Acosta Holdco: Payment default expected

We’re a few days late on this major story: Acosta Inc. – a leading marketing company to major brands – is about to miss a scheduled bond payment on October 1 2019, according to the Wall Street Journal. The company has been in trouble for some time and has hired a turnaround adviser and recently been downgraded by Moody’s.

Now a restructuring is underway, which appears to be arranged in conjunction with the company’s many bank lenders and bond investors. “ The Jacksonville, Fla.-based company, owned by private-equity firm Carlyle Group , has notified its lenders and bondholders they should sign nondisclosure agreements to enter into formal restructuring negotiations in advance of an expected credit default“, according to “people familiar with the matter“.

The immediate challenge for Acosta, which is squeezed for cash, is a $31 million coupon payment due on Oct. 1 to bondholders that own $800 million in unsecured debt maturing in 2022. BDC exposure, though , is in its 9/26/2021 Term Loan. Aggregate debt at cost is $40.1mn, all held by 5 BDC funds – both listed and non-listed – controlled by KS-KKR Capital. For example, FSK has $19.1mn of debt outstanding. Total income at risk for the group is $2.1mn as the debt is priced at only LIBOR + 325 bps.

Given that the Carlyle Group is the sponsor and as you can tell by the pricing, this was supposed to be a “safer” loan, given that the income barely covers the BDCs cost of debt capital. Unfortunately, the company has been under-performing – by our standards – since the IIQ 2017. At June 2019 the debt was discounted by as much as (59%) on the various BDCs books. As of today – according to Advantage Data’s real-time loan pricing records – the discount has increased to (67%) and could go lower.

We expect the debt to be shown as on non accrual in the upcoming IIIQ FS-KKR portfolios when earnings are released and to be written down to the market level, which should cut the fair market value by at least $6mn. We’re likely to see a restructuring done relatively quickly – if past experience is any guide – and a realized loss is likely to follow but we don’t have sufficient information to estimate the extent. This is almost certainly going to be another reverse for the FS-KKR organization. Curiously FSK, FSIC III and FSIC IV appear to have jumped in relatively recently – perhaps ill advisedly seeking a bargain. Total BDC exposure jumped from $13.4mn at the end of 2017 to the $40.1mn current level. That’s a tripling of Acosta debt held.

Capstone Nutrition: Acquired By PE firm

The news – reported on September 24, 2019 – that PE firm Brightstar Capital had finalized its acquisition of Capstone Nutrition should have been music to the ears of its 3 BDC lenders, with an aggregate $117mn in exposure. That’s a pretty penny to have outstanding and to a contract manufacturer much of whose debt has been on non accrual since 2016 !

The BDCs involved are Medley Capital (MCC), Sierra Income and Business Development Corporation of America. Big discounts in excess of three-quarters of cost have been taken as of the latest IIQ 2019 results.

What we don’t know – and nobody is saying – is whether the purchase price was large enough to ensure the repayment in full of the lenders – including the afore mentioned 3 BDCs. If so, that will be a major gain (over $80mn) – and elicit a huge sigh of relief from the BDCs and their shareholders. If not, a realized loss of an undetermined amount will be crystallised as early as the third quarter 2019 BDC results.

Deluxe Entertainment Services Group: Lays-Off Staff

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.

Pier 1 Imports: Reports IIQ 2019 Results

The embattled retailer Pier 1 Imports, who we wrote about on April 17 and April 29, reported second quarter 2019 results on September 25, and they were not pretty. One example: comparable store sales dropped (12.6%). As you might expect, the stock price dropped in reaction: by (12%).

Management, though, continues to argue that its turnaround plans will bear fruit and the company will be able to avoid Chapter 11 or equivalent. We have our doubts – as do the two BDCs with exposure, who’ve discounted their debt to the company by (74%) as of IIQ 2019, from (44%) in the prior quarter. (At the moment, based on Advantage Data‘s middle market liquid debt records, the same discounts apply as in June). There’s $1.0mn of annual investment income at risk, held by publicly listed Main Street Capital (MAIN) and non-listed sister BDC HMS Income.

