Global Liability Management Quarterly: Altice France Asset Drop-Downs Galvanize Investors Into Organizing; Rackspace Uptier Exchange Less Aggressive Than GoTo Group and Apex Tools; Parties Settle Robertshaw Uptier Challengers; Vedanta Consent Provides About 2 Years Extra Time

In our first-quarter 2024 global quarterly report, highlighting liability management exercises, or LMEs, used by stressed creditors to partially refinance capital structures, Reorg reviews recent uptier transactions at Rackspace, GoTo Group and Apex Tools with an eye toward comparing them quantitatively, recent discussions around Altice France regarding the potential for a management-led distressed exchange, and Vedanta Resources’ maturity extension for three of its offshore bonds.

This report summarizes “aggressive” transactions completed or contemplated by U.S., European and Asian borrowers during the first quarter that, among other results, raise cash, extend maturities or reduce outstanding principal, and sometimes all three. Transactions typically result in participating stakeholders improving their ranking relative to nonparticipating creditors.

The report concludes with a table summarizing select aggressive U.S. LME transactions covered by Reorg in the quarter.

To date, aggressive LMEs involving, for example, uptiering and drop-downs have been common in the U.S. market and very limited in the European market. However, discussions around a possible Altice France transaction have grabbed a lot of attention. Meanwhile, in China/Asia, the real estate sector has been a hotbed of LME activity as the industry continues to struggle.

Reorg’s RX 101 on LMEs and creditor-on-creditor violence is HERE, Reorg’s LME 101 covering double-dip transactions is HERE, and a replay of Reorg’s webinar discussing uptiers is HERE.

Rackspace: In early March, Rackspace disclosed that it had entered into a private exchange with lenders holding more than 70% of its existing senior secured debt. These lenders exchanged into new first lien second-out term loans and notes issued by a new subsidiary, Rackspace Finance LLC, which now holds all of Rackspaces assets. The exchange was done at approximately 80 cents on the dollar, with these lenders also providing the company with $275 million in new money under a new first lien, first-out senior secured term loan. The company also announced its intention to commence public exchange offerings for the remaining outstanding $182.3 million of existing secured notes and $592.3 million in existing term loans allowing holders to exchange into the new first lien, second-out securities, albeit at a slightly lower exchange rate near 70 cents on the dollar.

GoTo Group / Apex Tools: During February, both GoTo Group and Apex Tools announced non-pro rata uptier exchanges wherein specific groups of creditors were able to swap their holdings into new securities at a slightly higher price and slightly better tranche mix than offers that were subsequently opened to all creditors. While both of these transactions moved value away from the debtholders outside the respective ad hoc groups, they seemed to be less aggressive than the uptier exchanges at Wesco and Robertshaw, which were both the subject of bankruptcy court proceedings during the quarter.

Altice France: In late March, Altice France’s 8% 2027 senior notes dropped about 20 points in one day after management’s confirmation that the data center company UltraEdge and media company Altice Media were designated as unrestricted subsidiaries in connection with agreements to sell Altice Media and majority control in UltraEdge to third parties. Management added that it required “creditor participation” in discounted transactions to accomplish its new deleveraging target of below 4x and did not exclude some debt impairments. The movement of assets outside the restricted group obviously represents value leakage, as it depletes value within the group that investors into the credit box can look to for satisfaction of the obligations owed to them. However, Altice France’s bond documents provided sufficient investment capacity to carry out these drop-downs and allow the group to hold back disposal proceeds from the sale of any unrestricted subsidiary (and not be obligated to repay debt with such proceeds). Drop-downs can also be used as a negotiating tool to coerce creditors to agree to a liability management transaction - nonparticipating creditors risk being subordinated to participating creditors with respect to the assets that are dropped down.

Vedanta Resources: Vedanta Resources launched a liability management exercise to extend the maturities of three of its offshore bonds. With an embedded springing mechanism, this exercise essentially buys the company about two years of additional time with regard to its maturity wall. Executed via a consent solicitation exercise, the LME included certain amendments such as prepayment events and an amortization schedule. The extended bonds also benefit from guarantees from key subsidiaries Twin Star Holdings and Welter Trading Ltd., limitation on restricted payments and a mandatory prepayment mechanism, which governs the use of proceeds from certain dividends.

