Posts for Prospect Capital Corporation

K&N Engineering: In Restructuring Negotiations With Lenders

Bloomberg Law on July 29, 2022 ran a story for its subscribers indicating that K&N Engineering Inc. (aka K&N Parent) “began confidential negotiations with its lenders ahead of upcoming debt maturities, according to people with knowledge of the matter”. The sponsor is reportedly Goldman Sachs Asset Management and the object of the negotiations are first lien and second lien debt due in 2023 and 2024 respectively.

Here’s a brief lowdown on the company in the crosshairs, drawn from Wikipedia: “K&N Engineering, Inc. is a manufacturer of air filters, cold air intake systems, oil filters, performance parts, and other related products. K&N manufactures over 12,000 parts for various makes and models of cars, trucks, SUVs, motorcycles, ATVs, industrial applications and more.”

This is not a complete surprise to the BDC Credit Reporter because K&N was added to the underperformers list in the IQ 2022 when the BDCs holding the second lien debt increased their fair market discount to cost to as much as (30%). Even though the first lien remained mark near cost, we downgraded the company from CCR 2 to CCR3.

With this latest news, the odds of loss has greatly increased, and we are downgrading the company further to CCR 4. As of the IQ 2022, there were 4 BDCs with nearly $80mn of exposure: CION Investment (CION) is only in the first lien and Apollo Investment (AINV) only in the second lien. Barings BDC (BBDC) and Prospect Capital (PSEC) are in both layers of debt.

In the IIQ 2022, only AINV has published results, continuing to value its $23.6mn of junior debt at $19.5mn , only slightly less than in the prior quarter. Still, there’s a good chance the $51mn held by AINV, PSEC and BBDC (the latter has a very small exposure) in second lien debt could face ultimate losses of (20%) or more. Moreover, both the first and second lien debt is at risk of income interruption should a default occur.

What ails K&N ? We can’t make out what the challenges might be from a quick review of the public record and none of the BDCs involved are talking, but we’ll continue to root around. In the interim, we’ll be keeping an eye on how PSEC, BBDC and CION value their positions as IIQ 2022 results come out.

Engine Group: Sells Subsidiary

In March 2022, the Engine Group – “a global, multi-disciplined marketing services platform with leading-edge digital capabilities” – sold its British subsidiary : Engine Group UK, which is owned by Lake Capital. Since 2021, Lake Capital has been actively seeking to sell all or parts of Engine Group – now named just Engine. The proceeds here were Sterling 77.5mn, or roughly $100mn.

There is only one BDC with exposure to the Engine Group: Prospect Capital (PSEC). Advantage Data records shows that exposure began with first lien and second lien loans, first booked in IIIQ 2017, with a total cost of $40mn. Everything went to plan till 2018, when the first unrealized write-downs began. By the IIQ 2020, both loans were on non accrual, and written down to about $11mn from the-then $39mn advanced.

Some sort of restructuring appears to have occurred, with the exposure swapped into a first lien loan due in November 2023, with a cost of $12mn and equity of $27mn. The debt, though, has been amortizing in the intervening quarters and only $3.6mn was left as of March 2022, valued close to par. The equity at cost, though, was unchanged and valued at next to nothing : $294,000.

Normally, we’d expect that PSEC – as both lender and investor – might benefit from the sale of a key subsidiary. However, the transaction occurred in the first quarter of the year and did not seem to affect the equity valuation much, but may have accelerated the debt payoff.

In any case, we rate Engine CCR 4, and will wait to see if the ($27mn) of unrealized losses still booked will get realized, or if the loss will shrink. There was no word on the subject either this quarter, or at any other time, on its conference call.

Dunn Paper: Lenders Seeking Sale Of Company

Dunn Paper has been in financial difficulties in recent months due to “declining profitability and elevated leverage”, as admitted by the company in a press release. In March 2022, an interest payment on senior debt was missed, which required the borrower to enter into a forbearance agreement with some of its lenders. A new credit facility has been received, although the amounts and terms are not known. (For a brief explanation of Dunn Paper, see a company description at the bottom of this post).

