(Repeats story published on Thursday, with no changes, to reach additional subscribers)
* Aggressive dividend deal raises concerns
* Investors bemoan slipping standards in primary issuance
* Poor deal performance suggests demand waning
By Robert Smith
LONDON, Oct 6 (IFR) - Bond investors are nervously watching Verallia's private equity owners' attempt to cash out through an aggressive payment-in-kind note, in what is seen as a key test of discipline in the European high-yield market.
A slew of punchier deals, such as Schaeffler's placement of the largest post-crisis PIK toggle bond and Virgin Media's complex reverse factoring note, already raised eyebrows last month.
But Verallia's planned 500m 5NC1 PIK toggle has drawn the most visceral reaction from the buyside, coming little over a year after Apollo Global Management gained control of the business through a June 2015 LBO deal.
"If this deal gets done, then I'll really be worried," said one investor. "It's the most egregious deal I've seen in the European market this year and also the most aggressive conduct."
The PIK announcement triggered a sell-off in the French glass bottle maker's existing bonds, with the cash price bid on its 225m 7.25% 2023 unsecured notes collapsing more than four points.
PIK toggles - which allow companies to pay coupons with additional bonds rather than cash if necessary - are always deemed aggressive, but investors said Verallia's deal has multiple red flags.
It uses the stricter "pay if you can" structure but covenants on Verallia's existing bonds mean it only has 35m of cash available for servicing the PIK, which will likely only cover one coupon payment.
The company also wants to change its accounting policy around depreciating equipment to increase its reported Ebitda. Auditors are yet sign off on the change but sections of the PIK's offering memorandum already include the expected impact of the change, flattering its leverage metrics.
A source close to the deal said he was confident coupons will be paid in cash, however, as Verallia's high cash flow generation will quickly build up capacity under existing covenants to service the PIK. And he added that the accounting change would bring its policy in line with practices at other major glass bottle makers such as Owens-Illinois and Ardagh.
But investors have most strongly objected to the fact that Verallia's shareholders will take out more than the 578m of equity they initially put in last year. This is because the planned 490m dividend from the PIK follows a bond and loan deal in June that had 230m earmarked for reimbursing shareholders.
"They're basically taking their chips off the table," said a second investor.
European investors have had a strong aversion to large dividend recapitalisation deals since Phones 4U went bust in September 2014, just one year after raising an aggressive PIK deal to hand cash to its owners.
A third investor said that there was "a real distaste" for aggressive dividend deals in any market.
"Even if it was 2007 all over again, and it was the hottest market we'd ever seen, people would still have an issue with a sponsor turning round and taking out more money than they initially put in," he said.
For some in the market, Apollo's attempt to cash out through the Verallia PIK is the clearest sign yet that standards are deteriorating in the primary market.
"We're not on a buying strike in Europe, but we're close," said the first investor. "European high-yield has seen so many deals getting done with that late-cycle feel."
The third investor said that he thought the performance of recent new issues showed that the market's appetite for aggressively priced deals was waning across the board.
"There are some deals that have done okay, but by and large performance has not been pretty, and there are certain deals that have done really, really badly," he said. "New issues shouldn't trade down three points out of the blocks."
The euro tranche of a US$1.715bn-equivalent PIK toggle from glass bottle maker Ardagh fell five points to a cash price of 95 less than a week after it was issued on September 7. And a senior secured sterling bond that debt purchaser Cabot priced last week dropped as low as 96.50 this week.
Others said that taken as a whole, 2016 has seen a step down in aggression in European high-yield.
"There have been a number of suspect deals recently, but it's remarkable how few of them there have been in the year to-date," said Peter Aspbury, a portfolio manager at JP Morgan Asset Management.
"Despite how well European high-yield has performed, it hasn't been characterised by an all-out grab for risk." (Reporting by Robert Smith, Editing by Helene Durand and Ian Edmondson)