Rackspace Exchange Allows Excluded Lenders Opportunity to Participate; Recoveries 10 Points Lower
 
On March 12, Rackspace announced that it had entered into a private debt exchange with lenders that held more than 70% of its existing senior secured debt. The company moved all of its assets into a new subsidiary, Rackspace Finance LLC, for which the lenders participating in the private exchange provided $275 million in new money under a new first-out first lien secured term loan. At the same time, these creditors exchanged their holdings of Rackspace’s previously senior secured notes and loans into new notes and loans at Rackspace Finance LLC at an exchange rate of approximately 80%. The company also announced its intention to commence public exchange offerings for the remaining outstanding $182 million of existing secured notes and $592 million in remaining term loans, affording these lenders the opportunity to exchange into the new first lien second-out securities at a lower exchange rate near 70%. The company also announced that it had purchased almost $70 million in unsecured notes at a discount.
 
Viewing the exchange through a value transfer lens (more on that below) based on pre-uptier first lien trading prices of slightly over 40 cents for the bonds, and assuming that all the repurchased unsecured notes were held by members of the ad hoc group, Reorg estimates that just under $50 million of value was moved in each direction in the exchange when compared with a hypothetical pari passu scenario. This equates to a 17% reduction in consideration for the lenders outside of the ad hoc group compared with the pari passu scenario, while the ad hoc group improved its recoveries by approximately 7%, as shown below. We estimate that ad hoc group recoveries on their holdings are an estimated 10 points better as compared with the other Rackspace secured debtholders who were not privy to the private exchange.
 
Interest rates on the new debt are the same as that on the prior financings, so Rackspace’s total interest burden will decline as a function of the haircuts that the lenders are accepting as part of the exchange. The company anticipates that the exchanges will save it $45 million in annual interest costs, which will be partially offset by the additional $32 million of annual interest from the $275 million in new financing. No maturities were pushed out as a part of this transaction, so the company continues to face all of its secured debt coming due in May of 2028.
 

Over 97% of term lenders ultimately participated in the term loan exchange, while the secured note exchange achieved over 90% participation as of the early tender date. After the secured note early tender deadline, Rackspace amended the offer so that late exchange consideration matched the early exchange consideration.

GoTo Group and Apex Tools Uptier Exchanges Less Aggressive Than Wesco and Robertshaw
 
As Robertshaw was attempting to resolve its aggressive prepetition activities including an uptier, since settled, on an expedited timeline in bankruptcy court, and the Wesco uptier litigation was continuing, the first quarter included several non-pro rata uptier exchanges, including GoTo Group, Apex Tools and Loparex, which demonstrated that lenders were still willing to engage in creditor-on-creditor violence, albeit potentially on less contentious terms.

Given the financial challenges GoTo Group and Apex Tools were facing, as evidenced by the distressed trading levels of their debt, it is possible that management and creditors preferred pursuing more consensual transactions to allow management to focus on improving business fundamentals. By offering opportunities to participate in the deal, albeit on worse terms, GoTo Group and Apex Tools could be attempting to avoid the litigation that has ensued in the Robertshaw and Wesco situations. As illustrated below, Apex Tools’ offer to dissident creditors is significantly more aggressive than GoTo Group’s - although both are less aggressive than Wesco’s and Robertshaw’s - and this may be a factor in the lower initial acceptance rates in that exchange offer.
   
The table below ranks five recent uptier transactions based on the amount of value transferred between creditor groups. On the basis of Reorg’s valuation assumptions, it appears that the Wesco case resulted in the most transferred value, with creditors not in the ad hoc group transferring 100% of their value to the ad hoc group creditors, followed by Robertshaw, where participating creditors lost only 87% of their value, Conversely, in the Apex Tools transaction, creditors outside the ad hoc group lost only 38% of their value, Rackspace creditors lost only 17%, while in GoTo Group the creditors lost only 13% of their value.
 
As the value transfer analyses above illustrate, Apex Tool Group’s uptier diverted significantly more value to the ad hoc group, particularly when accounting for potentially impaired securities than did GoTo Group’s. Part of this may be due to the ad hoc group’s relative exposure to first and second lien instruments. While GoTo Group’s term loan and notes both had first lien priority, Apex Tool Group exchanged both first and second liens into its new trance A and B term loans. With the Apex ad hoc group holding 88% of the second lien term loans, which were likely significantly impaired, and only 60% of the first lien term loan, the group may have been more incentivized to commandeer value toward its first lien holdings to recoup second lien losses.

