser degree, credit markets have also seen refinancings whereby bank debt is traded and replaced with high-yield debt or traded for a discount in opportunistic exchanges.
"These are generally companies with balance sheets that are stable enough that they can tap the markets," says Gelles.
That's not to say that some of these companies will not ultimately default.
At the extreme, where a few lenders hold out, sponsors of severely distressed companies may just decide to hand over the keys to lenders. If everyone agrees, an out-of-court restructuring can avoid the steep costs, uncertainties and stigma of a regular bankruptcy.
Telecom provider Integra Telecom Inc. recently completed a debt-for-equity restructuring where creditors Goldman, Sachs & Co., Tennenbaum Capital Partners LLC and others acquired majority interest from New York private equity firm Warburg Pincus, reducing debt in the process. DLJ Merchant Banking Partners also recently ceded control of portable toilet provider United Site Services Inc. to its lenders.
Having even one or two senior creditors holding out could lead to a prepack, which at least helps limit the Chapter 11 stay to 30 to 90 days. Such was the case with sports products maker True Temper Sports Inc., automotive parts maker Accuride Corp., air-conditioning maker NTK Holdings Inc. and laminates maker Panolam Holdings Co., among at least nine companies that have filed for prepacks since September.
By averting the notoriety and substantial costs of full-fledged bankruptcies, prepacks could provide a well-ordered if more gracious alternative to an ignominious collapse. As Ropes & Gray LLP restructuring chief Tom Draper puts it, prepacks represent "a middling success or a middling failure" of a company in restructuring its debt.
Also see:Capital Calls archive