Sequential Brands: Files Chapter 11

At long last, highly leveraged, publicly traded Sequential Brands Inc. (ticker: SQBG) has filed for voluntary Chapter 11. Reportedly, the company – in co-operation with certain of its lenders – is seeking to sell off its multiple brands (presumably in combination or individually) in order to repay nearly half a billion dollars in debt outstanding. A debtor-in-possession (DIP) loan of $150mn has already been arranged with its so-called “Term B Lenders”:

The Company expects this new financing, together with cash generated from ongoing operations, to provide ample liquidity to support its operations during the sale process. The proposed transactions will be implemented pursuant to the terms of a Restructuring Support Agreement reached between the Company and its Term B Lenders.

From press release

The BDC Credit Reporter has been warning of trouble at the company as early as the spring of 2019, and with even more urgency with the impact of the pandemic on retail. We’ve written nine prior articles on the subject, including the most recent post in July when a bankruptcy filing had all the inevitability of an ancient Greek drama.

Here’s what we wrote last time:

Sequential has been shedding assets but the proceeds are too modest to ameliorate the overall picture by much and will only add to the income decline. Everything seems to point to the lenders taking over in some sort of bankruptcy filing before long.

BDC Credit Reporter, July 27, 2021

What we’ve found intriguing is how the two BDC lenders to Sequential – FS KKR Capital (FSK) and Apollo Investment (AINV) have marked their respective investments in anticipation in the debt due 2/7/2024 as of June 2021. Admittedly, AINV’s exposure is much more modest than FSK’s : $12.6mn versus $218.7mn. However, AINV rates the loan as second lien and FSK as first lien. AINV has applied an (18%) discount to its investment. FSK values the $215.9mn invested at a slight premium. Note, though, that the face amount of the debt is $266.8mn. We’re guessing that the gap between cost and par value has something to do with FSK acquiring the assets of its sister BDC FS KKR Capital II (previously FSKR) at a discount. The $2.8mn FSK has invested in Sequential’s stock, though, is valued at zero.

We’re pretty much certain FSK and AINV are both involved with the “Term B lenders”. FSK – at least – seems to believe that when all is said and done no loss will be incurred. This is supported by the fact that even after filing for bankruptcy Sequential’s stock still trades at over $6 as we write this. Investors and lenders seem to believe that the value of the assets will exceed all debt and leave something for the common shareholders. We are skeptical, but are keeping an open mind. In the next few weeks we’ll find out if FSK’s optimism will bear out, and any material loss will be averted.

Also interesting will be whether AINV and FSK place their debt on non accrual, which will materially affect the latter’s interest income in the IIIQ 2021 and beyond. We calculate that FSK has been booking over $23mn of annual investment income from Sequential, equal to just under 3% of the BDC’s total revenues.

How accurate the valuations of FSK and AINV prove to be in this slow moving train wreck, where both lenders have had full access to what is going on, will be an interesting test of management’s credibility in this critical area. To date, both sets of managers have avoided discussing Sequential on their conference calls. Maybe the IIIQ 2021 call will be different and Sequential Brands – and its ultimate disposition – will be addressed. We imagine we’ll be reporting back even before the third quarter results come out as the bankruptcy process unwinds.

Given that this is one of the biggest bankruptcies of a BDC-financed company ever, this is a story worth watching both for investors in FSK and AINV, and anyone interested in the BDC sector more generally.