Deluxe Entertainment Group will be shortly exiting from bankruptcy, after receiving court approval of a “comprehensive refinancing”. According to the company’s press release – which is short on details but big on reassurances – debt will be cut “by more than half” and $115mn of new financing will come available. If Bloomberg Law is correct, $800mn of debt will be written off. Bankruptcy should be officially exited within a month.
We’ve written extensively about this bankruptcy, and we will again. After all, the BDC lenders involved seem to be moving from creditors to owners, or maybe both. Most likely, any realized loss to be taken will occur in the IVQ for Harvest Capital (HCAP) and non-listed Cion Investment and TP Flexible Income Fund. Before that, we’re likely to see an unrealized write-down in the IIIQ results, given that HCAP was carrying its debt investment at par as of June 2019, while the other two BDCs discounted their positions no more than (10%).
Even after the company exits Chapter 11, we will continue to carry Deluxe on our under-performing list for an indefinite period. The weakness in the underlying business has not been eliminated by this partial de-leveraging and years may yet pass before the BDCs involved – who began lending back in 2017 – can exit this credit.
In a broader article by Bloomberg BusinessWeek about the CLO market, was a useful backgrounder on what happened to Deluxe Entertainment Group that caused the company to recently file for bankruptcy:
“Deluxe Entertainment Services Group Inc. shows just how quickly liquidity in the leveraged loan market can evaporate. A postproduction media services company for the film industry, Deluxe has struggled with a changing digital media landscape in Hollywood and an increasingly burdensome debt load. But with tens of billions pouring into the leveraged loan market and a CLO machine cranking out deal after deal, Deluxe and its owner, Ronald Perelman’s MacAndrews & Forbes, had little trouble in recent years raising new debt to keep the company afloat.
Deluxe refinanced its debt in 2014, getting enough demand from investors that it was able to upsize its loan by $35 million, to $605 million, and cut its interest rate by a full percentage point. Two years later, the company returned to the market for an additional $75 million, and it tacked on $200 million more in 2017 to refinance some of its other debt.
But as Deluxe’s problems mounted, its cash thinned. After an unsuccessful effort to sell its creative services unit, it turned to its existing lenders, who agreed to back a $73 million loan in July. That’s when it got ugly. The news of the abandoned sale and new debt caused the value of Deluxe’s loan—with $768 million still outstanding—to plunge from 89¢ on the dollar to less than 40¢ in some 24 hours. Within about a week, S&P downgraded its rating by three notches, to CCC-. The downgrade blocked some existing CLO lenders, bound by the 7.5% limit, from fronting additional cash. On Oct. 3, the company filed for Chapter 11. The existing loan now trades at less than 10¢ on the dollar. Deluxe said in a statement that “We appreciate the support we have received from our lenders throughout this process and look forward to completing the refinancing shortly.”
With BDC earnings season coming round, we’ll shortly learn how Harvest Capital (HCAP), Cion Investment and TP Flexible Income Fund, with $20.7mn invested in the bankrupt company as of June have navigated this complex situation. We expect substantial losses to be booked this quarter or next and – possibly – an increase in invested capital.
On October 3, 2019 Deluxe Entertainment Group filed for a pre-packaged Chapter 11. As we had reported on September 4, 2019, the “debt burdened post-production company” had been considering a bankruptcy filing earlier but had chosen instead to undertake a debt for equity swap with its lenders out of the bankruptcy system.
A month later, Deluxe filed Chapter 11 anyway. As before, there will be debt for equity swap with its lenders which will reduce debt by half, and a further cash infusion by the new owners of $115mn. “All lenders will be offered the chance to participate“, say sources to Bloomberg. The decision to choose bankruptcy court after all was agreed to by both sides as a way to speed along the restructuring, which will see the lenders own 100% of the business. Chances are Deluxe won’t be under court protection for long. An October 24 confirmation hearing is being requested.
This means the day of reckoning is nigh for the three BDCs with exposure to the company: Cion Investment, Harvest Capital (HCAP) and TP Flexible Income Fund, with a combined $20.7mn of senior debt. Seems like half that amount will continue to be yield producing in some new loan and the rest written off or converted into equity. What we don’t know how much new capital will be forthcoming from these BDCs to fund the $115mn capital infusion.
For HCAP – the only public BDC in the group – their existing $4.7mn loan at cost, which was performing at June 30 2019 and valued at par, will end the September 30 period in non-performing status and -presumably – written down to some degree. We may have to wait till the end of the fourth quarter 2019 to ascertain HCAP’s total exposure, values and any realized loss.
Finally, we have to wonder why HCAP purchased the loan to Deluxe – as recently as March 4, 2019 – when some of the troubles facing the company must have been on the wall ? Was it a deliberate strategy or poor credit underwriting ? (The other two BDCs have been lenders for a much longer period).
We wrote a long report about the debt for equity swap underway at Deluxe Entertainment on September 4, 2019. This time, we’ll be brief and note that the company laid off 10 employees in Ohio, according to news reports. That’s bad news for the individuals involved but might suggest the company is re-sizing itself in an attempt to be successful with a new capital structure and with former lenders as owners.
On September 4, 2019 Variety reports Deluxe Entertainment Services Group , which was headed for bankruptcy, has agreed for a debt to equity swap instead. “In a deal announced on Saturday, Deluxe said it would offer a deal to all of its term-loan lenders to exchange their debt for 100% of the equity of the newly organized company”.
BDC exposure – Harvest Capital (HCAP) and non-traded Cion Investment – is material at $20.3mn, all in senior debt and carried at par or at a modest discount at June 30, 2019. The income likely to be lost – and right away – is approximately $1.6mn annually. We had a quick look at HCAP and calculated that investment income lost is equal to 11% of its latest Net Investment Income annualized.
Based on other news reports we’ve seen, the company will be writing off half its senior debt, suggesting the losses – both realized and unrealized – will be around ($10mn).
A bankruptcy is not yet out of the question. If all the lenders do not agree to the “reorganization”, a pre-packaged bankruptcy will be filed.
The BDC Credit Reporter had the company rated as under-performing since the IVQ 2018 with a CCR 3 rating. However, the situation deteriorated more recently. In July, the company announced it had abandoned plans to spin off its Creative Services division. The company – and its lenders – had hoped that the proceeds of which, along with a debt raise, would repay a sizable amount of the company’s term loans and ABL borrowings. The value of the existing debt dropped to 20 cents on the dollar on the negative news.
We are now rating Deluxe Entertainment CCR 5 on our 1-5 scale as a material loss is baked in. Nonetheless, as in all these situations where lenders become owners after the traditional PE sponsor has failed, we have to wonder if additional capital will be injected and whether the business can ultimately be made to work. We’ll be hearing more about Deluxe Entertainment for some time.