We’ve now written about Sequential brands twelve times ! Most of the time we’ve focused on FS KKR Capital’s (FSK) substantial exposure to the now bankrupt business. However, we’ve mentioned Apollo Investment (AINV_ which has also been a long time lender, but only in the second lien debt and for a much smaller amount than FSK. With the IIIQ 2021 AINV results, though, we see that the second lien debt was placed on non accrual. That was expected given the Chapter 11 filing.
What we didn’t know till AINV reported is that the BDC and FSK had advanced another $6.5mn and $133mn respectively to Sequential recently but with a maturity at the end of 2022 and in a first lien position. This is DIP financing presumably. That debt is valued at par and the discount on the second lien has been reduced to only (8%). Furthermore – and also both reassuring and expected since we heard the sale of Sequential was turning out well – FSK values its own exposure at or above par – even its non performing loan.
All this suggests that both FSK and AINV will extract themselves from the slow moving train wreck that has been Sequential Brands with nary a scratch. We rate the company CCR 5 because of the bankruptcy but do not expect any material loss for anyone at the end of the day. (The only exception remains $2.8mn of equity invested back in the day by FSK, which continues to have a value of zero). Sequential is rated as Trending given that the final settlement of the transaction could result in substantial changes in holdings and proceeds received. That may occur in the IVQ 2021 or IQ 2022 results of FSK and AINV.
Bankrupt Sequential Brands was going to hold an auction for its multi-brand assets, but ended up cancelling. Some of the company’s brands – like Jessica Simpson which was sold back to the celebrity herself for $65mn – were disposed of previously. The principal transaction, though, was a $330mn bid by Galaxy Capital Partners, a portfolio of Gainline Capital Partners – a PE group. Earlier this year, Galaxy bought Apex Global Brandsincluding, Hi-Tec, Magnum and Tony Hawk and has licensing deals with top brands such as Justice, London Fog and many others.
This transaction is being financed with $55mn in cash and the assumption of debt. That debt is held – amongst others – by the two BDC lenders involved – FS KKR Capital (FSK) and Apollo Investment (AINV) to the tune of at least $231mn. As far as we can understand, Galaxy will be the new borrower and FSK – and to a much lesser degree – AINV, will also hold an equity stake in the business.
How all this gets reflected in the two BDCs schedule of investments is impossible to tell in advance. We’d guess that the $3.0mn in equity FSK invested in Sequential might be written off. AINV’s debt was valued at a discount of (12%) as of June 30, 2021 and might result in a haircut but total exposure at cost was only $12.6mn, so any impact will be minimal.
The most intriguing question is how FSK – with $216mn invested at cost in debt treats that investment. We expect no loss will be recognized but some portion of the debt may be converted into equity in Galaxy. Also unknown is whether the new facility will be priced as attractively as the advance to Sequential: LIBOR + 875%. When we get those sort of details we’ll be able to tell what the impact on FSK’s investment income – seemingly running at $24mn per annum before the bankruptcy – will look like. There’s some financial sleight of hand going on here, but the bottom line is that FSK – and seemingly AINV – are undertaking a mixture of a debt refinancing and debt for equity swap.
Sequential remains rated CCR 5 until the bankruptcy judge approves the many moving parts of this transaction and Galaxy gains control. We’ll report back when we hear more from the BDC lenders involved.
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 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:
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.
We’ve written extensively about publicly traded Sequential Brands (ticker: SQBG) , beginning in the spring of 2019. In a nutshell, the company has a huge amount of debt but only modest revenues and EBITDA – both of which are in decline – to service their obligations. The debt has required multiple waivers from lenders, which continue at present. On July 26, 2021 Sequential filed an 8-K discussing the non-filing of its financial statements as required by NASDAQ. Making matters more complicated, the Board of the company has now recognized that the 10-K and its IIIQ 2020 10-Q require restatement and can no longer be relied on. The company has a plan to deal with these inadequacies but admits that nothing is yet resolved with its lenders despite months of negotiations:
“The Company cannot assure you that its lenders would be willing to negotiate further changes to its financial covenants when necessary and the Company cannot obtain further waivers of the defaults under the Credit Agreements without the consent of the respective lenders thereunder. If the Company is unable to obtain additional waivers of ongoing defaults, or otherwise is unable to comply with its debt arrangements, the obligations under the indebtedness may be accelerated. If an acceleration were to occur, the Company does not have sufficient liquidity to satisfy the loan, and the Company would potentially need to seek protection under the federal bankruptcy code“.
