No Time to Be Valeant

Valeant in trouble Valeant Pharmaceuticals has been a bit of a nightmare for customers, shareholders, and debt holders lately. Its strategy of acquiring established drugs, paying with debt, and doubling prices to cover the costs has provoked a furious response from consumers and lawmakers. Its mis-reporting of a troubling relationship with a specialty pharmacy called Philidor, two SEC investigations, delays in issuing its 2015 annual report, problems with its banks and bondholders, and turmoil in senior management ranks and on the board, have led to massive drops in its share and bond prices, soaring price increases in its credit default swaps, and a brutal series of downgrades from the rating agencies. The timeline of Valeant’s troubles goes like this: 10/21/15 Short-seller Andrew Left’s Citron Research suggests Valeant is using Philidor to artificially increase revenues 10/26/15 Valeant defends its revenue accounting but announces its board is investigating the Philidor relationship 10/30/15 Valeant terminates its relationship with Philidor, which shuts down 12/29/15 Valeant CEO Michael Pearson goes on leave with pneumonia 1/1/16 Former CFO Howard Schiller becomes interim CEO 2/22/16 Valeant admits to overstating about $58 million revenue in revenues to Philidor in 2014 but says the investigation is continuing 2/28/16 Michael Pearson returns as CEO, and the company withdraws its earnings guidance for the fourth quarter of 2015 2/29/16 Valeant announces that it will not be able to meet the March 15, 2016 filing deadline for its 2015 annual report; the SEC launches a formal investigation into Valeant’s financial reporting 3/15/16 Valeant misses the deadline for delivering its annual report to its banks and bondholders 3/21/16 Valeant admits to $21 million more of...

Unitranche Loans

A unitranche loan, as the name implies, is one tranche of debt that can replace the traditional two tiered (i.e. first-lien/second-lien, senior/subordinated or secured/unsecured) debt structure for highly leveraged companies. For those unfamiliar with this increasingly popular structure, here is our summary. What they are Structure: One tranche of debt that is split into “first-out” and “last-out” pieces. First-out debt typically includes a revolver and part of the term loan; last-out debt is everything else. To replicate the differentiated seniority of traditional deals, unitranche deals define trigger events during which first-out debt is paid before any payments are made to last-out debt. Typical trigger events include a missed payment, bankruptcy or financial covenant default, or acceleration or other actions by first-out lenders to exercise their rights. Documentation: One credit agreement and one security agreement. In addition, if multiple investors will provide the debt, there is an additional agreement, the Agreement Among Lenders (“AAL”), which allocates interest and principal payments across the tranches and addresses other intercreditor issues. The borrower is not a party to the AAL. Pricing: One blended interest rate. The AAL replicates the different yields and repayment terms of the traditional two-tiered deal by skimming borrower payments and allocating them from the first-out lenders to the last-out lenders. Lenders: May be provided by a single lender (typically to companies with revenues between $10 and $50 million) or by multiple lenders. Participants in this market include finance companies, business development companies, and hedge funds.  Some banks also provide unitranche structures. Voting and exercise of remedies: Highly negotiated and vary significantly deal to deal. They are specified in the...

A Swing Line for Swingline

In November 2011, ACCO Brands, a leading manufacturer of office products, and MeadWestvaco Corporation, a leader in packaging, agreed to merge MeadWestvaco’s Consumer & Office Products business into ACCO Brands in a transaction valued at approximately $860 million. The deal, which closed in May 2012, gave MeadWestvaco shareholders 50.5% of the combined company.  Among the company’s many products are Kensington computer accessories, Mead school supplies, and Swingline Staplers. As part of the transaction, ACCO refinanced virtually all of its existing debt.  The new capital structure included $500 million of high yield bonds and over $750 million of term loans.  In addition, the company obtained two revolving credit facilities: $200 million U.S. dollar, and $50 million multi-currency. Let’s take a look at the $200 million U.S. dollar revolver.  It has commitments from 16 banks, ranging from about $4 million to about $20 million (i.e. 2% to 10% of the total facility) and was expected to be used for general liquidity needs and letters of credit.  If the company has a financing need, say $100 million for 6 months, it sends a borrowing notice to the administrative agent, in this case Barclays, who sends a notice to the other 15 banks, who all advance their proportionate share of the total borrowing.  This process happens for hundreds of syndicated revolvers every day. But what if the borrowing need isn’t $100 million for 6 months, and is, instead, $10 million for 6 days?  The process could work the same as for the larger, longer need, but that would mean that the bank with the smallest commitment, in this case Deutsche Bank, would have...

99 Cents Only Stores goes Lite

99 Cents Only Stores operates a chain of over 300 “extreme value retail stores” in California, Texas, Arizona and Nevada.The company was founded in 1982, and in January 2012 it was taken private by Los Angeles private equity firm Ares Management and the Canada Pension Plan Investment Board.  The new capital structure was typical of LBOs done at that time: Size (millions) % of Capitalization EBITDA Multiple(b) Revolver(a) $10 Term Loan $525 Total 1st lien debt $535 38% 3.4x Senior Notes $250 18% 1.6x Total Debt $785 55% 5.0x New Equity $536 Rollover Equity $100 Total Equity $636 45% 4.0x Total Capitalization $1,421 100% 9.0x (a) The Revolver commitment was $175 million, of which only $10 was borrowed at the time of the transaction (b) Using fiscal year 2012 pro-forma adjusted EBITDA, a reported by the company The company’s choice of loan products shows that one of its objectives was to maintain as much operating and financial flexibility as possible: The revolver is an Asset Based Lending (“ABL”) facility.  Compared to most secured “cash flow” revolvers, ABL facilities typically have fewer and less restrictive covenants.  In fact, it is common for ABL facilities to have no financial covenants, or to have financial covenants that are only measured if the company borrows most of what is available under the borrowing base.  This additional flexibility is a key advantage for ABL borrowers. The term facility is a Term Loan B (“TLB”).  This provides the company with significant cash flow flexibility.  It has amortization of only $5.25 million per year (i.e. 1% of the original principal) and a final maturity of 7...

5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...