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December 2020

Debt Advisory Update

So that was all very clear: we’re all out of lockdown next week, depending on which devolved administration and county you live in, who and how many people you are planning to see, what you want to do and whether that’s indoors or outdoors.  And once you pick your two ‘Christmas bubbles’ then you have to stick with them, even if you’re no longer speaking to each other by Boxing Day.

Debt weekly image - 27 November
TL / DR: Deleveraged Buy Outs; Maradona & Money; Cash flow under the microscope 

1. The AA – “The Deleveraged Buy Out”

  • Credit to Andrew Dennis at Aberdeen for coming up with this label for the acquisition of the AA by Towerbook and Warburg Pincus.
  • Currently 93% of the AA’s enterprise value is net debt and Towerbrook / Warburg Pincus’s big idea is to reduce net debt by £378m.  This should reduce leverage by x. 1x of EBITDA to about 6.5x, meaning cheaper access to the bond markets to refinance forthcoming maturities.
  • But this still leaves the AA geared 80%, which may be too much for a business which has been in structural decline and it will need a proper turnaround in EBITDA to achieve full stability.
  • The AA is financed by a Whole Business Securitisation (“WBS”): over the 2000s and 2010s, bankers (often employed by Guy Hands) took securitisation technology and applied it to “whole businesses” leaving towering debt piles for infrastructure such as water companies, electricity / gas distribution networks as well as other less convincing ‘quasi-infrastructure” such as airports, pubs, service stations, and funeral homes.
  • It may not come as a surprise that ‘true’ infrastructure has required no Covid waivers whereas all the pubcos and airports have needed to relax covenants this year, sometimes multiple times.
  • As Fitch argued last year, some benefits of WBS are often overstated, particularly the ‘bankruptcy remoteness’ of the assets vs the operator – in theory creditors have the power to appoint another ‘asset manager’ though in practice I don’t think this has ever actually happened.
  • As ever, Matt Levine says it best: “the corporation itself is a mechanism for securitizing a whole business … it seems as though there’d be diminishing returns from adding another box”.

2. The Maradona Theory of Monetary Policy

  • 34 years after two unbelievable goals in Mexico, Diego Maradona died this week.
  • I’m sure he appreciated Lord Mervyn King’s tribute to him in 2005 speech:
  • Maradona’s first “Hand of God” goal was an exercise of the old “mystery and mystique” approach to central banking … his second goal was an example of the power of expectations in the modern theory of interest rates.  Maradona ran 60 years from inside his own half beating five players before placing the ball in the English goal.
  • The truly remarkable thing, however, is that Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.
  • Monetary policy works in a similar way.  Market interest rates react to what the central bank is expected to do … central banks have … been able to influence the path of the economy without making large moves in official interest rates.
  • King was a colourful governor of the Bank of England and once likened the job to being an England batsman in the Ashes – presumably more Alastair Cook (average 40) than Mike Atherton (average 20).

3. FRC reviews cash flow statements

  • As an ex-accountant, I am always interested in how companies can play games with their accounts, but I know this is niche so I will keep this brief.
  • The Financial Reporting Council this week released a report on corporate reporting which contained a few debt-related points.
  • Topics this year included:
  • Disclosure of Supply Chain Finance, including a good analysis by the CFA Institute.  Appendix 1 of this FRC paper includes best-practice for disclosure on Supply Chain Finance, as well as how to dividend policies and ’use of cash’.
  • Insufficient disclosure on committed and undrawn facilities.
  • Inadequate disclosure on covenants.
  • Unlawful dividends (unnamed case study is probably Van Elle Holdings plc).
  • I still don’t agree with some of the required accounting (e.g. acquisition of assets via finance lease never hits operating or investing cash flows) but additional disclosure is never a bad thing.

UK debt financings this week:

  • Cineworld has secured a 3-year $450m facility as part of a new debt deal that includes a maturity extension and covenant waivers.  The new “super priority” facility costs 7% cash plus 8.25% PIK and 3% fees, plus warrants for 10% of the company at a discount of 10% to market price.
  • Electrocomponents have refinanced their £189m RCF into a 3 year £300m RCF – this is 1 year shorter than their last deal reflecting tighter current market conditions.
  • Marlowe has refinanced a £45m RCF into £70m 3 year RCF with HSBC and NatWest.
  • Mothercare announced a new £19.5m 4-year facility with Gordon Brothers ** NUMIS ADVISED.
  • Future is backing its £594m acquisition of GoCo Group with a £215m 2-year facility provided by HSBC, NatWest and Bank of Ireland. This will remain alongside the £175m RCF, maturing Feb-23.

Mike Beadle

Managing Director, Debt Advisory

Email Mike

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