McDermott International: Seeks Bridge Loan

We first wrote about trouble at oil field services giant McDermott International back on September 19, 2019 when a restructuring firm was hired. Now there are reports that the company is seeking a huge bridge loan to fund a $1.7bn working capital deficit until assets can be sold to repay existing debt. Here’s what Bloomberg said about what asset sales might accomplish:

The company confirmed it was working with Evercore to explore unsolicited interest in its Lummus Technology business, with a valuation exceeding $2.5 billion. That amount combined with its $1.5 billion in boats, equipment and buildings, as well as $500 million in storage assets, could be enough to cover its debt and preferred stock, Citi research analysts wrote in a Sept. 18 note.

McDermott said it had about $3.8 billion of gross debt at the end of the second quarter and $1 billion of cash available.

If it were to sell the technology business for more than $500 million, McDermott’s bond rules stipulate that it must use the net proceeds to repay debt, according to a Covenant Review report“.

We’re not expert enough in the intricacies of McDermott’s arrangements to determine if asset sales – were they to happen – would be positive or negative for the 2025 Term Loan held by the two BDCs with $11mn in exposure at cost. What does seems clear: the McDermott story – thanks to its massive cash needs and already high debt – will be on the front burner where credit developments are concerned through the rest of 2019. We maintain a CCR 4 (Worry) rating.

Medical Depot Holdings: Raises New Equity, Restructures Debt

Last time we wrote about Medical Depot Holdings, also known as Drive DeVilbiss, we concluded in this manner: “It’s hard to envisage a scenario where some sort of loss does not occur given the amount of debt involved, but we’ll have to wait and see. We have a Corporate Credit Rating of 4. That’s our Worry List”.

On September 20, 2019 the company announced by press release that it “had agreed in principle” to receive $35mn of additional capital “together with a reduction in cash debt service obligations from its current
lenders
“. This was quickly picked up and repeated in different forms by financial and trade publications as evidence of a successful “rescue operation”.

However, from the BDC Credit Reporter’s standpoint, the company’s announcement raises more questions than answers. There’s the “in principle” part; the source and form of the $35mn and what is meant by “reduction in cash debt service“. Also not clear is what the lenders have received in return – besides the heartfelt thanks of the company and its owners. So we’re marking this development as trending positive, but not changing our Credit Rating till the many blanks get filled in. When that might occur – and from what source- remains unclear.

We have reported that there are two BDCs with $32.4mn of exposure at cost: Bain Capital Specialty Finance (BCSF) and Business Development Corporation of America (BDCA). We may learn from them what “reduction in cash debt service” means. We’re guessing: a lower interest rate on the debt (but whose ?) and – potentially – lower income.

Oaktree Medical Centre: Files Chapter 7

As anticipated Oaktree Medical Centre filed for Chapter 7 liquidation, According to an AP news report, the filing occurred on September 23, 2019. That almost completes an unfortunate credit story that we’ve written about previously – punctuated by claims of massive fraud by the company brought by the DOJ – and which resulted in Fidus Investment (FDUS) having to write to zero its $13.4mn investment. The BDC may book the realized loss in the third quarter results or at year end, but with all the investment reserved and no income forthcoming, this one’s over.

Obviously for FDUS not a satisfying conclusion and which deserves some future discussion by investors and analysts as to whether there were warning signs of the fraud that due diligence or ongoing monitoring could have caught. Most likely the BDC’s managers would just like to forget this investment was ever made but there’s plenty to learn from a discussion of process and procedures even after the fact.

California Resources: Denies Hiring Restructuring Firm

It’s been a crazy week for public oil & gas producer California Resources (ticker:CRC), as explained by the Wall Street Journal: “Exploration and production company California Resources has also taken bondholders on a roller-coaster ride in recent days. The firm’s 8% bond due 2022 jumped about 15% to 64 cents on the dollar Monday after attacks on Saudi Arabian production facilities lifted global oil prices before falling about 25% to 48 cents on the dollar Thursday, following a media report that the company was also hiring a restructuring adviser. The debt rebounded to 58 cents on the dollar Friday after the company denied the report.“.

