Wednesday, January 16, 2013

School Specialty 3.75% Convertible Subordinated Debentures

This is my take on an idea suggested by Tbone Sam in the comments section of a previous post.

School Specialty sells classroom, janitorial and office supplies to schools. It’s a cyclical business that took on far too much debt to fund acquisitions of businesses that were worth far less than the price it paid for them. As a result, with large debt maturities due in 2014, it’s in a bit of a pickle, perhaps presenting us with an opportunity.

The capital structure:

I.                Secured debt:
SCHS has drawn on $54.8 million of a total $200 million LIBOR + 250bps, Wells Fargo-led asset based loan facility (“ABLF”) that is secured by a first priority interest in substantially all of SCHS’ current  assets and a second priority interest in all other assets.
It owes a further $67 million under a Term Loan facility (“TLCF”) that has first claim on all non-current assets of the company and has a second priority claim on the current assets. This loan is held by Bayside Capital Partners, costs 12.75%.
It owes $12 million under capital leases and a further $65 million under its operating leases (or only $10 million under a liquidation scenario).

II.             Unsecured debt:
The company has issued convertible subordinated debentures (“the convertibles”) with a book value of $157.5 million and a 3.75% coupon payable semiannually in May & November.

The Opportunity:

Scenario #1: Refinancing of the convertibles

What’s important for our purposes is that the holders of the convertibles have the right to require the company to repurchase them on November 30, 2014 for $115.9  (including accreted principal) – a hard put that values them at 2.4x their current market value.

The company says that it plans “to refinance the debentures prior to September 30, 2014 and to obtain the money to refinance the debentures from the issuance of new debt and/or additional equity.” And it may be able to do just that, in which case for the convertibles is a simple and clean one.

Scenario #2 Involuntary Chapter 11 Reorganization

If the company is unable to refinance the convertibles before that date – the credit markets stink; the company’s cash flow profile deteriorates – then the company will be in default on the terms of the secured loans, the ABL and TLCF creditors will call in their loans, and SCHS will enter the Chapter 11 process.

One can see from the above that the business is worth something like $455 million. After accounting for the $134 million in secured liabilities, the residual value is ~$320 million, meaning that the convertibles will receive at least what they are owed, i.e. $183 million, either in cash or stock.

Of course, the restructuring process being what it is, and creditors being what they are, it seems quite probable that a  valuation professional engaged by the court could slap a 5x multiple on current (or on average trailing 2 year) EBITDA which, if approved , would value the enterprise at $400 million and the leave the convertibles owning 85% of the business (183/(400-134).  In that eventuality, the convertibles will be worth $270 million (85% of the real value of $320 million).

Scenario #3 Prepackaged Chapter 11 Reorganization

This seems to me the most likely scenario: covenants have been breached, forbearances granted, and reorganization lawyers and bankers engaged by both the secured and unsecured creditors.

One imagines that Bayside Capital Partners’ TLCF credit line to SCHS was strategic, and that they will pay off the ABL creditors and come to an arrangement with both the holders of the convertibles and with the equity owners whereby the equity survives (but only just), and Bayside and the holders of the convertibles take ownership of the lions’ share of the remainder.

It is hard to pin down the exact value of the convertibles under this scenario, but we can, I think, be confident that is somewhere between the minimum value envisaged under Scenario #1 and the maximum value envisaged under Scenario #2 – i.e., somewhere north of $115.9, though much closer, I would have thought, to the lower end of that range: Bayside Capital Partners’ hand seems to me much stronger in a prepack than it would be under an involuntary Chapter 11 process.

I haven’t discussed Chapter 7 scenarios because I don’t think there’s even a small chance of a liquidation process: all parties would lose under that scenario.

The bonds haven’t traded for a month. I think they are attractively priced: a likely 130% recovery in 21 months. If and when they trade at under $55, I’ll try to establish a position.


  1. For a company that did $20mm+ of EBITDA in the quarter ending 10/27/12 and had a cash balance along with a large receivables balance at that date, what do you make of their recent liquidity problems? Is it possible that there has been a large drop off in their business?

    The Bayside credit facility has a $25mm "Early Payment Fee" that they have declared payable as a result of the Events of Default that have occurred--brings their claim up to $93.7mm as of 1/4/13.