For a time common stock investors – apparently believing in the fundamental value of the many brands Sequential licenses – were looking beyond these difficulties, pushing the stock price to nearly $40 a share in March. However, the mood is darker now, with the stock price under $10 a share. Likewise, back in 2019 and 2020 we were surprised by the full valuations the BDC lenders to Sequential were continuing to book, despite the very obvious challenges.
However, that has changed of late and may change again once a resolution is reached. As of March 31, 2021 BDC exposure to Sequential remained huge: $290mn. All but $10mn (which is in equity) consists of debt due in 2024, split between FS KKR Capital (FSK) and Apollo Investment (AINV). (95% of the debt and all the equity is held by FSK). Currently, the equity has been written to zero – the stock price notwithstanding. The debt is discounted as much as (18%), but seems to be current. (We have to wonder if Sequential is actually paying its interest bill in cash or the lenders are just adding the amount due to the principal, and what might happen when a settlement occurs. FSK and AINV might have to unwind income previously booked).
Anyway, trying to handicap how this transaction might end up for the BDCs is well nigh impossible. 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. However, whether this will be just a modest setback – especially for FSK – or a major realized loss, remains unclear. We will continue to watch this unfolding story and will be interested to see how FSK and AINV value their investments at June 30, 2021 and whether they speak to the subject on their upcoming conference calls. (AINV reports 8/5/2021 and FSK 4 days later).
Common stock shareholders were excited to hear that lenders to Sequential Brands had extended a waiver of loan defaults from May 10 to June 7, 2021. At the time – according to Seeking Alpha – the stock price jumped 30%. However, for the lenders to the troubled company this means no resolution has yet been found to troubles that date many months back. We’ve written about Sequential Brands seven times before, so we won’t rehash the whole backstory.
However, we’ll note that BDC exposure – in both debt and equity – to the company remains huge: $277.1mn at cost. The debt at March 31, 2021 has been discounted by (16%) and the equity by (100%). The BDC lenders are FS KKR Capital (FSK) and FS KKR Capital II (FSKR), as well as Apollo Investment (AINV). However, given that FSKR is to be merged into the outstandings can rightfully be allocated all to FSK. Over a quarter of a billion dollars is a Major exposure for the KKR-managed BDC. (AINV has invested $12.8mn at cost).
We have no idea how this is going to play out, although some sort of resolution must be the horizon. We retain a Trending rating for Sequential as chances are good valuations or income derived therefrom could change shortly. We’re also affirming our CCR 4 credit rating which suggests we believe some sort of realized loss will eventually occur. However, whether that will be a few tens of millions or hundreds of millions – an important distinction – remains unclear.
Sequential Brands is the BDC Credit Reporter’s Godot. We’ve written multiple articles over the past two years breathlessly warning that something bad – a bankruptcy or a forced sale – was close to happening. Then: nothing. The company and their lenders always seem to arrive at a temporary modus vivendi, but no permanent resolution. (We’re desperately trying not to use the kicking of cans down the road analogy again). At times – given the high valuations the BDC lenders have maintained – we’ve doubted ourselves and the urgency of the situation.
However, the latest developments suggest – once again – that SOMETHING is going to occur at Sequential in the near future and that there is a possibility the BDCs – with $290.5mn outstanding in debt and equity to the company – may be materially impacted. Here’s what we know: According to a March 31, 2021 regulatory filing the company and one of its lender groups – led by Wilmington Trust – extended “a waiver of existing defaults under the Credit Agreement through April 19, 2021“. Furthermore, the lender “shall have the right to appoint an independent majority of the Board of Directors of the Company“. So gone is Martha Stewart and three other less famous Board members, probably letting out a sign of relief. Also a red flag: the company has not yet filed its IVQ 2020 and full year results.
The short extension period by Wilmington suggests that whatever “strategic alternatives” the company has been exploring since December 2020 is reaching some sort of conclusion. That might involve a sale of the business – in whole or in parts – or some pre-agreed Chapter 11 filing. The public shareholders seem to be bullish about this likely outcome, with Sequential trading at $22.22 as of the close on Thursday April 1, 2021. We are less optimistic – as is our self appointed mandate.