We doubt that will be the end of the story with so much of the oil patch – even larger companies like California Resources – in financial trouble, but in this case the trend – which we mark every story with our assessment of – is up.

However, we couldn’t help noticing that the debt tranche held by the only BDC with exposure – non listed Business Development Corporation of America (BDCA) is currently trading at a (9%) discount to par after all these oscillations, compared to a (3%) discount on BDCA’s books as of June 2019. The exposure has a total cost of $12mn and yields 7.15%.

SES Investors: Acquires Manufacturing Plant

We had been worried about spray foam producer SES Investors (aka SES Foam) for the last several quarters. Back in the IIQ of 2018, its only BDC lender – Fidus Investment (FDUS) – had written down its second lien debt by (32%) and small equity stake to zero. Recent valuation trends, though, have been favorable and $1mn was repaid late in 2018.

Now we hear the company has just acquired “a state-of-the-art manufacturing plant in Spring, Texas, USA”. Of course, we can’t say if that’s a positive or a negative, knowing nothing of the nitty gritty financial details. Common sense, though, suggests this demonstrates the company is doing well given the “tremendous growth we have achieved over these last few years”, as mentioned in the press release.

This is a small investment even for a smaller sized BDC like FDUS, with only $3.7mn remaining of exposure (outstandings used to be $12.5mn) but is notable because chances look good that SES investors might be one of a minority of BDC under-performing companies that shortly makes its way back to the performing ranks. At June 30, 2019, we rated the company CCR 3 (Watch List) due to the 9% discount on the second lien debt and the (26%) discount on the equity stake. Maybe we’ll even see a modest increase in the value of the SES stock held ?

Charming Charlie: Intellectual Property Sold

This will probably be the last post we write about Charming Charlie, the women’s accessories retailer which went bankrupt twice in a short period and is being liquidated. We wrote a major article on bankruptcy number one back in December 2017 in the BDC Reporter. In the second round, multiple BDCs with $37.4mn of debt and equity invested at cost lost (almost) everything. At June 2019 two BDCs were still holding out for $0.9mn in FMV, presumably from any net proceeds from the Chapter 7 liquidation.

In this regard, a trade publication reported that the founder of the company had acquired the intellectual property associated with Charming Charlie for $1.1mn. That will be little succor to lenders after all other expenses are paid, but brings closer the date of the ultimate Realized Loss crystallization and the end of this sad attempt to keep what was not so long ago a prosperous and fast growing business alive.

Prairie Provident: Additional Reserves Identified

Canadian energy company Prairie Provident issued a press release about “the results of an updated independent reserves evaluation of the Company’s interests in respect to specific reserve entities within three future undeveloped waterflood expansion areas in Evi “.

From our unlearned reading of the release, the company is suggesting “an incremental 2.1 MMboe of proved plus probable (“P+P”) undeveloped reserves (97% oil and liquids) have been assigned to future waterflood expansions, comprised of approximately 1.6 MMboe of proved undeveloped reserves and approximately 0.5 MMboe of probable undeveloped reserves. Relative to year-end reserves bookings for specific reserves entities within the three Evi Waterflood areas, the undeveloped reserves additions attributed to the future expansions represent an increase of nearly 40% in original recoverable reserves estimates on a proved (“1P”) basis for those areas. As a result of the increased reserves assignments at Evi, PPR’s total estimated corporate reserves volumes grow by 7.1% on a 1P basis and by 6.1% on a P+P basis, relative to year-end estimates“. 

That all sounds favorable – and given we spend most of the time reporting bad news – that’s a plus. However, as we noted the prior time we wrote about Prarie Provident BDC exposure at cost (Goldman Sachs BDC or GSBD) is $9.2mn and the FMV is only $0.2mn – all invested in non income producing equity. As of June 2019, the latest valuation was even lower than the quarter before. This type of news may boost future valuations, but Prairie has a long way to go in a tough industry. Either way, income to GSBD is not affected.

