A Nine compromise wins the day

Ultimately commonsense did prevail and the hedge funds that have had effective control of Nine Entertainment's destiny for most of this year appear to have struck a deal with the group's mezzanine debt holders that has averted a destructive insolvency.

While it went down to the wire, the compromise reached today was a pragmatic one, albeit it is at this point only an agreement-in-principle that is yet to be documented. Given the twists and turns in the Nine saga, and the tension between the negotiators, it isn't yet a done deal but it is a massive step towards one.

When the discussions started to really heat up yesterday there was a significant gap between what Goldman Sachs, representing the mezzanine debt holders, which include some funds
its manages, was asking for and what the hedge funds and the other senior lenders were prepared to concede, with both sides adamant they had their final positions on the table.

Goldman, representing mezzanine debt of just over $1 billion, was insisting that its investors needed 7.5 per cent of the equity in a recapitalised Nine and warrants that gave them about 12 per cent of any upside if and when Nine were ultimately sold.

Given that any capital reconstruction would involve a scheme of arrangement and that the mezzanine debt providers would constitute a separate class of security holders, Goldman had the capacity to veto any scheme and to force Nine into an administration that could have badly damaged and destabilised Nine's businesses.

The senior lenders, led by US hedge funds Oaktree Capital and Apollo Global Management, were insistent that their last and final offer was 4 per cent of the equity and no warrants.

If one put the warrants to one side on the basis that they might never have had any value, and took into account the fact that Goldman was basing its claim on a Nine balance sheet that contained about $1 billion of debt whereas the hedge funds were talking about a debt-free balance sheet, the difference between the two sides – and whether the outcome was a recapitalisation or an administration – was probably less than $10 million, although that's a calculation complicated by the fact that the parties had different views on Nine's equity value.

The solution thrashed out today is, in the circumstances, an elegant one. Instead of wrangling about the base for a calculation of value – whether the starting point should be Goldman's equity value of about $2.65 billion with $1 billion of debt or the hedge funds' $2.34 billion and a debt-free balance sheet – and rather than try to assign some value to warrants the parties came up with a simple solution.

Goldman was offered, and accepted, an increase in its equity stake from four per cent to 4.5 per cent and the warrants were ditched from the negotiation. In effect Goldman relinquished its demand for the warrants in exchange for an extra 0.5 per cent of equity.

From the hedge funds' perspective, instead of giving Goldman about $93.5 million of value under their original proposal they raised their offer to about $105.3 million, a pretty small additional price to pay to avoid the uncertainties and value destruction of an administration.

Nine's Ticketek business, for instance, would have been gutted by an administration, given that it relies on the faith of ticket buyers that it can deliver what they've paid, for while the network's ability to acquire programming, particularly high-value programming, would have had a questionmark over it.

Goldman will, if the deal is executed as they parties agreed, would be reasonably satisfied with the outcome in the circumstances.

While the investors in its funds and the other mezzanine debt investors it represented were owed just over $1 billion, the original investment by the funds was just under $700 million and taking into account the interest they received they had about $560 million of actual capital exposed to Nine (the rest was accrued interest) so Goldman has extricated nearly 20 cents in the dollar for them and created an exposure to any upside delivered by an eventual sale or flotation.

The senior lenders, particularly the hedge fund who piled into Nine's senior debt at prices ranging from about 60 cents to 80 cents in the dollar will also be happy to end up with 95.5 per cent of, on their calculations, a company with $2.34 billion of equity and no debt.

It is curious that the senior lenders insisted on a debt-free entity, given that some of the original bank lenders are known to have wanted to be either bought out at par or to continue to lend to a recapitalised Nine on normal terms. Some may not be allowed to take equity exposures.

From Nine's perspective, however, if the agreement is translated into the capital structure envisaged it will be in a very strong position to capitalise on its recent ratings successes.

Nine's problem (apart from the magazine business it sold recently, which was responsible for a lot of the value destruction that saw its equity holder, CVC Asia Pacific lose $1.9 billion) has been its balance sheet and not its operations.

David Gyngell and his team have if anything improved the performance of the television network, which has added two digital channels in the period since it was acquired.

With the balance sheet fixed a very solid business should emerge, particularly if the cyclical element of what has been an advertising recession in recent years were to fade.