    Also, the press release regarding the forbearance agreements that the company has reached makes it seem like they will be borrowing more, resulting in less value available to the converts.


    1. JGB -- this is a seasonal business. The bulk of profitability is generated in the Fall quarter, immediately before and after school starts (in the US, this is ~September). You cannot run-rate the last Q.

      Other quarters have negative profitability given fixed operating costs.

      As for liquidity problems, read my note. There are also sizeable working capital needs for this business (timing mismatch for payment to suppliers for inventory and payment from schools can be highly variable).

    2. Shouldn't the EBITDA they generate in the Fall be collectible right now?

      During this comparable quarter in the prior year, they generated approximately $40mm of cash from operations. In the year before that, they generated $15mm of CFO. And in the year before that, they did $55mm of CFO.

      - jgb

  2. Thanks for your thoughts here Red. Although I’ve come to the situation with some slightly different premises, we arrive in the same place – namely, that the converts at 50¢ on the dollar are worth at least a slight discount to par, and much more if converted to equity and you allow the U.S. K-12 market to heal over the next 3-5 years.

    Here are my observations:

    1. I think this is going to either go into Chapter 11 or at least be a pre-pack. The Jan 4th 8k detailing the forbearance agreement and appointment of a Chief Restructuring Officer both point to this. I also have another reason why I think this (#3 below), but I’ll get to that in a minute.

    2. I don’t believe this business is worth a whole lot more than $300m today. How do I get there? In a normalized environment, I’m assuming it can generate $65m of EBITDA, $(25)m of CapEx, $(5)m of cash taxes, and $(5)m of working capital outflows (a glance at the B/S makes self-evident that SCHS needs to hold a lot of inventory). So $30m of Unlevered FCF. I don’t want to pay anything more than a 10% cap rate given the risk of competition from Office Depot, et. al., so I arrive at a 10x uFCF multiple and $300m EV.

    Reasonable minds can disagree here on either the 10x multiple or the normalized EBITDA. I know the Business generated more than $120m of EBITDA in 2007. I just want a significant margin of safety (A) to keep me safe through a potentially tough Creditor negotiation, and (B) to factor-in the structural market evolution away from the personal school agenda planners that generated outlandish profits for SCHS pre-2008 and are eroding today given that they are fundamentally unnecessary for kids (were you given these as a school kid? I did, and in a world of anything less than a blowout school budget expenditure environment, these will be scrapped in favor of a commodity planner from Office Depot). Now, if these planner sales do come back, that’s gravy... I just don’t want to pay for that call option.

    The thing I don’t feel comfortable with using the ROIC calculation is that it the US school spending market is a fairly well-defined addressable market that has hard borders of non-profitable business. So I don’t want to assume an ROIC-based valuation, but again, reasonable minds can disagree.

    Either way, it doesn’t matter at 50¢ on the dollar for the converts.

    3. The New CEO, Vander Ploeg, has 0.8% equity ownership with option strike prices nearly 6x the current market price. If there’s anything I’ve learned about these situations, it’s that if Current Management doesn’t have a lot of skin in the game in the form of pre-restructuring equity, they will do everything they can to ensure they get a big slice (5-10%) of the equity Post-Restructuring. How do they do this?

    (1) Negotiate strangely punitive financing arrangements,
    (2) Manufacture a liquidity crisis, and
    (3) Say and do all the right things regarding “restructuring the business” to make Creditors want to keep you on-board Post-Restructuring.

    *** to be continued ***

  3. (1) Accomplished. How in the world could they not arrange for anything less than 12.75% cash coupon on secured debt that’s fully backed by $163m of accounts payable and inventory? In this rate environment? And don’t forget about the $25m Early Termination Fee owed to Bayside Capital Partners? And the min cash requirement on the ABL? I would love to read a “Background to the Summer 2012 Financing”... I’m sure it would be scandalous reading.
    (2) Accomplished.
    (3) The CEO just came from Houghton Mifflin, another bankruptcy. He knows the routine from his old co-workers. Read his Letter to Shareholders in the FY2012 Annual Report. He says all the right things. I can already hear him saying “my Management team inherited a tough situation…” in front of a judge and Creditors.