J.C. Penney: Downgraded by Fitch Ratings

S&P recently downgraded J.C. Penney – the iconic retailer – and now Fitch has joined suit. In this case, the rating for the company has dropped to “junk” status or CCC+ from B-. The reasons given are just what you’d expect. For our prior three articles on Penney’s, click here.

As we’ve explained previously, BDC exposure is modest and whatever happens will have little impact on the three non-listed FS-KKR BDCs involved, which are in the process of going public as a combined FS-KKR II. Also in there is TPG Specialty (TSLX), but with its asset-based status is not expected to lose any money under most possible scenarios.

Of course, Penney is just one example of the retail sector “apocalypse” that’s been going on for years in a long running burn of companies of all kinds. Currently we’ve identified 20 retail-related companies that are under-performing, with a cost of investments of $1.27bn. That’s probably not everyone caught up in this seismic change in how consumers and businesses shop, but captures all the names you’d expect and a few more. The BDC sector has taken a hit, and will continue to do so, but the damage has been spread out over more than two dozen BDCs (roughly a quarter of the listed and non listed players) and over several years, mitigating the blow. Junk bond investors and other forms of lenders have taken more of a body blow f rom this once-in-a-lifetime shift in American commerce.

McDermott International: Hires Restructuring Firm

We placed giant oil field services company McDermott International, Inc. on our under-performing list back on July 30, 2019 with a Corporate Credit Rating of 4 (Worry List) after results came in much worse than expected and the stock sank. Now matters are getting worse, as the company has just hired turn around firm AlixPartners. What followed was the equivalent of an earthquake in terms of market reaction, even more so than back in the summer. Here’s what Bloomberg reported: ” The Houston-based company’s stock plunged as much as 76% Wednesday — trading was halted for volatility at least five times — while its bonds dropped more than 30 cents to 37 cents on the dollar, making them Tuesday’s most actively traded debt in the U.S. high-yield market..

BDC exposure is relatively modest ($11mn at cost), divided between two BDCs: non-listed Business Development Corporation of America (BDCA) and listed Oaktree Strategic Income (OCSI). Both appear to be in the same April 2025 senior Term Loan and both valued their exposure at June 30, 2019 at par, or very close. We expect next time round that valuation will drop and even more so if McDermott files for Chapter 11 or restructures. There’s about $750,000 of annual investment income at risk, with BDCA having the bulk of the exposure.

The troubles of McDermott are part and parcel of the distress in the energy industry – especially but not exclusively in oil field services of one type or another, as we’ve previously mentioned. We expect to hear considerably more about the company and its less well known peers in the months ahead. In this segment at least recession-like conditions are already in play.

Bluestem Brands: Reports Weaker IIQ 2019 Results

We’ve written about Bluestem Brands before on two occasions, on April 12, 2019 and June 19, 2019. Now the multi-name retailer – whose results are publicly made available every quarter – has just completed its IIQ 2019 results. Unfortunately, the turnaround at Bluestem continues, and there are signs that the situation is getting a little worse. We won’t undertake an in-depth diagnosis, although we’ve reviewed both the earnings press release and the Conference Call transcript.

We’ll focus on a key metric – and one of two material debt covenants. Required minimum liquidity – demanded by the senior lenders – is $40mn. This quarter, Bluestem had $50mn, down from $59mn the prior quarter. That’s pretty close, and principally why we’re writing this update.

We have a Corporate Credit Watch of 4 (Worry List) for the company, which has been “troubled” since 2016. The latest results don’t change our rating, but we continue to worry that the company is just one reverse away from a covenant default. That would not be the end of the world, but might suggest the attempt to turnaround the business with its current capital structure is unfeasible. That might involve some debt haircut in some form. Given BDC exposure of $29mn – already discounted – by (23%) by 3 of the 4 BDCs, there could be some further Unrealized Losses to come in the short term.

(We should point out that – for reasons unknown – Capitala Finance (CPTA has only a (4%) discount on its share of the 2020 senior debt, one sixth of what Main Street Capital (MAIN), HMS Income and Monroe Capital (MRCC) have valued the same exposure. There’s been a deviation between CPTA and the other BDCs for several quarters, and we don’t know why. If matters do get worse, CPTA – with $3.7mn of debt at cost – has the farthest to fall).

