Avril 2014 - Crédit - L'endroit où il faut être

A tale of three French LBOs – lessons for credit investors

The number of attractive long and short opportunities offered by European credit markets continues to grow in our opinion. Specifically, the increasing disintermediation of credit supply to European corporates, combined with the continuing deleveraging trend among European banks and a credit cycle less advanced than in the US, provides dedicated fundamental credit investors with a very favorable environment.

This month put three French LBOs from the 2006-07 era under the spotlight: (i) Numericable pulverized all Euro HY issuance records, (ii) Materis is finally out of the woods after several debt amendments, and (iii) Vivarte is about to haircut its senior secured debt, currently trading in the 30’s. We thought it would be topical to highlight these three situations. Numericable and Materis contributed significantly to the Fund’s performance this month (+1.4%); while we have always stayed away from Vivarte (long and short).

1/ Numericable is a French cable operator which went through a few tough years of poor commercial, operating and financial performance. As a result, its senior secured debt traded as low as in the mid 60’s in H1 2009 and had to be amended consensually several times with the consent of the company’s creditors. However, after a profound operational turnaround, Numericable regained financial strength and restored its access to capital markets: first, with two HY bonds issued in February and October 2012 and then, via the IPO of the company in November 2013. This paved the way for the latest step in the company’s transformation which occurred last month.
On 23 April, Numericable and its controlling holding company Altice jointly issued more than €12bn equivalent of HY bonds in 7 tranches – including a record-size €2.075bn single-tranche 2022 bond issued by Altice. Those bonds – in addition to €3.8bn equivalent of term loans also issued by Numericable that same week – will fund part of the €15.6bn acquisition of France-based mobile operator SFR from Vivendi, as well as the refinancing of the existing Numericable debt, the takeout of some shareholders and various transaction costs. Our various positions in the Numericable complex contributed +0.4% in April.

2/ Materis is an international leader in specialty construction chemicals and materials. Its most junior debt instruments traded in the 10’s in H1 2009 as the market priced in some form of hard restructuring of the group’s debt. At the end of 2013, the Fund entered a long position in the mezzanine notes issued by Materis in the mid-80’s with the view that after years of adverse operating environment, the construction sector was bottoming out and the group’s operations had started to benefit from such a recovery. Specifically, we expected a continuing improvement of the group’s operating and credit metrics with a potential EBITDA growth in the 3-7% range and positive free cash flow generation in 2014.
In the meantime and as a result of various amendments of the original loan and bond documentations (the original facilities were signed in April 2006), the net proceeds of the first asset disposal had to be used to repay the whole capital structure of the company (i.e. the senior and second lien facilities, as well as the mezzanine bonds) on a prorata basis, and not through a seniority-based waterfall as it is usually the case. We expected such a disposal to occur quite soon after our initial investment. In turn, the company announced in December 2013 the sale of its Aluminates division for €600m – which closed in March 2014 – thus reducing the group’s leverage from 7.3x to 6.8x. In addition, it also announced the disposal its Mortars division in March 2014 for €840m – to be closed in H2 2014, which should delever the group further to 5.5x. All those developments create a favorable deleveraging momentum for Materis, which should lead to an early repayment of our mezzanine notes and the resulting monetization of our return on the position by the end of 2015 at the latest. The position contributed +0.9% in April 2014 (+1.5% year-to-date).

3/ Vivarte is a French apparel retailer. It provides a live example of an LBO-ed company which never managed to regain its footing after the financial crisis despite various rounds of amendments and waivers on its debt. Interestingly, its debt never traded below the high 60’s in H1 2009 – i.e. the higher cash price of these three LBOs during that period – as the company was seen at the time as the most stable business. It did not turn out that way as after years of operating underperformance, a deteriorating competitive environment, some strategic mistakes and management changes, the company’s financial profile went from bad to worse. Although the trading levels of Vivarte’s debt stayed significantly below par ever since – and therefore looked attractive to some for that reason – we never managed to get comfortable with the sustainability of its capital structure in light of the lack of stabilization in the group’s operating performance. Interestingly, it showed some resilience through the difficult 2009-2011 period with an EBITDA ranging between €435m and €480m, but it has dramatically fallen since as some press reports indicate that management is guiding for a level close to €240m for 2014. Then, little wonder that management put a moratorium on its interest payment earlier this year and is trying to negotiate a significant debt writedown, leading Vivarte’s 1st Lien loans to trade in the 30’s and its 2nd Lien debt to trade “single digit”.
We held a position in Vivarte five years ago, for a couple of quarters, and it had been a profitable investment on the back of some consented debt amendments. Since, the Fund never invested in Vivarte, avoiding one of the largest single-name traps of European credit markets – Vivarte’s debt instruments total ca. €2.8bn in nominal value. Note that as a “loan-only” capital structure, there was no tradable instrument available to short the name