The above notwithstanding – on April 26, 2022 – a specialist publication – quoting anonymous sources – indicated second lien lenders are banding together; hiring counsel and seeking to push for a sale of the company. As you’d expect details are sparse. However, we imagine several BDCs might be represented in this group of second lien lenders. Prospect Capital (PSEC), Southwest Capital (CSWC) and a non-traded BDC all have second lien exposure to Dunn. (PSEC is also in the first lien debt).

Dunn has been underperforming only quite recently – since IIIQ 2021 – when all the BDCs involved started to write down the value of the second lien debt. As of the IVQ 2021, the biggest discount was applied by CSWC: (16%). All in all, BDC exposure amounts to a relatively modest $21mn, with PSEC holding $16mn, including $4mn in first lien exposure. Until the latest news, we rated Dunn CCR 3 on our 5 point investment rating scale. Now, Dunn has been moved – due to its failure to make an interest payment – to CCR 5.

The yield on the second lien debt was being charged at just over 10%, suggesting total annual income forgone on the second lien debt is ($1.7mn), and another ($0.3mn) on the first lien.

Dunn’s weak financial performance – according to their own reports – seems to derived from the supply chain and related inflationary increase of input costs. That might mean what ails the business might be salvageable by a restructuring or the sale to the right party. The PE sponsor recently brought back “Founder” Brent Earnshaw as CEO, amidst other senior executive changes. That must give some hope to the second lien lenders that a full recovery – or something very close to one – is a realistic prospect. We get the impression from reading between the lines that this troubled situation will be resolved within a relatively short period.

We will continue to track the public record and ascertain what valuations PSEC and CSWC ascribe to their respective positions when IQ 2022 results are published. Neither BDC, though, has yet set a date for reporting their most recent results. At the moment, we expect neither the interruption of income nor any realistic prospective loss to be material for the BDCs involved, and there’s always a chance this will be resolved without any significant loss.

About Dunn Paper
Dunn Paper is a leading manufacturer and supplier of advanced paper, tissue, and packaging products for use in food, medical, and specialty markets. The company operates 7 paper mills across the United States and Canada and focuses on eco-friendly specialty paper and tissue. Dunn Paper also works with top converters allowing their sustainable paper products to have thousands of potential applications. The company’s first mill opened in 1924, and in 2016 the company was acquired by Arbor Investments, a specialized private equity firm with a focus on premier companies in food, beverage, and related industries.

Dunn Paper Press Release April 22, 2022

Dunn Paper Holdings: Debt Refinancing Concerns

The bad news continues to pile up at specialty paper manufacturer Dunn Paper Holdings (“Dunn Paper”). In late November 2021, the company was downgraded by Moody’s. Importantly, the borrower’s 2022 first lien debt was also downgraded to Caa1 and the second lien debt coming due in 2023 to Caa3. The major culprit: higher pulp prices, but also very high debt/EBITDA (over 9x), “negative free cash flow” and refinancing concerns with the debt needing refinancing in August 2022. S&P followed suit with its own downgrade in January 2022.

Now we hear that loan defaults have occurred and the lenders have brought in an advisor to assist with negotiations and that an investment banker is pounding the pavement determining market appetite for a refinancing.

There are 3 BDCs with $21.3mn invested in Dunn Paper in both the first lien and second lien. Two of those BDCs are public : Capital Southwest (CSWC) and Prospect Capital (PSEC) and then there’s non-traded $1.0bn AUM Barings Private Credit. PSEC is invested in both the first and second lien but the other two players are only in the second lien.

