Underperforming Company Table

Posts for PennantPark Investment

RAM Energy Holdings LLC: IVQ 2020 Update

Every quarter we get an update from PennantPark Investment (PNNT) about its portfolio company RAM Energy Holdings, LLC. The BDC and company go all the way back to 2011 when the BDC first advanced $17mn in debt. Now, PNNT – after doubling down again and again – has invested $162.7mn at cost in the E&P company. The investment is currently in the form of non-income producing common stock. RAM is the BDC’s largest investment at cost and deserves our periodic attention.

RAM has has been an underperformer for years. As recently as the IVQ 2019 PNNT converted its first lien debt to equity. By the IIIQ 2020, the discount on the investment was -45%.

PNNT had the following to say on its February 10, 2021 conference call about the latest developments at the company, which we are quoting in full:

The new credit facility led by Vast Bank under the Main Street Lending Program, materially lowered RAM’s cost of capital and provide the runway to execute on its operating plan and time to wait for a recovery in prices. During Q4, RAM was impacted by the lingering impact from COVID and a difficult 2020, which included higher debt, continued lower prices, reduced production and the impact of monetizing its hedge positioning at the time of the refinancing. Additionally, RAM began work on its last 2 uncompleted wells, which were finished recently. While still early, production of these wells is expected to be strong. Even though the December 31 quarter had several impacts, RAM is now on stable operational and financial footing that should benefit from higher prices and production. The company is free cash flow positive after debt service, and we use any free cash flow to service and repay debt”.

The sanguine tone above notwithstanding, the discount increased to -55%, bringing the value to $73mn.

We retain a CCR 4 rating on the company. If the remaining value were to be written off – not inconceivable in an oil & gas investment at the bottom of a balance sheet – PNNT would incur a -$1.09 a share loss, an eighth of its net assets. No wonder management is looking for another way out. Given all the recent “great escapes” we’ve seen in the credit markets of late – admittedly very few in the energy complex – maybe Ram Energy can yet surprise us.

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.

Montreign Operating Company: Debt Repaid ?

A few months ago, the Montreign Operating Company, which owns and operates a major upstate New York casino called Resorts World Catskills, and which is an indirect subsidiary of Empire Resorts Inc, was on the verge of bankruptcy. We wrote about the liquidity challenges the business faced at the time. Since then, much has happened. First, one of the partners in Empire Resorts – a Malaysian gaming company called Genting Malaysiabought control of the portion of the business not owned for $129mn. Here is a synopsis of the complex transaction:

As of August 18, Kien Huat Realty III – the family trust of Lim Kok Thay, a businessman who is the controlling shareholder of the Genting group, a Malaysia-based casino and plantations conglomerate – held approximately 86 percent of the voting power of Empire Resorts’ capital stock, according to a filing by the American firm. Under the operation announced in August, affiliates of Kien Huat Realty III and Genting Malaysia additionally plan to acquire the outstanding shares held by Empire Resorts’ minority shareholders, for US$9.74 a share. The deal would lead to the privatisation of Nasdaq-listed Empire Resorts via a joint venture between Genting Malaysia and Kien Huat Realty III

Then Covid-19 came along and in March, the casino was closed. The new owner raised additional monies to support working capital needs. Now we understand that the company’s 1/24/2023 Term Loan has been repaid and Moody’s has withdrawn its CCC rating, based on a April 17, 2020 report by the ratings group. This – if correct – would be good news for the 4 BDCs with exposure to Montreign/Empire , all of which is in the said Term Loan. That debt was valued between 0% and a (15%) discount at year end 2019 by the BDCs involved and was rated CCR 4 by the BDC Credit Reporter.

At a time when BDCs are taking losses left right and center and are anxious to de-leverage their portfolios with borrower repayments, this could be good news for non-traded Business Development Corporation of America; PennantPark Floating (PFLT); Investcorp Credit (ICMB) and PennantPark (PNNT) – in descending order of the $74mn invested at cost. We’ve checked as closely as we can, but we’ll need final confirmation from the BDCs involved at some point. We won’t be removing the company from the Underperformers list till we’re certain but the odds look good that we’ve got some good news to report.

