Paper Source Inc. : Files Chapter 11

On March 2, 2021 stationery retailer Paper Source Inc. filed Chapter 11. According to Bloomberg: “The company intends to hand control of the business to an affiliate of MidCap Financial, a lending arm of Apollo Global Management, in exchange for debt forgiveness, court papers show. Paper Source owes about $103 million to lenders, including more than $55 million under a first-lien term loan“.

This is no great surprise to the BDC Credit Reporter, which has had the company on its underperformer list with a CCR 3 rating since IIQ 2017. A further downgrade occurred in April 2020 to CCR 4 and will now be moved to a CCR 5 – non performing. The principal BDC lender is Apollo Investment (AINV) , which has invested $14.2mn in the company, principally in the form of first lien debt, which was valued at $11.4mn at year-end 2020, a (20%) discount. Presumably some ($1.2mn) of annual interest income will be forgone as Paper Source is sorted out.

From what is being said in court papers, the Apollo Global owned lender Mid-Cap Financial – with whom AINV participated – envisages some sort of debt for equity swap. This will make the lenders owner/lenders going forward and reduce the company’s debt. Here is an outline of the plan, according to the Chicago-Tribune, quoting from court papers:

Paper Source said MidCap Financial agreed to serve as an initial bidder, or “stalking horse,” to purchase the company’s assets for up to $88.8 million, which includes $16.5 million in financing to help the company continue operating… A sale is expected to close in about 90 days”.

AINV only arrived on the scene as a lender in June 2019 when Paper Source was already underperforming, possibly as part of a “lend-to-own” strategy or just in a case of bad timing. Chances are now high that the BDC will be advancing additional monies; restructuring debt and the like and extending indefinitely its relationship with the retailer.

For AINV, whose credit troubles have been mostly concentrated in “legacy assets” booked some time ago under a different management team, this is a rare setback for loans booked by Mid-Cap Financial, the principal source of the BDC’s current new investment activity. We’re adding Paper Source to our Trending List because both income and investment values should be substantially different in the IQ 2021 results.

Paper Source: Sold To Elliott Management

Last time we wrote about Paper Source Inc., the stationery retailer was bankrupt and Mid Cap Financial – an affiliate of Apollo Global Group – was preparing to acquire the company in a “stalking horse bid”. This would have made Apollo Investment (AINV) – a lender and investor to the company – a part owner (and also likely a lender) to the post-bankruptcy business. AINV as of March 31, 2021 had $16.4mn in debt at cost to Paper Source (its equity stake had no dollars attached) and a value of $13.4mn. For some reason, AINV carried the debt as performing, notwithstanding the bankruptcy.

Anyway, scrub all the above. In the interim, Elliott Management – owner of Barnes and Noble – has swooped in and acquired Paper Source out of bankruptcy for $91.5mn. Here is a link to a trade publication article on the subject, and an extract which explains the appeal of Paper Source to the buyer:

In a presentation, Elliott described the businesses of Barnes & Noble and Paper Source as “highly complementary, with shared product ranges and a common commitment to excellent customer service.” The investment firm noted that Paper Source will continue to operate independently and keep to its core product offering of greeting cards, stationery,office supplies, gifts and other products. At the same time, Elliott noted that “considerable opportunities exist for mutually beneficial retail partnerships.”  

Although Mid Cap/AINV lost the opportunity to acquire Paper Source – something of a mixed blessing given brick and mortar’s endemic challenges regardless of the pandemic – this is probably good news for the BDC. We get the impression the first lien debt – as well as DIP financing recently provided – will be repaid in full. That should allow AINV to post a several million dollar increase in value from the ultimate proceeds, which should show up in the IIQ 2021 results, or by the third quarter at the latest, as the transaction closes.

We may be jumping the gun, but expect to take Paper Source off our underperformers list. Given the potential increase in value, we are adding the company to our Trending List for the IIQ 2021 given the likely upside to be booked. This was never going to be a major setback for AINV and now looks likely to be a minor success. As has been the case on multiple occasions of late, thanks are due to a frothy financial environment and the fast recovery from the pandemic conditions that initially brought the company low.

Horizon Technology Finance: IIIQ 2021 Underperformers

Horizon Technology Finance (HRZN) has reported its IIIQ 2021 results. Total portfolio assets amount to $452.3mn (including $21mn in equity and warrants) spread over 74 companies.

According to HRZN’s own investment rating system – see below – there are only 3 underperforming investments, including 1 in its lowest rating. The total fair market value of these investments is $13.941mn, or 3.2% of the BDC’s total debt investments. That’s down from 4 investments and $14.612mn at December 31, 2021, or 4.4% of total debt.

 September 30, 2021   December 31, 2020   
  Debt Percentage  Debt Percentage 
 Number of Investments at of Debt Number of Investments at of Debt 
 Investments Fair Value Investments Investments Fair Value Investments 
 (Dollars in thousands)      
Credit Rating      
 4 5 $                       56,337 13.1% 6 $                       77,950 23.4%
 3 35 359,658 83.7 24 240,933 72.2
 2 2 11,141 2.6 3 12,875 3.9
 1 1 2,800 0.6 1 1,737 0.5
Total 43 $                    429,936 100.0% 34 $                    333,495 100.0%
HRZN: Investment Rating Table -IIIQ 2021

The three investments/companies – the BDC Credit Reporter believes – are MacuLogix, Inc. – a medical device manufacturer; Betrabrand Corporation, a technology driven women’s clothing company and MVI (ABDC) LLC, aka Stereo Vision, Inc – a software company.

We rate the first two companies CCR 3 in the BDC Credit Reporter’s system, where the likelihood of full recovery is greater than of loss. However, Stereo Vision – which went on non accrual in the IIIQ 2021 – is rated CCR 5.

MacuLogix is an investment that dates back to 2018 from HRZN. As of September 2021, HRZN has advanced $7.2mn at cost, mostly in the form of first lien term debt due in 2023. The preferred is discounted (59%) and the first lien debt (4%), from par in the prior quarter. The company was added to the underperformers list from the IIIQ 2021.

The company develops equipment for the treatment of macular degeneration. We have no idea – from the public record what might be going on at the company. We calculate that investment income potentially at risk is $1.25mn annually.

Betraband Corporationdesigns amazingly comfortable clothing for women who like to stay active all day long“. HRZN has invested $7.9mn in the business, dating back to IQ 2019. The name was added to the underperformers list from the IVQ 2020 but has been improving in valuation of late. The first lien debt is being discounted only (1%) and the preferred has been written to zero. On paper, $0.8mn of investment income annually is at risk, but this name might be returned to performing status shortly.

The only seriously troubled underperformer is Stereo Vision, which manufactures facial recognition technology for the army. However, HRZN’s exposure is modest: $3.8mn, of which $3.0mn is in debt. The BDC is foregoing (0.240mn) of investment income as a result of being on non accrual. The debt has been discounted between (7%) and (11%). The company was added to the underperformers in the IIQ 2021 and became non performing in the IIIQ 2021. We have no information as to why the investment has been written down.

We’ll be tracking all 3 companies in our daily searches of the public record, but only Stereo Vision – currently – in seriously enough impacted to warrant full length updates.