Worryingly for BDC valuation credibility, the discount applied by the 3 BDCs with second lien exposure varied widely in the most recent quarter ended September 30, 2021. PSEC and Barings discounted their positions by only (1%) and (6%) respectively from cost , while CSWC was more conservative with a (15%) discount. (The first lien debt remains valued at par).

With some sort of default having already occurred – if those reports mentioned are true – a bankruptcy or out-of-court restructuring seems increasingly likely, as does the need for the BDC second lien lenders ($16.8mn in total) to further write-down their debt, which should show up in the IV Q 2021 results and – possibly – in the IQ 2022. We add Dunn Paper to our Trending list, meaning that we expect a material change in value is coming, and rate the company CCR 4. Given that considerable exposure is in a junior position and borrower and lenders have already unsuccessfully sought to refinance the business (so it seems), the odds of an eventual realized loss seem higher than repayment in full.

We’re also noting – a new feature in 2022 – the underlying reason for the company’s financial difficulties: an increase in pulp prices that Dunn has not been able to fully pass along to its own customers. This makes the company a victim of the much discussed inter-twined challenges of supply chain disruption and rapid inflation. The BDC Credit Reporter will be highlighting these causes when possible, using the tag INFLATION.

With BDC earnings season round the corner, there’ll be more news shortly, or at least up to date valuations, although that value may be in the eye of the beholder. We may also hear more whispers from unidentified sources or even the principals themselves as the restructuring discussions play out.

Still, to keep matters in perspective, the aggregate amounts at risk for the BDCs are modest, with PSEC having the most exposure by far: $15.8mn or three quarters of the total.

For anyone interested in getting all the details of each BDC’s exposure since inception where Dunn Paper – or any of the companies we track in the BDC Credit Reporter – is concerned, we recommend talking to Advantage Data about a subscription to their BDC Holdings module – which contains a treasure trove of data that we regularly utilize for these articles. In this case, BDC exposure dates back to 2016.

Edmentum Ultimate Holdings: Company Sold

In December 2020 , the Vistria Group – a private equity firm – acquired Edmentum Inc. and its parent, Edmentum Ultimate Holdings. Terms were not disclosed but the press release announcing the acquisition indicated “New Mountain Finance Corporation and funds managed by BlackRock will retain ownership positions“.

From a BDC perspective this is a very important transaction as Edmentum was – through September 30, 2020 – one of the larger BDC-financed portfolio companies (number 79 on the list maintained by Advantage Data). Also, there are five BDCs involved, many of them with very large dollar exposure. These include New Mountain Finance (NMFC) and BlackRock TCP Capital (TCPC). Also important is that with the Vistria Group acquisition the future exposure of the 5 BDCs involved is changing. See the Advantage Data Table for IIIQ 2020 of all BDC exposure:

Edmentum has been on BDC books since IVQ 2012 – initially only in the form of first and second lien debt -and has had a chequered past. In 2015 the company was restructured and several of the lenders recognized realized losses. (For example, NMFC lost half of its $31mn then invested). In the restructuring, Oaktree Specialty Lending (OCSL); Prospect Capital (PSEC), NMFC and BKCC initiated equity stakes. To keep a long story short, over the years BDC exposure increased to reach $204.4mn even as some of the debt outstanding was carried as non-performing at different times by different lenders. The BDC Credit Reporter has carried Edmentum on its underperforming list since the IVQ 2014.

However, in recent quarters the valuation of the BDC investments has been improving. As of September 2020 virtually all the different debt and equity stakes held by BDCs were valued at par or at a premium, with the exception of a small equity stake held by Gladstone Capital (GLAD). Now as we begin to hear from BDCs about IVQ 2020 results the outcome of their investments is becoming known, with varying results. GLAD reported the following :

In December 2020, our investment in Edmentum Ultimate Holdings, LLC was sold, which resulted in a realized loss of approximately $2.4 million on our equity investment. In connection with the sale, we received net cash proceeds of approximately $4.9 million, including the repayment of our debt investment of $4.6 million at par.