US Well Services: IVQ 2019 Results Published

On March 3, 2020 troubled publicly traded US Well Services (ticker:USWS) published its IVQ 2019 results and held a conference call. The bottom line: in the last quarter of the year the bottom fell out of the market for electric fracturing of oil wells. Here are extracts from the conference call transcript:

“Throughout the course of the year, market conditions deteriorated, culminating in a sharp deceleration activity during the fourth quarter. U.S. Well Services was adversely impacted by customer-driven decisions to delay jobs and longer than anticipated holiday shutdowns. As a result, U.S. Well Services active fleets experienced lower utilization than in prior quarters…Revenue for the fourth quarter was $92.7 million, which represents a 29% sequential decline relative to the third quarter of 2019. USWS generated an adjusted EBITDA of approximately $12.1 million for the fourth quarter as compared to $35.3 million for the third quarter of 2019.”

That’s a two-thirds drop in EBITDA in a short period. No wonder that the stock price of USWS is down to $1.07. That’s much lower than the last time we wrote about the struggling oil services business back on October 3, 2019. Then the stock – at a then all time low – was at $1.82. Only some $50mn in cash and the fact that several drills are operating for customers seems to keeping USWS from imploding. Management does not seem worried but the BDC Credit Reporter notes the $274mn of debt on the balance sheet and the much deteriorating market conditions. We don’t want to be unfair but these seem like ingredients for a bankruptcy (again) or equivalent.

From a BDC perspective, all the lenders who got repaid when the company went public recently must be sighing in relief. At one point not so long ago, there was over $100mn of BDC capital invested, mostly in debt in the company before its transformation into a public company. Now, there are still BDCs with equity exposure, but the amount at September 30, 2019 (we don’t have all the relevant BDCs results yet) was $9.4mn at cost. The BDCs involved were PennantPark (PNNT); Capitala Finance (CPTA) and BlackRock Capital (BKCC). The first two have reported and – curiously – PNNT seems to have increased its exposure from a immaterial $0.7mn to a more material $3mn. Their discount is only (21%), presumably because stock was purchased more recently and cheaply. CPTA’s equity is discounted by as much as four-fifths.

We’ll continue to watch the company’s progress, but the likelihood is high that this will end badly for US Well Services – managerial optimism notwithstanding. For the BDCs involved that would almost certainly result in a complete realized loss on all invested capital, given the debt sitting higher on the balance sheet.

Hollander Sleep Products: Credit Post-Mortem

For some time, the BDC Credit Reporter has been promising to undertake credit post-mortems of under-performing BDC investments that reach the end of the line, and are removed from active status. That removal can be because of a successful resolution where all invested capital is returned or any number of scenarios where some sort of realized loss is incurred. Expect more of the latter than the former. The goal of looking back is to ascertain how an investment played out and what we can learn in hindsight about the risks taken and what the outcome tells us about the underwriting of the BDCs involved. As always, information is patchy and we will have to make some assumptions to get to any conclusions. Nonetheless, we believe this is a valid undertaking which should be instructive, both about whatever individual investment is involved and as a window into the broader leveraged debt investment process.

Our inaugural post is about Hollander Sleeping Products, a bedding manufacturer, which first appeared on the books of PennantPark Floating Rate (PFLT) and sister firm PennantPark Investment (PNNT) in late 2014 and was originally consisted of $35.5mn in first lien term debt due in 2020. The debt was priced at LIBOR + 8.0% and was a syndication. The debt was part of the leveraged buy-out of the company by Sentinel Partners. The type of borrower, the pricing, the terms and the purpose were in line with both BDCs stated target market. The external manager does not seem to have originated or “controlled” the loan.

That initial loan performed very well and was valued at or close to par throughout its entire tenure, which ended with its pre-payment in the middle of 2017. At that time, the company acquired Pacific Coast Feather and raised a new Term Loan – also first lien – with a 2023 maturity which, presumably, also financed the acquisition. The pricing remained the same: LIBOR + 8.0%.

The merger makes Hollander the single-largest supplier in the U.S. in the home textiles industry,” said Jennifer Marks, editor-in-chief of industry publication, Home & Textiles Today. She said Hollander already was the single-largest supplier in the nation of filled utility bedding”.

