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UPDATE 1-Verallia's PIK fails to pass investors' scrutiny
October 10, 2016 / 10:52 AM / a year ago

UPDATE 1-Verallia's PIK fails to pass investors' scrutiny

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By Robert Smith

LONDON, Oct 10 (IFR) - Verallia called off an attempt to issue a 500m payment-in-kind toggle bond, after facing pushback from the buyside over the deal’s aggressive use of proceeds and weak structure.

The bond was intended to pay a 490m dividend to the French glass bottle maker’s shareholders. Private equity firm Apollo Global Management is Verallia’s majority owner.

Casualties in the European high-yield market have been very few and far between in 2016. LeasePlan had to pull a 1.55bn-equivalent LBO bond in the middle of February, though extremely volatile market conditions were to blame and the transaction quickly resurfaced.

“Verallia and its shareholder Apollo have decided not to pursue this opportunistic transaction under current market conditions,” a message to investors said on Monday.

The deal attracted widespread criticism from European high-yield investors, and one portfolio manager described the transaction’s failure as “a rare victory for sanity.”

“This is the right outcome,” said another fund manager.

The deal was originally slated to price by the end of last week, but IFR reported on Friday that lead-left bookrunner Credit Suisse told investors there would be a further announcement on the deal’s status on Monday.

Sources said price whispers on the trade had backed up to high-9%, having begun at an eight-handle yield.

While increased yields are often effective at coaxing reticent bond buyers into a deal, those running Verallia’s trade found themselves between a rock and a hard place.

This was because one of the buyside’s chief concerns was that the coupon would be too high to guarantee it would be paid in cash, a problem that jacking up yields would exacerbate.

PIK toggles allow companies to pay coupons with additional bonds rather than cash if necessary. Verallia’s deal adopted the stricter “pay if you can” structure that guarantees cash payments if certain criteria are met.

But covenants on its existing bonds meant it only had 35m of cash available for servicing the PIK, which would have only covered one coupon payment.

EQUITY RISK

Investors’ strongest objection was that Verallia’s shareholders would have taken out more than the 578m of equity they initially put in through an LBO last year.

This is because the planned 490m dividend from the PIK followed a bond and loan deal in June that reimbursed 230m to shareholders.

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.

While Schaeffler and Ardagh sold multi-billions of euro and dollar PIK toggles last month, these deals primarily refinanced existing PIK debt.

Investors said that poor performance of the PIK issued by fellow glass maker Ardagh, which traded down sharply after pricing, had further dampened demand for Verallia’s transaction.

Bond buyers were also concerned about Verallia’s high 5.4x net debt to Ebitda if the PIK had been sold, particularly as this ratio included the expected impact of an accounting change that auditors are yet to approve. The change around depreciating equipment would boost reported Ebitda, flattering this leverage metric.

“If you strip out all their adjustments you’re nearing 6x leverage, and Owen-Illinois trades around 6.5x,” said a third high-yield fund manger.

“It’s proper equity risk you’re taking here.”

US glass bottle making giant Owen-Illinois has an enterprise value of 6.6x its expected 2016 Ebitda, according to Morningstar research analysts.

The PIK’s announcement last Tuesday triggered a sell-off in Verallia’s existing bonds, with the cash price bid on its 225m 7.25% 2023 unsecured notes falling by more than four points.

Those bonds jumped on Monday following the deal’s collapse, rising 1.5 points to a 104.875 bid according to Tradeweb.

The failure of Verallia’s trade comes after US restaurant chain Steak ‘n Shake scrapped a US$400m junk bond on September 30, which was also intended to pay a dividend to its owner. (Reporting by Robert Smith, Editing by Helene Durand, Alex Chambers)

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