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— Capital Calls —
In November, casino operator Harrah's Entertainment Inc. and real estate brokerage Realogy Corp., both owned by Apollo Management LP, said they plan a $2.1 billion exchange offer for new second-lien notes and a $500 million offer for new second-lien incremental term loans, respectively. Soon after, Neff Corp., a rental construction equipment provider backed by Lightyear Capital LLC, followed with an offer to convert holders of $230 million senior notes offer into term loan lenders.
Debt exchange offers arise when companies have to choose between raising capital in constrained markets or filing for Chapter 11, says Christopher Garman, president of Garman Research LLC. With the primary debt markets all-but frozen, sponsors may need to inject more equity in their companies. But why should they bother when existing noteholders may choose to take a haircut on their behalf? Just what existing noteholders stand to gain or lose in these debt-exchange offers would have to be determined case by case. But these companies are stressed, so "it's more of a least bad choice," says Garman. In many cases, "the least bad choice is to give the company some breathing room on terms," with the expectation that it will grow out of its difficulty by the time capital markets reopen, he adds. One private equity executive, commenting on Neff's hope that holders of its 10% senior notes due 2015 will exchange them for term loans, says, "This must be a disaster. ... Under the trade, every $1,000 of old notes gets you $450 million of new notes," the person adds. Neff's bonds were trading at around 22 cents on the dollar, a sure sign of operational distress, the source adds. "I do not understand why [the sponsors] are not being forced to give up equity to the noteholder, which would make a lot of sense at this point in a negotiation." In June 2007, Lightyear Capital, General Electric Pension Trust and Norwest Equity Partners bought Neff from Odyssey Investment Partners LLC in a $900 million secondary buyout. Neff has since fallen on hard times. In the third quarter, it posted $71.35 million of revenue, a roughly 12% drop from the $81.42 million generated the same time last year. Adjusted Ebitda fell 20%, to about $28 million, from $35 million. Ratings agencies have a similarly downbeat opinion. Moody's Investors Service placed Neff on review for a possible downgrade after lowering its corporate rating to Caa1, from B3, in May. Likewise, the credit ratings firm downgraded Realogy's rating to Caa2, from Caa1, on Nov. 17 after its debt swap announcement. The exchange offer would reduce Realogy's debt by as much as $600 million but result in a 50% to 64% principal reduction for noteholders, Moody's said. The ratings firm said it viewed the Realogy transaction "as tantamount to a distressed exchange" and added that it would classify it as a default upon closing. On Nov. 20, Moody's lowered Harrah's corporate rating to Caa1, from B3, and its probability of default rating to Ca, from B3. But even if all existing investors participate, the debt swap would yield only a modest decrease in leverage, Moody's credit analyst Peggy Holloway said. Apollo and TPG Capital acquired the casino operator in January for $31 billion. As recently as Sept. 30, it carried $24 billion of long-term debt, according to a filing. Like Neff and Realogy, its earnings have also dropped. In the third quarter, it posted $2.65 billion of revenue, a 6.8% decline from the same period last year. Its adjusted Ebitda took a more drastic fall of 19.4%, to $633.9 million. In at least one of the recently announced debt exchange offerings, the private equity sponsor is also a noteholder, which may help facilitate the transaction's success. Apollo, which bought Realogy for $8.75 billion in April 2007, plans to participate in the swap. The buyout firm owns $69 million of the company's 12.375% senior subordinate notes due 2015. Looking at the previous downturn from 1999 to 2002, Garman says debt exchange offers did seem to buy companies time -- about six months. After that, he warns, a number of the companies continued to deteriorate. |
As the dreaded D word -- default--looms over struggling businesses, some sponsors hope debt exchange offers will lift the fortunes of their poorly performing portfolio companies. The view among observers, though, is that they're really stuck between a rock and a very hard place.
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