    4. I’m getting to a different Administrative + Secured Claims total than you.

    Here’s where I see it:

    $25m for Administrative Claims [this may be high, but let’s be ultra-negative]
    $55m for ABL
    $67m for Secured Term Loan
    $25m for Early Termination Fee on the Secured Term Loan
    $13m for Unpaid Interest Expense on the Secured Claims from 1-yr in a Bankruptcy Court
    *** $185m for Claims senior to the Converts ***

    With ~$50m of EBITDA today, I could imagine a judge agreeing the business would be able to support a capital structure of ~3.5x EBITDA without the 2014 Convert Put overhang. In today’s rate environment, ~3.5x EBITDA would maybe have a blended cash coupon interest rate of ~7-8%.

    Assuming 8% on $185m of debt, that’s $(15)m of interest expense, or 50% of Unlevered FCF.

    Using the above assumptions for $300m EV, that leaves us with an equity value of $115m. Assuming $(15)m of interest expense, that leaves us $15m of Levered FCF.

    Would you pay 7.7x Levered FCF for this business? A 13.0% growing cash coupon? I sure would. Others would probably pay a lot more for it in fact.

    And that’s just to get to 73¢ on the dollar (115/157.5).

    Anyway, all things considered, I like this situation a lot factoring in all the risks and uncertainties inherent in the Bankruptcy process.

    P.S. Bayside is the lending arm of HIG Partners, a PE-Fund known for control investments. Will be an interesting negotiation, but don't forget that getting $95m ($70m + $25m) + 12.75% interest in <1yr is a mighty fine outcome for a middle-market lending platform.

    1. Tbone- I agree with everything you say and like your analysis much better than my own.

      I'm astonished at the terms of the Bayside financing.

    2. But you could also argue that even if you use a $50mm Ebitda figure that you wouldn't want to buy the bonds at this level. IF, and I capitalize "if", the company or advisors successfully argue that this business deserves only a four multiple (it is only a distributor), then you would have an EV of $200mm, subtracting out $135mm of debt and EVEN assuming the $25mm early prepayment fee gets thrown out by the judge (messy fight), that gets you $65mm of a recovery for the subs for a 41% recovery of face (forget about accrued interest). Now, if this gets really messy and you aren't able to do a prepack, well they you could be in big trouble since the bonds are subordinate and if there are leases or trade that they don't need to pay, the claims pool at your level gets bigger and your return gets diluted. Just something to keep in mind.

      Now if you are generous and give it a 5 multiple, assume $50mm of Ebitda, and still throw away the $25mm early prepayment fee, then you get a 71% recovery. Unless the biz improves between now and the restructuring, paying 50% seems very risky.

    3. Thanks for this.

      The key to the amount recovered by the convertibles is certainly in the EBITDA multiple one uses to estimate the size of the pie. I think 4x or 5x trough EBITDA is too low. It presumes both that (a) a prepack fails, and (b) that it enters into a forced Chapter 11 during which time no outside entity comes forward with an offer greater than 3x average historical EBITDA. $200m would be represent 4x average FCF over the past 10 years: the secular challenges facing SCHS are not so great that it is not worth twice that.

    4. Anon -- all very fair comments.

      Ultimately, you need to look at this with both your debt and equity hats on. The equity math is $157.5m of unsecured debt + $[?]m of unsecured trade claims & operating lease breakage costs + [5%] management equity incentive dilution. The breakage costs cannot be more than $25m (and I think that would be high), so being in the bonds means you're making up a significant chunk of those unsecured claims and therefore a significant % of the equity ownership.

      The thing about the equity is... it's variable. It fluctuates. Neither the 4x multiple nor the EBITDA $ figure is permanent.

      You have to ask yourself -- do I feel good about owning equity in this distributor at 7.7x Levered FCF? I do, since I think we're going to see some cyclical tailwinds at your back and I think the business isn't going to be crushed by Office Depot & other big boxes. Reasonable minds can disagree.

      At 50¢ on the dollar, however, I like my odds.

      Anyway, as I've said about myself before... often wrong, never in doubt. We'll see in 3-4 years.