Interestingly, on the basis of the illustrative valuations used in the analyses, overall recoveries appear to be in the range of 50 cents on the dollar in both cases, so GoTo Group’s ad hoc group was also likely highly incentivized to take actions to advantage their holdings. The creditors involved and the bases in the securities likely informed the contours of the individual exchanges, but given that the companies are private, it is challenging to ascertain all these dynamics. Regardless, the precedent created by these situations may have a significant influence on the trajectory of these transactions going forward.

Altice France
 
The first inkling that things were going wrong was the announcement by Altice France of an exclusivity agreement for the sale of Altice Media that disclosed that the business has been designated as an unrestricted subsidiary. Then, on March 20, Altice France said on the group’s earnings call that the data center company UltraEdge had also been designated as an unrestricted subsidiary and that “creditors’ participation” in discounted transactions was required to achieve its new net leverage target of below 4x. Investors were shocked to hear this, as the UltraEdge designation had not been disclosed last November when Altice announced the exclusivity agreement to sell a 70% stake to Morgan Stanley Infrastructure Partners. Management added that it intended to hold back disposal proceeds outside the restricted group until it is able to address its capital structure holistically. Management did not exclude some debt impairments, a clear change of tone from controlling shareholder Patrick Drahi’s confident deleveraging commitment last August, where the medium-term leverage target was set at 4.5x.

Until that earnings call, and on the basis of earlier management statements, the market expectation was that deleveraging would be achieved via asset disposals and possibly opportunistic buybacks of near-term bonds at less than par. The market also expected the asset disposals to be done within the credit box, with proceeds applied in accordance with the debt covenants.

The news led to a steep decline in the price of Altice France’s debt and acted as a catalyst for creditors to organize across the pond. Altice France has one of the largest and most liquid capital structures in Europe, with a total of about €24 billion debt as of March 12, or 6.1x L2QA EBITDA pro forma for assets sold, with €1.2 billion debt maturing in 2025, across euro- and dollar-denominated loans and bonds.

A simplified structure diagram illustrating the assets that have been dropped down - UltraEdge and Altice Media - is set out below. To view Altice France comprehensive organizational structure, click HERE.

A simplified structure diagram illustrating the assets that have been dropped down - UltraEdge and Altice Media - is set out below. To view Altice France comprehensive organizational structure click HERE.
   
During the call, management confirmed that XpFiber, in which Altice France has a 50.01% stake, and La Poste Telecom, in which it has a 49% stake, are the other assets under review for sale. XpFiber has already been designated as an unrestricted subsidiary. While La Poste Telecom is not a subsidiary of Altice France since it does not have control over the entity, the 49% stake is an asset of the group. However, Altice France appears to have sufficient capacity to also drop down this investment into an unrestricted subsidiary, as explained below.

How were these drop-downs permitted under the terms of the bonds?

An “unrestricted subsidiary” is a group subsidiary that is not deemed to be a part of the “restricted group” or the credit box for the purposes of the restrictive covenants in an issuer’s bond financing documents. As a starting point, all of an issuer’s subsidiaries are treated as restricted subsidiaries unless they are specifically disclosed as unrestricted in the bond documentation. However, an issuer is free to designate subsidiaries as unrestricted subject to a few conditions, the main one being that the restricted group must have enough investment capacity under its restricted payment covenant.

In most high-yield documentation, certain negotiated baskets provide general-purpose investment capacity without complying with a ratio test, which in Altice France’s case provided for about €1.7 billion in capacity. This was enough to accommodate the value of one but not both of the assets dropped down; indeed, UltraEdge was valued at €764 million, implying proceeds for Altice of about €535 million, and Altice Media was valued at €1.55 billion.

In addition, the restricted group can use capacity under its builder basket to increase investments capacity. Altice France’s builder basket started accruing in 2014, building with 100% of EBITDA over the period minus 1.4x interest expense. Ordinarily, use of the basket is subject to a ratio condition and a no-default or event-of-default condition. However, Altice France’s documents have weakened the condition for accessing the basket, with the 4x net leverage test applying only for use of the basket for dividends or subordinated debt payment, but not for making investments. This creates investment capacity even when the net leverage test is not met, which can be used for designating unrestricted subsidiaries.