At risk for the BDCs involved is the prospect of ($28mn) of annual investment income from their 2024 Term debt outstanding being interrupted. Then there’s a good chance – based on the most recent quarterly valuations which discounts the equity owned by (99%) – a realized loss of up to ($10mn) will be incurred. However, the most important question mark is how the second lien debt will fare in the half billion dollar of borrowings Sequential owes. FS KKR Capital (FSK) and FS KKR Capital II (FSKR) and Apollo Investment (AINV) have advanced $280.5mn– more than half the total debt outstanding.
Currently, FSK and FSKR discount their debt by only (12%) and AINV by just (4%). If we apply the more conservative discount, that would still result in ($34mn) of realized losses on the debt and ($44mn) in total. The loss could be higher, but even ($44mn) is material given the big bets placed by the FS- KKR organization and which will shortly all be held by FSK, as FSKR is about to merge into its sister BDC. (AINV’s exposure is – clearly – much more modest even adjusting for the respective BDC sizes).
We should say – to be fair and recognizing that the stock market seems to believe that there is considerable market value left in Sequential – that this could all pass as quickly and harmlessly as a summer storm. Some deep pocketed buyer could be finalizing a generous deal as we write this or some hard working lawyers could be arranging a favorable “debt for equity swap” which will leave creditors undiminished. Maybe there’s a SPAC out there who wants to own a group of consumer brands…We don’t know, but we are as confident as we’ve been in two years that a change of status is in the cards for the company in the near future.
We are maintaining our CCR 4 rating on the company – as an eventual loss seems more likely than repayment in full. We are also adding Sequential to our Trending list because of the expectation that whatever is in the company’s future in the weeks ahead will be reflected in the BDC valuations and income – most probably in the IIQ 2021. For FSK especially this could either be a body blow, or not. We’ll be tracking the situation daily and will report back when something material occurs.
The BDC Credit Reporter has written multiple articles about publicly traded Sequential Brands (SQBG) over the last two years. There are five different updates in the archives. In the past, we were mostly concerned about the consumer brands conglomerate’s liquidity. Now the company, it’s shareholders and creditors face a new challenge: charges by the SEC that the company did not properly account for goodwill.
“The complaint, filed in federal district court in Manhattan, charges Sequential with violating antifraud, reporting, books and records, and internal controls provisions of the federal securities laws and seeks injunctive relief and civil monetary penalties”.
As reported previously, there are three BDCs with exposure to the company, of which two have outsized amounts outstanding – mostly in first lien debt due in 2024: FS KKR Capital II (FSKR) and FS KKR Capital (FSK), with $218mn and $61mn respectively invested at cost. Far behind in terms of dollars – but invested in second lien debt is Apollo Investment (AINV) with $13mn.
For our part, we had recently upgraded Sequential from CCR 4 to CCR 3 in mid-year 2020 as our concerns about weak liquidity and a potential restructuring or bankruptcy seemed overblown at a time when the BDCs themselves (through IQ 2020) were valuing their debt almost at par. We had removed the company from our Weakest Links list as well.
Still, back on September 2, 2020 we wrote in our internal notes: “We wonder – after reviewing the IIQ 2020 results again – whether we were wise to upgrade from CCR 4 to CCR 3 following the IQ 2020 valuations. We may have allowed ourselves to be taken in by the almost knee jerk optimistic valuation of BDC lenders/investors when facing a major exposure. For example, AINV’s second lien debt is discounted but -5%. Regrets. We may have a few“.
Now we’re back to downgrading Sequential to CCR 4 again. It’s not just the SEC charges – which do not seem to have fazed shareholders. We also note that the Board has announced its intention to explore “strategic alternatives“. Furthermore, we’ve noticed that the FS KKR BDCs have been increasing their discount of the first lien debt in the last two quarters. At September 30, 2020 the discount was (15%). (AINV discounts its more junior debt only -4%).
Taken together, this is worrying and given the aggregate size of BDC exposure – $292mn at cost and $25mn of annual interest income – worth paying attention to. FSKR and FSK shareholders should have a special interest in any outcome – especially a poor one. Given the “strategic alternatives” exploration, we may hear sooner rather than later about the direction of Sequential Brands.