    5. Tbone - I understand and agree with all that. Unfortunately, your equity percentage is going to be struck now and the worse things are for the company now, the lower the EV and thus the lower the % of equity you are going to get (as a % of the total equity distributed). If the company aligns itself with the bridge note, and considering that they took that ridiculous note on to begin with I have a sneaking suspicion that they've had those talks alread, the harder it will be for the converts to argue for a higher valuation. And if you can't do an out of court restructuring, then you have to think about all the leases and trade (non priorty trade) that will come in pari passu to you. Even if that is $25mm, that will dilute your recovery by 16% ($25mm/$157mm). Not an easy situation.

    6. I think we're talking past each other.

      I'm saying the unsecured claims are the fulcrum security (i.e. EV today is greater than the secured claims, or $185m) -- the unsecured claimaints own 100% of the equity post-reorg. You will face the same $[25]m in unsecured claims whether they agree on a higher valuation or a lower valuation, it does not matter.

      It seems the risk you pose ("your equity % is going to be struck now" and "company aligns itself with the bridge note") is that the secured claims are the fulcrum security (i.e. EV today is <$185m).

      Notwithstanding all the comments I've made about valuation (from the EBITDA multiples in the goodwill impairment analysis or FCF multiples) and normalized FCF yields... yes, there is risk that Mgmt comes out with a low-ball operating plan + some Mgmt-hired valuation expert concludes that the EV <$185m, whereby unsecured claimants are impaired. This is the "Bankruptcy Court Risk" I alluded to.

      I don't want to sugar-coat that this is a slam-dunk -- but I believe strongly that the EV is worth much more than $300m in a normalized environment, as outlined above.

      As for Mgmt aligning with the secured creditors... that's what discovery is for.

    7. TboneSam,

      "Would you pay 7.7x Levered FCF for this business? A 13.0% growing cash coupon? I sure would. Others would probably pay a lot more for it in fact."

      it might be a 7.7x levered FCF, but you are ignoring the yield on the enterprise; and it will eventually have to pay the debt when it matures.. so realistically, it will be ~20x EV/FCF, with 185M of debt coming due in a couple of years...

      please correct me if im wrong

    8. You cannot dock them twice for the leverage / interest expense.


      EV = $300 million
      Unlevered FCF = $30 million
      EV / uFCF = 10.0x

      *** LEVERAGED BASIS ***

      Equity Value = $115 million
      Levered FCF = $15 million
      Equity Value / lFCF = 7.6x

      To address your comment, "it will eventually have to pay the debt when it matures" --

      (A) $15m of annual Levered FCF will be used to pay back the loans over time, and this $15m will be growing (potentially at significantly higher rates given the fixed operating leverage) over the next 2-4 years as the end markets heal.

      There is very strong evidence that the K-12 end markets are seeing greenshoots -- see municipality budget allocations for school expenditures and YoY increases in 2012 property tax revenues.

      We also have no idea what the tenor of the $185m will be -- it could be 5-7 years. Assuming a totally flat-line $15m per year in FCF, that is $75-105m of cashflow available to pay down debt over the period.

      (B) Refinancing markets.


  4. Vander Ploeg is not the CEO

    1. Nope, you're right -- I swapped names with the CFO. CEO's Michael Lavelle.

  5. Btw, very interesting now at 36¢ on the dollar for the converts. Bunch of selling today ($6m of face).

    1. Do you believe a convert refinancing or debt/equity swap is in the works? And would it be worth tapping into a shareholder stake at this level? A $12mm market cap seems nil in the first place.

    2. Also, both the asset-backed and term loan are eligible for a 1 year extension if the convertibles are refinanced. This should provide as reason to restructure the debt into a convertible refinance which also allows School Specialty extra time to pay those two loans through its ebitda improvement.

    3. It depends on the issuer, but Lenders frequently receive monthly / quarterly operating results (*especially* in circumstances involving forbearance, etc. and lenders are mandating the issuer appoint a Chief Restructuring Advisor, as is the case here) in advance of reporting to the SEC.

      My guess is that the Company is engaged with lenders in some form and/or simultaneously preparing to file (issuers typically do both at the same time to prevent being held over the barrel by creditors or potential buyers of the Company's various business units which may be up for sale).

      This information is now leaking out into the market.

      And since this is a small issuer with closely-held TL and a "small" convertible bond ($157.5m is small in the grand scheme of the debt markets), there's an air pocket after the “hold-to-maturity” lenders sell and before distressed debt HF's start circling. This presents us with an opportunity if you're properly prepared....