PSEC fared better: On December 11, 2020, we sold our 11.51% Class A voting interest in Edmentum Holdings and recorded a realized gain of $3,724 in our Consolidated Statement of Operations for the quarter ended December 30, 2020. Concurrently, Edmentum Holdings fully repaid the $9,312 Unsecured Senior PIK Note and the $45,277 Unsecured Junior PIK Note, and Edmentum, Inc. fully repaid the $8,758 Second Lien Revolving Credit Facility receivable to us at par.

OCSL also ended up in the black : “We realized a full par recovery on our debt investment and recorded a total gain of $23 million”. 

Not heard from yet are NMFC and BKCC. However, we get the impression from the press release and comments made by TCPC after the IIIQ 2020 results that New Mountain and BlackRock intend to maintain investments in post-sale Edmentum. Here’s what NMFC said on its November 5, 2021 conference call in answer to a question about its intentions for Edmentum: “We’d like to maybe take some chips off the table, recapitalize the balance sheet, maybe bring in a partner. But at the same time, we do think there’s very significant upside from here that you probably wouldn’t quite get until you show the sustainability of the earnings trend, which we absolutely believe in. And so we may elect to hold some exposure for another period of time to get the benefit of that incremental value gain”.

So while 3 BDCs are going out the door, these two others are likely to remain, but we’ll need the IVQ 2020 results to suss out all the details.  The GLAD realized loss and the earlier 2015 losses notwithstanding, this is a positive turnaround for Edmentum, which was rated CCR 5 as recently as September 2019 and which we have maintained at a CCR 3 rating ever since. After we hear from TCPC and NMFC we’re likely to return Edmentum to CCR 2 status, especially if and when we get a better understanding of the new capital structure and prospects for the business.   

Capstone Logistics Acquisition: Downgraded To CCR 3

On April 27, 2020 the BDC Credit Reporter pro-actively downgraded Capstone Logistics Acquisition to a Corporate Credit Rating of 3 from a CCR of 2. Capstone is “an outsourced supply-chain-solutions provider offering freight handling services, supply-chain consulting, and management of distribution centers“. We downgraded the company, and the $128mn in BDC debt due to our concerns what the national shut-down of business activity may have had on business activity given the leveraged nature of Capstone.

Broder Bros: Layoffs Announced

We learn from a list of layoffs in the Fresno area that Broder Bros (aka Alphabroder) had to let 253 people go due to Covid-19 closures. Another major shipping location in Pennsylvania has also been shut down since March. This is happening only a few weeks after the company was the target of a hacker ransomware attack and was forced to pay up. More fundamentally, the huge promotional products company must be facing sales and profits challenges in this period with most of its corporate clients closed down, and their own fulfillment centers shuttered. Out of an abundance of caution – that again – we are moving the BDC-financed company to the Underperforming list with a Corporate Credit Rating of 3.

This is a Major exposure for the BDC sector with $201.9mn invested at cost – all in the company’s 2022 Term Loan. The BDCs involved are headed by Prospect Capital (PSEC) with $172.8mn at cost; followed at a great distance by PennantPark Investment (PNNT) with $27.1mn. Non-traded Flat Rock Global has a minimal $1.9mn stake. There’s about $20mn of annual investment income at play here. To date, the debt has been valued at par through IVQ 2019 and interest has been paid on time. It goes without saying that an ultimate downgrade to non–performing would be disastrous for PSEC. Broder Bros is the BDC’s 4th largest single position in a portfolio filled with large exposures.

This is a private company, owned for years by LittleJohn & Co and public information is hard to find. PSEC has been lending to the company since 2013 but has not mentioned Broder by name throughout that time. PNNT has one reference in its conference call transcripts – back in 2016. Nonetheless, given the size of the exposure to PSEC (12% of the BDC’s market capitalization as of time of writing), this company’s progress is worth watching.