On May 15, 2020Sequential Brands reported IQ 2020 results. More importantly, the company reported very tight liquidity even after drawing on its Revolver: just $14mn. Furthermore, in a press release, the company admitted to being in negotiations with its lenders to avoid any prospective loan defaults and raised doubt about its status as a “going concern”. The stock price – not very material to start with – dropped (11%) to $0.19.
The BDC Reporter has rated the company CCR 4 for some time. The chances, though, of a bankruptcy or recapitalization have greatly increased thanks to Covid-19, as reflected in these latest developments. This is what we call a Major BDC borrower (over $100mn), with $292mn invested at cost as of December 31, 2019. (Not all the IQ 2020 outstandings have been reported). The 3 BDCs involved are publicly traded Apollo Investment (AINV); FS-KKR Capital (FSK) and sister non-traded fund FSIC II. Most recently FSK valued its position in the 2024 Term Loan at just a (2%) discount. However, the $10mn in equity owned by two FS-KKR BDCs is valued at next to nothing, as the stock price mentioned above suggests.
If Sequential does default – as we’ve mentioned in earlier articles – the biggest immediate impact will be the receipt of the $30mn of investment income the three BDCs have been used to collecting. Whether there will be any realized loss from the debt held continues to be questionable, but the equity will certainly be written off. Most impacted of all will be FS Investment II, which holds 75% of the BDC exposure.
Of the 6 Major BDC borrowers on the BDC Reporter’s Weakest Links list, Sequential is by far the largest. Should a bankruptcy/restructuring occurs it will be the biggest one since the Covid-19 crisis began from a BDC lender perspective. Like so many other names on that Watch List, Sequential was already deeply troubled before the crisis. Current conditions make an unhappy outcome – and possibly a much bigger loss than the BDCs have been planning for in their valuations – almost certain. We expect to be reporting again shortly.
May 20, 2020 Update: From another news report we have learned that “The company closed the first quarter with $13.3 million of cash and $460.7 million of debt net of cash. As of March 31, availability under its revolver was $7 million, which the company fully borrowed subsequent to the end of the quarter“. The above underscores that Sequential Brands is effectively out of cash and some sort of action will be necessary.
In early November 2019, Sequential Brands Group , Inc. (SQBG) reported earnings, held a Conference Call and filed a 10-Q. As usual, and despite widening losses and the absence of a permanent CEO and the recent announcement by the Board of its intention to explore strategic options, the tone of management remained upbeat. Here’s an extract of what acting CEO and Chairman William Seedler said on the CC:
“While we’re in the final stages of our CEO search, I’m pleased to fill in and join today’s call with Peter. The executive team has been hard at work executing on the plan to best position Sequential for long-term success…
First, the management team remains focused on driving revenue growth across the portfolio. …Second, we are well underway to rightsizing the cost structure of the business post the sale of Martha Stewart, which includes a significant reduction of our expenses. As management previously outlined, we expect an operating expense base of approximately $30 million before minority interest starting next year. This new optimized operating expense base reflects a significant reduction to the company’s current overhead, including corporate head count, SG&A and headquarter-related expenses. To that end, we’ve made significant progress on the sublease front. … We expect these savings to drive a significant and immediate margin improvement as we head into 2020. Third, we recently amended our lending agreement with KKR, which further improves our liquidity and cash flow and demonstrates the continued support of our lenders. With no upcoming debt maturities, we believe that the company has ample runway to focus on driving the business forward”.
We remain concerned nonetheless as Adjusted EBITDA in the latest quarter was $13.2mn, just covering interest of $13.0mn. Debt to EBITDA annualized was 8.3x… In fact, even debt to REVENUES is 4.4x ! Most importantly, liquidity, as per the 10-Q, includes just $5mn in cash and $24mn of availability under the company’s Revolver. Yet, last quarter Sequential registered ($18mn) in negative cash flow from continuing operations.