Fairway Group Acquisition: Company Up For Sale

The Wall Street Journal reported that “quintessential New York grocer” Fairway Market is up for sale and potential bidders are already squeezing the melons.

That might or might not be good news for the lenders to the company – who are also owners following a 2016 debt for equity swap as part of a bankruptcy. There has also been a 2018 debt restructuring which Moody’s – never once to mince words – called ” a distressed exchange” and predicted that a new restructuring would be needed in 12-18 months. It’s taken less time than that for Fairway – best by competition from Whole Foods and others – to be back in hot water.

If a buyer does come along and pay full price, the two BDCs with exposure are sister firms FS Investment II and FS Investment III, owned by FS-KKR. According to Advantage Data, the two BDCs have multiple first and second lien loans to the company and equity besides for a total of $30mn. Some of that debt is already on non accrual or accruing only Pay-In-Kind income.

This exposure began back in 2014 with $10mn in advances, tripled in 2016 and has been nothing but trouble first for GSO Blackstone and now KKR. The second lien and equity has been written to zero and some of the original first lien debt has been discounted (90%) as of June 2019. Total FMV is close to $16mn.

Just as likely as a deep pocketed buyer is a Chapter 22 situation, i.e. another bankruptcy. We would speculate that the existing owner/lender group is unwilling to risk any new capital in the business. Should that occur, the two BDCs involved are in danger of booking some mid-sized Realized Losses and a enough-to-be-noticed amount of investment income. A failure here would – once again – place a spotlight on the controversial (at least in the eyes of the BDC Credit Reporter) practice of BDCs and other lenders turning into distressed asset owners. However, before we get all judgmental, let’s see if the sales process turns out to be a godsend, and allows the two BDCs involved to get out with little or no damage.

Basic Energy: Downgraded By Moody’s

On August 12, 2019 – but only noted by us on September 17 – Basic Energy Services, Inc. was downgraded by Moody’s to Caa1 at the corporate level. The company provides a variety of oil services, a segment that’s been in the doldrums of late. The summary view from the ratings giant was as follows: “The downgrade of Basic’s ratings to Caa1 reflects slow recovery in the business amid a decelerating market outlook, that we expect will keep financial leverage high”, commented Elena Nadtotchi, Moody’s Senior Credit Officer. ‘The company’s cash balances support its liquidity position, while Basic is cutting costs and reduces investment in 2019’.

BDC exposure, though, is limited to one non-traded fund: Guggenheim Credit Income Fund. The BDC has $2mn invested in the 2023 first lien debt, and had valued its position at a (21%) discount as of June 2019, down from the quarter before. The debt was only booked in the third of 2018 but has been sliding in value ever since. Moody’s value this debt even lower than the corporate at Caa2.

We checked Advantage Data’s real-time bond pricing and found that the current discount is (27%), suggesting a potential unrealized write-down is coming in the third quarter 2019 results. If a default does occur, Guggenheim is at risk of annual investment income interruption of $2.2mn. A default does not seem likely in the short run, but nor does a full recovery barring a sea change in industry conditions. We have a CCR 3 (Watch) rating , with a downward trend.

Frontier Communications: Makes Scheduled Debt Payments

Those are sighs of relief you’re hearing. On September 16, 2019 the Wall Street Journal reported that Frontier Communications was making its scheduled debt payments. This would not normally be news, but many investors were – apparently – concerned the troubled and highly leveraged communications company might choose to file for Chapter 11 or a restructuring instead.

That’s good news of a kind, but the problems at Frontier continue, so this may be more respite than anything else. (We’ve written about the company multiple times previously. Here’s a link to the list of articles). There is $62mn of debt outstanding at 8 different BDCs and over $5mn of annual investment income at risk. The exposure is carried as of June 2019 at close to par, so if anything negative happens to Frontier in the future the impact will be material from a BDC perspective (and much more so in the high yield bond market). For the moment lenders and shareholders can breathe easy. Tomorrow, though, is another day.

