Companies Consider Junk Bonds to Exit Ch. 11
February 25, 2010
The way out of the deep hole of bankruptcy could be a ladder of junk.
As increasing numbers of companies climb out of Chapter 11 protection, more have begun to consider junk bonds to finance their exits. But while high yield bonds provide more flexibility and other advantages for debt-laden issuers, they are not a panacea by any stretch, nor are they a real option for smaller companies, market participants say.
Reader’s Digest, Six Flags and LyondellBasell are among the companies that have used or are considering high yield bonds to fund (or partially fund) their exits from bankruptcy. The advantages drawing such issuers to the strategy include the bonds’ fixed interest rate, which provides greater pricing stability than the Libor-linked leveraged loan, sources say. Moreover, junk bonds tend to have longer maturities, giving issuers more time to refinance or pay off the debt. And they usually have covenants that prohibit the company from taking on additional debt, but do not have covenants that require it to stay within strict financial parameters. “A lot of companies have gotten stung by covenant breaches,” said Bruce Mendelsohn, co-head of Goldman Sachs’ restructuring group. “To the extent they can emerge from bankruptcy with bonds, it gives them more flexibility going forward not having to live with financial
covenants.”
Risky Business
Jeffrey Werbalowsky, a senior managing director with Houlihan Lokey, notes that exit financings reflect a larger movement in favor of risk. “It’s all part of a bigger trend in banking generally and restructuring particularly, where increasing risk is being embraced,” he said. “Exit financings are even being proposed with equity in at least two major transactions today, as capital has become relatively abundant and therefore relatively cheap for large liquid transactions.” He declined to name the transactions that include equity proposals.
In the case of Reader’s Digest, its high yield bond exit financing provided the company with approximately $30 million in interest expense savings compared with the credit facility it had initially arranged at the start of its restructuring, the company said upon its emergence from bankruptcy Feb. 22. The Pleasantville, N.Y.-based publisher on Feb. 2 issued $525 million in floating-rate notes at Libor plus 650 bps to finance its exit. JPMorgan, Bank of America Merrill Lynch, Credit Suisse and Goldman Sachs were the underwriters.
The company won bankruptcy court approval on Jan. 15 for its reorganization plan. It wiped out 75% of its debt with the restructuring, slashing it to $555 million from $2.2 billion and lowering its operating leverage to 3.2x from 17.5x.
Now, LyondellBasell, which filed for Chapter 11 bankruptcy protection for its U.S. operations and one of its European holding companies on Jan. 8, may take a page from Reader’s Digest’s playbook. The Houston-based chemical company is due to disclose its restructuring plan Monday, and a source familiar with the company confirms that it is considering using high yield bonds to finance its exit. The Houston-based chemical company reached a restructuring agreement with a group of unsecured creditors earlier this month that included an exit loan (LFN, Feb. 16, 2010). It was unclear as of Leveraged Finance News’s Thursday deadline whether the company was considering replacing the loan with the bonds or using a combination of the two.
Amusement park operator Six Flags, however, is considering the latter, according to someone familiar with the deal. The company already syndicated a term loan for its exit, but may add a bond tranche. Before the exit loan was syndicated, underwriter JPMorgan made some last minute changes, upsizing it to $730 million from $680 million and decreasing the credit facility’s revolver to $100 million from $150 million. Six Flags, which filed for Chapter 11 bankruptcy protection in June, would gain an advantage in having its exit debt diversified, with the additional debt being fixed and not floating-rate, observers noted.
However, financing an exit with high yield bonds is not without its drawbacks, one of those being timing the bond offering to the exit, said Barry Ridings, cohead of Lazard’s restructuring group. “The difference between a syndicated bank loan deal and a high yield deal is that it’s a little more elaborate to do the high yield deal,” said Ridings. A bank loan does not have to be syndicated before the company can exit bankruptcy, whereas a bond deal has to be sold to a group of investors in order to close. This could hamper the already sensitive timing issue of the bankruptcy exit date. “And unlike a bank deal where they give you a quote ... on the high yield bond deal, you don’t really know the final terms of the deal until you’ve priced it. It’s a little bit harder.”
It’s a Large World
Ridings also points out that using bonds to emerge from bankruptcy is mainly the preserve of larger companies. “If you have a mid-market deal where the company is only worth $400 million or $500 million, there’s not enough debt capacity for you to do a high yield bond that generates interest,” he said. Exit financings that include both loans and bonds, as may happen with Six Flags, also tend to be an option only for large companies, market observers agree. “In larger situations we may start seeing a combination of bank and bond exit financings,” said Mendelsohn.
More food for thought: today’s bankruptcy exits carry greater risks than in past cycles. “You’ll find that the leverage and risk associated with these deals are far above more conventional bankruptcy exits given the economic environment we are now in,” Werbalowsky noted. He said that junior creditors are pushing the issue in order to increase the likelihood of their recoveries. “The junior constituencies in most leveraged restructuring situations these days are focused on maximizing the borrowing in the exit so they maximize their notional recoveries, sometimes at the cost of materially reduced feasibility.”
Ridings warns that companies must be on guard and not carry too much debt with them out of bankruptcy. “It’s worrisome when companies get out of bankruptcy with
too much debt, that they haven’t reduced it to the extent they might have.”
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