Frankly, we’ve been expecting “something to happen” at Sequential for months, since our first report in April of this year. We continue to rate the company CCR 4 (Worry List) and BDC exposure (concentrated in the FS-KKR group) huge at $292mn. Our jaundiced view is that the proverbial can is getting kicked down the road, judging by a second amendment to the lenders loan agreement in so many years. A bankruptcy filing could affect a whopping $281mn of BDC debt from 4 funds (one of which is Apollo Investment or AINV). That’s about $30mn of annual investment income at risk of – at least – interruption. We’re loath to add the credit to our Bankruptcy Imminent List given both that Sequential has survived for longer than we expected and the optimistic tone of the Chairman and the fact that there are only 6 weeks left in the current quarter. We’ll shortly see if we have become too lax in our assessment. In any case, it’s hard to imagine Sequential getting through another year without a bankruptcy or major restructuring event. As we are talking about the retail sector here – in an indirect way – it’s hard to see how the company or its lenders (who also own its almost worthless stock) come out of this undamaged. Unfortunately, neither AINV nor FSK even mentioned the company in their most recent Conference Calls, according to our review of the transcripts.
On October 14, 2019 Sequential Brands, Inc. announced its intention to explore various strategic options, including a sale of some of its brands. Other alternatives were also mooted including a stock buyback; making an acquisition and “others”, but the sale is the most likely. The Chairman of the company said the decision was triggered by interest expressed by third parties in acquiring some of the company’s retail lines.
We’ve been tracking Sequential for some time and get the impression the Board is putting a good face on a bad situation. As we reported back on May 29, 2019, the company is under-performing financially and highly leveraged – a deadly combination. As noted on April 19, 2019 Sequential already sold two brands, but with little lasting impact. More recently, in another ominous sign, its CEO has resigned and Stifel has been hired to help explore its options.
Something is going to happen here before long but exactly what is unclear, though our money in on an asset sale or a bankruptcy filing. The lenders involved – which includes 4 BDCs and exposure at cost of $292mn – will be very interested in the outcome. All but $13mn of the BDC exposure is held by one of three KS-KKR BDCs, including $61mn by publicly traded FSK. The only unrelated BDC is Apollo Investment (AINV). The $10mn invested in the equity of the company – all by FS-KKR entities – seems a lost cause as Sequential’s stock price continues to reach new all-time lows and currently is a penny stock with a value just $0.27.
More important will be how the 2024 Term debt in which all the remaining BDC exposure lies- currently trading at a modest (3%) discount – will fare. The lenders will be hoping that Sequential will sell assets sufficient to pay off some or all its debt. That could happen, but nothing is for certain in the retail sector these days, so we’ll be staying tuned to what is likely to be a major news story in the weeks ahead, given the size of BDC exposure, and the urgent tone of the proceedings.
On May 10, 2019 publicly traded Sequential Brands (SQBG) published its 10-Q. Two days earlier, the company held its regular Conference Call and issued its earnings press release. We reviewed the results on May 29, which only reinforced our concerns about the future of the business. Without getting into all the details, Sequential has $600mn in debt outstanding and is generating $16.8mn in “Adjusted EBITDA” and $15.6mn in interest. Plus, performance is headed south, with first quarter result “below expectations”. The stock is virtually worthless, valued at $0.6670, close to its all-time low. Yet, the 4 BDCs with a sit up and notice $293mn in exposure at cost continue to value their debt at or close to par. Admittedly, there is $10mn of equity invested which has been virtually written off, following the stock price. That leaves, though, a whopping $283mn in debt – almost all nominally first lien. The BDCs with exposure – ranking from largest to lowest are FSIC II, FSIC III, FSK and AINV, all in the 2024 Term Loan. FSK has exposure of $63mn and AINV $13mn. Should the company default, both the income loss from a non accrual and the potential loss of capital in a restructuring or bankruptcy could be sizeable. We assume in a Worst Case, the BDC lenders would lose all their equity stake and half their debt outstanding, or over $150mn in total. Given the size of the exposure; the financial condition of the borrower and the possibly overly optimistic valuation we’re placing Sequential on our Daily Watch List to make sure we don’t miss any development.
On April 17, 2019 Sequential Brands Group, Inc.sold two major brand lines to Marquee Brands LLC for $175mn and an earn-out. The Company plans to use a substantial portion of the proceeds from the transaction to pay down debt. The transaction is expected to close in the IIQ 2019. BDC exposure to the Company is high at $295mn, in first lien, second lien and equity.