From a valuation standpoint, the new loan performed well all the way up to IVQ 2018 when a (3%) discount was applied by the BDCs, more or less in line with the trading value of the debt at the time. However, by the IQ 2019 the debt was on non-accrual and by May 19, 2019 Hollander filed for Chapter 11.

As of March 2019 the debt was valued at a discount of only (13%) and as of June – which the last quarter on the books – the discount was (53%). At the time, an analyst inquired as to why the valuation could remain so high on a non accruing debt and the BDC manager pointed to the valuation firm who came up with the number, probably linked to the “trading” price of the debt.

The company blamed higher raw material costs and the expense of integrating Pacific Coast for its failure. The initial plan involved new DIP financing from ABL lender Wells Fargo and its existing term lenders. PNNT and PFLT ponied up $3.3mn of extra debt for a total of $34mn. The initial idea was to undertake a partial debt for equity swap.

However, by September management switched course and returned to court to request that the plan be changed to a $102mn asset sale to the only remaining would-be strategic buyer:

A revised plan with a “toggle” feature to allow switching to an asset sale was put to a vote by the impaired creditors and received approval from the holders of all of the company’s $173.9 million in term loan debt and the holders of more than 95% of its $38.5 million in unsecured debt, it said.

Hollander noted that additional changes to the plan include that the providers of the company’s $90 million in debtor-in-possession funding have agreed to accept less than full repayment and to cede repayment priority to Hollander’s prepetition term loan creditors, as well as the establishment of a $1 million wind-down reserve fund.”

As a result of the sale – according to PennantPark – its Hollander investment “was written down completely “. Exactly what that means is not clear as neither BDC calls out by company realized losses. We know that Hollander is no longer carried as an investment as of the September 2019 results and that the PNNT Realized Loss for the quarter was exactly equal to the investment at cost in the 2023 Term Loan. Maybe the DIP financing was repaid in full ?

PennantPark claims it favored proceeding with the debt for equity swap but was out voted by other lenders not willing to move forward in that direction. However, as the quote above shows in the final plan “all” the company’s term debt creditors voted for the asset sale.

From PennantPark’s standpoint the lesson learned from its substantial ($30mn) or so loss is the risk involved in sponsor-led company “roll-ups” and insufficient oversight by the PE group. Here is what was said on the PFLT CC: “And with Hollander, they were just doing too many acquisitions too quickly. They didn’t have enough kind of oversight of the company. And the last acquisition didn’t work. So moving too quickly“.

From the BDC Credit Reporter’s standpoint there are 3 lessons here:

  1. Investments can go from hero to zero in a very short period (i.e. from performing to under-performing or non-performing in this case). We doubt that Hollander’s business performance deteriorated so quickly, suggesting that there can be a lag between when bad things begin to happen (higher costs in this case) and its reflection in the valuations despite all those experts re-valuing positions every 3 months. Maybe there was undue reliance on the “market price” of the debt rather than an evaluation of the enterprise value of the firm.
  2. As is often the case, a “First Lien” or “Senior sScured” nomenclature tells investors very little about the prospects of capital recovery – in this situation nil – when a default/bankruptcy occur.
  3. BDC lenders – if PennantPark is a fair example – are loath to offer much in the way of financial details or color about “failed” investments. Just identifying how much realized losses come to is difficult. In terms of discussion, the manager offered on PFLT’s Conference Call only 3 sentences in their IIIQ 2019 conference call on the subject. Yet, the realized loss incurred for the quarter was roughly equal to the BDC’s entire Net Investment Income, on which much more time was spent parsing the numbers. Most of what we did learn about Hollander – slightly more substantively – came in response to analyst questions. It’s understandable that managers don’t want to linger over credits gone wrong but – in our opinion – it’s a critical element for investors to evaluate how much of performance is “idiosyncratic” and how much not.

U.S. Well Services: New 52 Week Low

On October 2, 2019 the stock price of publicly traded U.S. Well Services (USWS) reached a 52 week and all-time low price in its short history of $1.82. That was more bad news for the three BDCs with $66mn of equity at cost invested in the company. Ever since the company underwent a reverse capitalization back in November 2018 and was listed on the NASDAQ, its price has headed downward. That impacted the BDCs involved, whose fair market value at June 2019 was lower than at March, as the stock price dropped from $7.98 to $4.20. That put a dent in the FMV values of PennantPark Investment (PNNT), Capitala Finance (CPTA) and – most of all – BlackRock Capital (BKCC). Coincidentally or otherwise, all 3 BDCs reported lower NAV Per Share in the quarter.