On the basis of our calculations, prior to the two drop-downs, we estimate the group had about €17 billion in its builder basket, providing a cumulative investment capacity of about €18.6 billion, including the €1.7 billion mentioned above. Pro forma for the two drop-downs, we estimate there is about €16.1 billion remaining for potential further drop-downs. See Reorg’s covenant analysis and capacity calculations HERE.

Reorg highlights certain provisions investors could introduce in financing documentation going forward to limit the risk of drop-down transactions in the broader European high-yield bond and leveraged loan market HERE.

Investors have been wondering whether, by taking UltraEdge and Altice Media out of the restricted group, Altice France’s directors may be in breach of their duties under French law. While there are civil law and common law duties under French law that determine how directors should act, as we explained HERE, absent wilful mismanagement, fraud or a failure to file for insolvency at an appropriate time, such protections appear quite weak.

What are the implications for creditors?

The movement of assets outside the restricted group obviously represents a loss of value, as these assets can be put out of reach of bondholders; this depletes value within the group that investors into the credit box can look to for satisfaction of the obligations owed to them. Once a subsidiary has been designated as unrestricted, it is outside the scope of the covenants, although it remains a subsidiary of the group. This means that Altice France is free to sell the subsidiary or its assets without using the proceeds from the sale to repay debt or invest in the business. It is also free to incur debt secured against assets of that subsidiary. Altice France’s bonds also permit it to spin off the subsidiary to its shareholder as a dividend.

Altice can choose which tranches of creditors it wants to negotiate with, because having the proceeds outside the restricted group gives the group more flexibility on how it applies the proceeds. Altice can also potentially use drop-downs as a tool to undertake a priming/subordination transaction through which it could favor certain creditors over others. For example, this could be achieved by providing additional credit support from assets dropped down to creditors who agree to participate in a discounted exchange and/or removing existing credit support from such dropped down assets for creditors who do not. This flexibility could be a useful bargaining chip for Altice France in its negotiations with creditors, pitting creditors against each other. Cooperation among the various creditors will therefore be key.

In anticipation of a possible nonconsensual restructuring of the group, we looked at the restructuring tools available in France which Altice could use to implement a debt impairment to its capital structure if a consensual deal cannot be reached.

Note that a restructuring or liability management exercise proposal has not been advanced yet. Sources told Reorg that a cross-holder group led by Arini and Attestor advised by Houlihan Lokey, Milbank, and subsequently Wilkie Farr, had formed several weeks before the March 20 call and had been trying to engage with management without success. A second group comprising mainly secured creditors advised by Gibson Dunn formed in the wake of the call and is hearing pitches from PJT, Evercore and Rothschild. It is preparing to sign a cooperation agreement.

Vedanta Resources Consent Solicitation Extends Maturities With Springing Mechanism
 
Vedanta Resources Ltd., or VRL, launched a LME to extend the maturities of its three offshore bonds. In this analysis, Reorg models the cash flows of the extended bonds on the basis of proposed terms. By applying a 25% to 30% discount rate (based on historical yields observed in the first half of 2023), the estimated fair value of the extended bonds ranges from 68 cents to 92 cents on the dollar with a 25% to 30% discount rate. A sensitivity analysis against various discount rates has also been included in the attached Excel spreadsheet.

On the basis of the proposed terms by VRL, the post-restructuring cash flows across the three series of bonds are shown below:
 
The LME’s proposed amendment terms are further summarized below:
 
After VRL’s successful consent solicitation in respect of certain of its U.S. dollar-denominated bonds, Reorg has reviewed certain key amendments made to VRL’s $1 billion of 6.125% bonds due 2024, which are now the 13.875% bonds due 2028. Amendments include mandatory prepayment events, amortization schedule for principal repayments, increased coupon and credit enhancement via subsidiary guarantees provided by Twin Star and Welter, alongside other protections.

Americas First-Quarter Liability Management Transactions

Select first-quarter out-of-court liability management transactions in North America are summarized in the table below: