One of the more peculiar episodes of corporate manoeuvring that will continue into 2012 is the very public attempt by a group of hedge funds to pressure private equity group CVC Asia Pacific into a conversation that it neither wants nor appears to need to have.
The hedge funds, led by Oaktree Capital and Apollo Global Management, hold more than $1 billion of the $2.7 billion of senior debt within the CVC-owned Nine Entertainment. For weeks, the funds have been mounting an escalating public campaign to force CVC to meet with them to discuss a plan they have devised to restructure that debt.
So far CVC, which has $1.9 billion of its clients’ money tied up in Nine, has declined to engage, preferring to pursue its own exploration of refinancing alternatives that would avoid the massive losses that would be triggered within a debt restructuring.
Earlier this month it reached an agreement with the holder of most of its $975 million mezzanine debt, a Goldman Sachs fund, to conduct a debt-for-equity swap in the event it can organise a refinancing.
Acquiring distressed debt and then participating in restructurings that involve swapping their debts for equity control has been a key post-crisis strategy for the big US hedge funds. In this market the complex but successful restructurings of Alinta and the Centro group have been the benchmark transactions.
Unlike those companies, however, Nine wasn’t plunged into defaults on its debt covenants almost the instant that the crisis erupted. Like Alinta and Centro, CVC paid too much and leveraged its acquisition too much just ahead of the crisis but the major parts of Nine – its television, magazine and ticketing businesses – have been trading reasonably in the context of very difficult advertising markets.
Most importantly, Nine isn’t in default and has a significant buffer before it would trigger its covenants. It is generating earnings before interest, tax, depreciation and amortisation of more than $400 million but the initial trigger for a default – a fall in EBITDA to around $360 million – would only force it to disclose more information to lenders rather than causing its debts to become due and payable.
It also has some time up its sleeve – the senior debt doesn’t mature until February 2013. That denies the hedge funds, at least for the moment, the leverage they have had in similar situations, where the knowledge of an impending default forces existing lenders and equity holders to the negotiating table from very weak negotiating positions.
CVC has Macquarie Group and Goldman working with it to come up with a refinancing plan, rather than a restructuring of the debt. The hedge funds presumably believe that they will be unsuccessful and that, as 2012 develops and CVC becomes more conscious of the February 2013 deadline, it will have no option but to agree to their terms. The apparently insoluble eurozone crisis will complicate CVC’s task.
While it would hate the notion of throwing good money after bad, of course, CVC does have the resources to tip in more funds as part of a refinancing. The conversion of the mezzanine debt into equity would also help produce a more sustainable structure.
A failure to force a restructuring wouldn’t be a disaster for the hedge funds, but more of a missed opportunity.
Having acquired their exposure to Nine from conventional lenders at between 80 cents and 90 cents in the dollar, the worst-case outcome for the funds is that they continue to receive souped-up yields on the debt until it is repaid, an attractive safety net that explains why the distressed debt strategy has become so popular.
The big prize, however, would be to swap that discounted debt for control of Nine on distressed terms, which explains why the funds appear to be running a very public and intensifying campaign to try to intimidate CVC into starting negotiations over the terms of its surrender.