Look for a repeat in the third quarter as the stock price of USWS dropped to $2.19 at the end of the IIIQ. That’s roughly another (50%) drop in the last 3 months and should result in a further unrealized loss of ($16mn) or more. At the 52 week low price, the loss would be even higher.

Unfortunately for the BDCs involved their common stock holdings are “locked up” and cannot be disposed off till November. By then, the value of the USWS common will be down by (75%) or more compared to cost. Not inconceivable is that the oil services company – which we wrote about last on July 13, 2019 – could file for Chapter 11, wiping out all $66mn of the stock – mostly received as part of a debt for equity swap last year.

Not to rub things in, but this story is part of the broader troubles in the oil field services sector, which the BDC Credit Reporter has been warning bout for months and which we most recently opined about on September 6, 2019.

Hollander Sleep Products: Change In Exit Plan

On September 3, 2019 mattress retailer Hollander Sleep Products asked a New York bankruptcy court for permission to switch from a reorganization plan centered on a debt-for-equity swap to a $102 million asset sale.

Details are scarce at this point, but does suggest chances are higher the company will shortly exit from bankruptcy. We don’t have enough data, though, to evaluate whether the price offered will increase or decrease the roughly 50% of debt and equity value written down through June 2019 by PennantPark Investment (PNNT) and PennantPark Floating Rate (PFLT), or ($16mn).

As we wrote on August 16, Hollander has been on non accrual in both the first and second quarter of 2019 and in bankruptcy since May. It’s likely that both the BDCs involved will be booking a significant realized loss in the third or fourth quarter, depending when the judge responds to the latest request and the proposed acquisition becomes effective.

Hollander Sleep Products: Chapter 11 Plan To Progress

Bedding manufacturer Hollander Sleep Products is under bankruptcy court protection since May, but seeking to get its plan approved and to return to a normal, but less leveraged status. On July 22, 2019 the company “sought a court order … approving a settlement with unsecured creditors that revises its restructuring support agreement and marks an important step toward the maker of bedding products emerging from Chapter 11 bankruptcy”.

There are two sister BDCs with $34mn of exposure to Hollander: PennantPark Floating Rate (PFLT) and PennantPark Investment (PNNT). Most of that exposure is in pre-petition debt and on non accrual. (There is also $3.7mn of DIP financing paying interest currently). At June 2019, the Pennants had discounted the old debt by (53%), up from (13%) after the debt first became non performing. That suggests realized losses – when Chapter 11 exit does likely occur in the IVQ – will exceed ($20mn) and leave the two BDCs with over $2.0mn a year in lower investment income. What the new capital structure of Hollander will look like; whether there will be a debt for equity swap and what the role of the two BDCs will be we’ll leave for a future post as the dust settles.

Arthur Penn – CEO of both BDCs- did address the subject of Hollander on the latest PNNT Conference Call on August 8, 2019. He made clear PNNT/PFLT were not leading the debt discussions, He said there were “stalking horse” bids, but did not seem confident what the ultimate value of the company might be in the marketplace. That leaves open the possibility that the value at June 30, 2019 may yet materially drop further, making a bad situation worse for both PFLT and PPNT.

Affinion Group Holdings: Recapitalization Completed

Affinion Group Holdings, and several of its subsidiaries, have completed yet another recapitalization of the highly leveraged company. We’ve used the opportunity to update the Company Profile page which provides a summary of all prior restructurings and evolving BDC exposure. Speaking of the latter, the only remaining exposure is by Pennant Park (PNNT) and PennantPark Floating (PFLT), which has $46mn invested in the equity at cost and which was valued at $18mn at year end 2018. The BDCs relationship with the Company goes back more than a decade and – as the Company Profile page shows – there have been many twists and turns along the way. This is unlikely to be the last. In the short run, we expect the recapitalization will reduce the BDCs investment valuation, but the trend may reverse in the future depending on the performance of the Company. On the other hand, the equity could be fully written off one day. This is just a snapshot.