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Capital Markets

Restructuring: The revenge of the zombie balance sheet

Second restructuring in six months for Seat Pagine Gialle; Subordinated bondholders wreak their revenge

US sporting terminology was probably not uppermost in investors’ minds as they negotiated the protracted restructuring of Italian directories publisher Seat Pagine Gialle in August – but holders of its senior secured notes due 2017 became all too familiar with it this week as their investment turned “collegiate”. NCAA stands for the US National Collegiate Athletic Association but it also, as in this case, stands for No Coupon At All. A bond that does not even make it to its first coupon payment, as Seat Pagine’s senior secured did on January 29, is therefore branded a collegiate bond.

This is a sorry outcome for the €2.7 billion restructuring the Italian firm negotiated barely five months ago. The deal involved a €1.3 billion debt for equity swap on the junior debt and the restructuring of €720 million senior lending.

Under that UK scheme of arrangement – for which rumour has it the Italian company paid fees of around €80 million – subordinated bondholders, dominated by Anchorage Capital, Owl Creek Asset Management, Sothic Capital and Monarch Alternative Capital, took control of 90% of the company from CVC Capital Partners, Permira and Investitori Associati.

The private equity firms bought Seat Pagine from Telecom Italia in 2003 for €5.7 billion.

Having announced it will hold back the €42.2 million coupon payment on its €788 million senior secured bonds, the company had a 30-day grace period before a default is triggered. Seat Pagine has yet to announce whether it will hold back a €6.3 million interest payment due on its RBS–led term loan as well.

The impact of the board of directors’ decision was swift: Seat Pagine’s senior bonds plummeted 20% the day the coupon payment was missed and are now trading at around 39 cent on the euro.

Given that the restructuring deal took 19 months to negotiate, it seems Machiavellian to throw the company back into turmoil so soon. However, the situation is a stark illustration of the risks that corporates run by not sufficiently equitizing during an – expensive – restructuring.

Joe Swanson, co-head of European restructuring at Houlihan Loke
Joe Swanson, co-head of European restructuring at Houlihan Loke

This has been an unfortunate characteristic of restructurings in Europe. “In Europe, LBO capital structures are dominated by commercial banks most of whom account for leveraged loans on a hold to maturity basis,” says Joe Swanson, co-head of European restructuring at Houlihan Lokey in London. “As a result, banks often find themselves in a position where they are unable to equitise sufficient debt in a restructuring to normalize the balance sheet without taking a capital charge as part of the process. In those cases, banks typically prefer to risk additional impairment of their loan (as a result of overleverage) rather than take an immediate loss. While this might be the right business decision for the bank, it frequently leads to additional rounds of restructuring for the companies in question.” Despite having undergone a debt-for-equity exchange, this now looks likely to be the case at Seat Pagine. Rahul Gandhi at CreditSights points out that the fact the firm’s shareholders are now dominated by former subordinated bondholders nursing substantial losses goes some way towards explaining the decision to suspend the coupon payment.

Things could, however, be set to change. Speaking at a recent Debtwire meeting, HJ Woltery, managing director at Strategic Value Partners (SVP), claimed that the attitude of the banks is changing. “What is interesting to us is the fact that the banks are selling,” he said. “They have been selling on a broad scale and banks that haven’t sold before are selling now. Anyone waiting for the big bang on banks selling has missed it – it is here.”

SVP wrested control of German plastics and packaging firm Klöckner Pentaplast from Blackstone last summer in another restructuring that saw junior lenders come out on top.

“There is an increased appetite for banks to take write-offs,” agreed Glen Cronin, managing director at Rothschild, at the same meeting. “Amend and extend is creating zombie capital structures and has been a bad deal for banks as they are stuck with the deals. Banks will now be prepared to take debt-for-equity swaps or run a genuine M&A process out of a restructuring.”

However, there is a sense that the market could be getting ahead of itself here: all the reasons why banks have not sold to date still remain, and despite the improvement in funding conditions not many European banks are in a sufficiently strong capital position to undertake large sales.

“There has been selling but it has been confined to the UK market,” David Ross, executive vice-president at Sankaty Advisors, stated. “In Europe, the banks are starting to see stability and maybe can take losses but European banks are riding on the coat tails of the UK.”

Many will continue to avoid deleveraging their zombie investments for as long as they can.

Seat Pagine is an incumbent of an industry in terminal decline, the impact of which is all too apparent at other European directories businesses such as the UK’s Yell and France’s PagesJaunes.

The projections that the 2011 restructuring were based on were wildly wide of the mark but the firm’s problems are representative of those across the distressed European corporate universe.

The senior creditors in Seat Pagine face substantial dilution if a second restructuring takes place but such will be the fate of deals across the region if adequate deleveraging of distressed balance sheets cannot be achieved.

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