United Sporting Companies: Justice Department Objects

One step forward, one step back. A day after we heard that United Sporting Companies had repaid Prospect Capital (PSEC) a seventh of its loan, we hear that the Justice Department is not happy. According to Bloomberg Law:

…[the] bankruptcy watchdog division objected to firearms distributor United Sporting Companies’ proposed liquidation plan, concerned that it grants pre-bankruptcy lenders immunity from lawsuits related to the case.

The Chapter 11 plan’s exculpation provision goes too far, the U.S. Trustee said in its Oct. 15 objection filed at the U.S. Bankruptcy Court for the District of Delaware.

We don’t know how to evaluate this new spinnet. We’ll just have to wait and see if anything further develops.

United Sporting Companies: Prospect Capital Partly Repaid

Details are sparse but in an SEC filing Prospect Capital (PSEC) revealed receipt of “$19.5 million of our Second Lien Term Loan investment in USC [United Sporting Companies] using proceeds relating to their June Chapter 11 bankruptcy filing and ongoing asset liquidation“. That’s good news for the BDC, which is in the hook for a massive $127mn at cost invested in the debt of the bankrupt sports supply business. (We wrote about United Sporting – and PSEC’s predicament- back in June 2019 ). This is a sliver of good news (one seventh) for the BDC about to take a very big realized loss on what used to be one of its largest portfolio companies.

United Sporting Companies: Files Chapter 11

On June 10, 2019, Sportco Holdings, the parent of United Sporting Companies – an intermediate holding entity with no assets of its own  – and all its subsidiaries Ellett Brothers, LLC,  (“Ellett”), and four of Ellett’s six wholly-owned subsidiaries: Evans Sports, Inc.,  ; Jerry’s Sports, Inc. , Outdoor Sports Headquarters, Inc ; and Simmons Gun, filed for Chapter 11 bankruptcy. The filing is attached.  From the report provided to the bankruptcy court, the financial difficulties of the group are of long standing, and both sales and EBITDA have declined precipitously. The owners – who include WellSpring Capital Partners IV and Prospect Capital (PSEC) – have been seeking a buyer since the beginning of the year, but Houlihan Lokey – who was in charge of the auction – found no buyers despite contacting 55 prospects. Liquidation of the companies assets seems to be the likeliest course of action in bankruptcy. 321 jobs are at risk of being lost.

From a BDC perspective, PSEC serves as both equity holder (21%) and a second lien lender. The BDC first became a lender in 2012 with a $100mn advance. Over the years, exposure reached $160mn, but was reduced by March 31 2019 to $127mn at cost. (We don’t know if the reduction in outstandings was due to repayments by the borrower, or the sharing of the debt with other PSEC entities or third parties). The debt has been on non accrual since IIQ 2017. The most recent value of the debt was $35.7mn. We expect that the entire second lien loan will be written down to zero, judging by the information in the filing. The company reports adjusted EBITDA of only $8mn, while there is an asset-based loan senior to PSEC’s debt with $23mn outstanding. In addition, the company reports $41mn in unsecured obligations outstanding which, arguably, rank pari passu with the second lien debt, which totals $250mn. There are also unpaid wages and ongoing payroll to contend with. A $30mn Debtor In Possession facility is being envisaged, but we’re not clear if PSEC will be providing that new debt capital in bankruptcy. If we are correct, the Realized Loss will amount to approx $0.35 a share and the incremental hit to net book value will be $0.10. There will be no impact on income as PSEC has been forgoing over $17mn in annual investment income for two years.  This is obviously a major credit reversal for PSEC, and another indirect casualty of the shake-out happening in retail, made worse by some managerial miscalculations (see pages 7-8 of the filing). Although the business – according to management’s admission in the filing – has faced “headwinds” since 2d015, PSEC did not materially write down its second lien position until the non accrual occurred in IIQ 2017. That discount has risen over the subsequent quarters from (41%) to (72%) most recently.