Vivint Smart Home: To Merge Into SPAC

On September 16, 2029 Vivint Smart Home, a subsidiary of APX Group Holdings, which is owned by Blackstone announced it is being acquired by Mosaic Acquisition Corp., a publicly traded special purpose acquisition company (“SPAC”), backed by Fortress Investment Group, itself a subsidiary of Softbank. The existing investors will throw in another $100mn of equity to add to the $2.3bn already invested and Fortress affiliates will fund another $125mn. According to the press release discussing the merger: “With an agreed initial enterprise value of $5.6 billion, Vivint is anticipated to have revenues of $1.3 billion for fiscal year 2020E and Adjusted EBITDA of $530 million, implying an Adjusted EBITDA multiple of approximately 10.5x”.

According to Lisa Abramowicz at Bloomberg, this boosted the bonds of APX, which had been trading at a discount.

BDC exposure to Vivint is substantial ($137mn), spread across 4 different debt instruments and with valuations ranging from par to a discount of (20%). The debt is very recent, added during the IVQ 2018, and was added to our under-performers list only in the IIQ 2019 as Moody’s downgraded the company and BDC valuations dropped measurably, many beneath the 90% FMV to cost we consider a useful trigger in the absence of any other information.

All the BDC debt is held by FS – KKR Capital entities including its public vehicle (FSK) and 4 non-traded funds. This merger should result in an upgrade of the debt values but we don’t know if Mosaic will be refinancing the debt or assuming the obligations. We get the impression this is more of a capital infusion than anything else, and expect some debt may get repaid while the rest might be retained. Anyway, good news for the FS-KKR Capital group in the short run. In the long run, though, we’ll have to see if Vivint’s ambitions for domination of the “secure home” market can live comfortably with its capital structure. We’ll be leaving the Corporate Credit Rating at 3, but the trend is positive.

Constellis Holdings: Sells Assets To Improve Liquidity

According to the Wall Street Journal’s crack Pro publication, Constellis Holdings – a troubled leading defense contractor with multiple operations – has sold a training facility for $40mn. More than the amount involved – which is modest by comparison with the debt on the company’s balance sheet – we noted that the WSJ article indicated the sale was undertaken to “avert a liquidity crunch”.

We added Constellis to the under-performing list (CCR 3) only in the IIQ 2019, as reported in a post on August 17, 2019 and based in downward valuation changes, rating downgrades and changes in the C-suite. As we become more familiar with the Apollo Global-owned private company, we recognize that Constellis should have been a candidate for our concern some time before. The drawdown of US forces in Afghanistan and Iraq, which has been going on for some time, is one negative factor; along with a major restructuring of its business underway, discussed by its CEO in a recent article in a defense trade publication.

The sale of the training facility by itself will not be sufficient to right the ship, and we’ll be keeping a close eye on developments at the company in the months ahead. Given the over $100mn invested by 9 BDCs – especially 4 FS-KKR entities – this deserves watching.

Anchor Glass: Downgraded By S&P

On September 5, S&P Global Ratings downgraded packaging company Anchor Glass Container Corp to CCC+. That’s bad news for non-traded BDC Business Development Corporation of America (BDCA), which has a $20.0mn position in the company’s 2024 second lien debt. S&P reduced the rating on that debt to CCC-.

As of June 2019, BDCA had discounted its debt position by (30%). However, this is a traded loan and the current price is at 50% of par, suggesting an unrealized depreciation is coming in the IIIQ 2019 of (20%) or about ($4mn).

Judging by what S&P is saying about the financial performance, cash flow and leverage at Anchor Glass that may be the least of BDCA’s problems. If the company files for bankruptcy or restructures, there is $2.0mn+ in annual investment income at risk for BDCA. Last time we checked (two seconds ago) BDCA’s annualized Net Investment Income Per Share was just under $110mn. In these situations a 100% write-off of junior debt is possible, so a material Realized Loss is possible.

Given that debt to EBITDA is over 10x; capex requirements are heavy and the economic backdrop is not favorable, the odds of things going wrong seem high. However, according to S&P, the company – thanks to an asset based Revolver – has no immediate liquidity problems so this is likely to be a slow burn.