Nine teeters on an administration cliff

The $525 million sale of Nine Entertainment's magazine business to Germany's Bauer Media, which Nine's lenders appear to have endorsed overnight, should clear the way for the embattled network and its lenders to have some very serious discussions about a reconstruction of the group.

Those negotiations between groups currently a long way apart will have to produce a compromise within weeks – about a month at the outside – if Nine isn't to fall into administration and the lenders to lose control over the fate of their exposures.

That rough deadline arises because, with $2.8 billion of senior debt falling due on February 13 next year, the company needs time to put together a scheme and obtain court approvals if it is to avoid a default.

Nine is in this predicament because private equity firm CVC Asia Pacific paid too much and loaded the group up with too much debt when it acquired control of it from James Packer in 2006. Nine has $2.8 billion of senior debt (which will be reduced to $2.2 billion by the sale of the magazine group) and just over $1 billion of mezzanine debt, most of it held by funds managed by Goldman Sachs, which matures early in 2014.

It is generally accepted that CVC has lost the $1.9 billion of equity its funds invested in Nine. It would take an act of selfless generosity for the lenders to allocate it even a token amount of value in any reconstruction. That also means, however, that it has nothing much to gain and nothing much to lose from the negotiations over a reconstruction of Nine's capital structure.

The real negotiation occurring is between the senior lenders, a disparate group of hedge funds and traditional lenders, and Goldman acting on behalf of the investors in its funds.

About 40 per cent of the senior debt, perhaps a little more, is held by two US hedge funds, Oaktree Capital and Apollo Global Management, which acquired their interests at around the 80 cents in the dollar mark. There are other hedge funds holding perhaps another 30 per cent of the senior debt, with the rest owed to conventional lenders.

Oaktree and Apollo want to leverage their exposures into equity control of Nine. The situation is complicated because some of the hedge funds and the banks are unlikely to want to convert their debt into equity and Goldman wants to salvage some material value in the form of equity for its investors.

There is therefore a dynamic matrix of potential mixes of debt and equity and how they are allocated within the lending group to be negotiated if Nine is to avoid falling into administration.

Administration would be the option of last resort for all those with potential value at stake because they would lose control of the process and Nine would be put up for sale in the midst of an advertising recession. Worse, the benefit of Nine's ratings momentum – network ratings lead revenue – might not be reflected within the six months or so time horizon for a sale.

With CVC having nothing of consequence to gain regardless of the process and Goldman determined to salvage something material for its investors – not just for reputational reasons but because it has a fiduciary obligation to maximise their recoveries – they do have the ability to effectively veto any proposal put forward by the senior lenders and force Nine's directors, acutely conscious of the spectre of being found to have traded while insolvent, to call in an administrator.

That creates the basis for a sensible negotiation between the senior lenders, and the hedge funds in particular, and Goldman.

The sale of the magazine division will reduce Nine's overall debt burden to about $3.2 billion and make it a purer television play in the process.

Goldman has proposed a reconstruction that would see the senior lenders agree to exchanging their $2.2 billion of remaining debt for $500 million cash, a continuing $1.25 billion facility on normal commercial terms and 70 per cent of Nine's equity. Its funds would swap their $1 billion or so of debt for a 30 per cent equity stake

The lenders would have the ability to choose to swap some of their pro rata share of the debt and cash for more equity, which would enable Oaktree and Apollo and the other hedge funds to maximise their equity interests and the conventional lenders to maximise their share of the ongoing facility and the cash.

In effect, the proposal would see Goldman's funds take a $550 million "hair-cut" in a transaction that would attribute an enterprise value of about $2.65 billion, or about 10 times earnings before interest, tax, depreciation and amortisation to Nine and give the mezzanine debt holders about 30 per cent of the equity, or about $420 million.

There are arguments with the hedge funds about how much value the mezzanine debt holders are entitled to, the appropriate on-going capital structure for Nine and the valuation of Nine, with the senior lenders wanting to use global television reference points that are about half those on which the Goldman proposal is based.

Free-to-air television in Australia, thanks to the anti-siphoning regime and the limited number of licences is somewhat different to it offshore counterparts. It's also operating within a stronger economy than most of the rest of the developed world and Nine is, as indicated, developing momentum. The valuation would also reflect the reality that the key hedge funds are themselves proposing a debt-for-equity swap that is effectively a ‘'control transaction.''

Goldman essentially wants $400 million of value but appears indifferent as to the level of equity that delivers – a reconstructed Nine could have more equity and less debt than its proposal envisages if the senior lenders are uncomfortable with its ongoing debt burden and Goldman would still agree to the deal even though that would give it less than 30 per cent of the new equity base.

As usually occurs in these types of corporate situations, of course, the hedge funds, and most particularly Oaktree and Apollo, are playing hard ball to try to maximise their outcomes, as you would.

There's a game of chicken underway or maybe, because of the potential for Goldman and CVC to refuse to agree to their terms and to force Nine into administration, something more akin to Russian Roulette.

The rational outcome, as we've seen previously in analogous situations (Alinta and Centro are probably the best examples) is for the brinkmanship to continue up to the 59th minute of the eleventh hour – and then for pragmatism to be demonstrated.

That generally means all concerned give up a little to get a consensual deal done and retain control of their circumstances.

With the hedge funds having bought in to Nine at discounts to the face value of the debt they hold (discounts that probably aggregate something approaching $500 million) Goldman, however reluctantly, expressing its willingness to take a $500 million-plus hit and CVC already having lost $1.9 billion it ought to be possible to construct a sensible compromise that delivers control of an intelligently recapitalised Nine to the hedge funds while giving something meaningful to the mezzanine debt holders for co-operating.

If it isn't, and we'll know within a few weeks, the fate of Nine – and its lenders – will probably be in someone else's hands.