      Anyway, is this information leak presumably a violation of Reg FD? I sure think so. Welcome to the slimy world of distressed credit though.


      I was noodling on the pre-file equity purchase idea. I posted my thoughts (on the general subject) on another blog, which I will repeat here below:


      - 95% of pre-file equity recoveries occur in scenarios where one or more assets were sold to strategic parties. This makes intuitive sense because it is difficult to see a full par recovery for the liabilities without some kind of synergies that turn a negative operating environment around.

      - Re-orgs without asset sales usually result in such massive dilution that it may as well be a zero

      - Obviously exceptions abound, but this seems to be a good rule-of-thumb


      - Refinancing need during broader credit crunch forces bankruptcy for orderly sale/refi process (GGP)

      - Lawsuit / fraud / other sudden event (non-core business related) creates sudden liquidity crunch. Orderly sale/refi process needed (classic Texaco / Pennzoil case)


      - A major non-management shareholder who has a lot to lose from being zero'd out and will fight for value in front of a judge

      - <10% management shareholders have perverse incentives vis a vis pre-file equityholders in selling assets or otherwise maximizing value. They are likely to buddy up with creditors and argue for low valuations in order to secure post re-org positions and 5-10% equity stakes.

    4. So as the above pertains to School Specialty common, I see a couple watch-outs that lead me to say “too much risk.”

      1. Current Management has very little skin-in-the-game – they WANT to restructure, lower the cost of a bunch of expensive senior secured debt, wipe off a $157.5m slug of unsecured converts, and take 5-10% of the equity pie. This means that Current Management does not have pre-file Common’s back.

      That is bad. Very bad. Why? Because they are responsible for the sausage-making session that is “Plan Projections” – i.e. financial projections for the Judge and Restructuring Advisor who are tasked with saying what the EV $ is.

      Management has every incentive to lowball, so they can beat projections and earn their bonuses (both cash and equity).

      You don’t want to bet against Current Management here.

      2. Common is only getting value if a Strategic / Financial buyer steps up and values the business is worth the Admin Claims + DIP + Secured + Unsecured Face Value. This means $185m + $157.5m = $342.5m needed before you get $0.000001 of value for the Common. At 60¢ for the Common, you need to get to at least $355m before you get your money back ($12m equity value).

      Given the valuation exercise we were just arguing above, $342.5m represents 6.9x on today’s $50m EBITDA or 11.4x Normalized $30m Unlevered FCF.

      If a Strategic / Financial Buyer thought this was a trough profitability figure and they can do much better with these assets over the next decade, maybe they would step-up and pay north of $350m. But that’s a big risk considering Management has been “trying” to sell various business units over the last year with no success.

      All that said, there are some deep-pocketed investors in the Common (Michael Dell’s fund, Zazove Associates) today, so maybe they would offer to do a rights offering or something to buy them more time. I wouldn’t stick my neck into that kind of situation though.


      With respect to your question on the convertible extension… fundamentally, the issue is not really about the covenant breach or the converts’ put date in ~18 months. The issue is about the Company being way overlevered at today’s (trough profitability) snapshot. A Management Team and BoD that had major skin-in-the-game with >10% ownership would fight much harder than they have.

      Understand incentives and you’ll have your answer.

    5. Thank you for your assessment. Management does not have much foot in the game regarding common stock, the latest purchase being 60k shares from the vice president of sales. However, Lavelle has done an impressive job on flipping this company 180 degrees into a positive ebitda and cash flow machine.

      If this CEO had a priority of incentivizing himself via chapter 11 I think it would have already occured by now, as he'd be deemed hired simply for restructuring through bankruptcy, like Fritz Henderson was for GM. Lavelle gave quite an effort on fixing this mess and was even able to acquire this latest refinance back in May. Not sure why Lavelle would bother with any of this if bankruptcy was his priority. Thanks.

    6. Has Current Management managed the Company's through a particularly tough operating environment? Yes.

      Did Current Management buy the Company some more runway with the Summer 2012 re-financing? Yes.

      Has Current Management said and done all the right things to show Creditors that they're "working hard to preserve value for all stakeholders." Yes.

      OK, a couple fact checks:

      1. Current Management was hired in January 2012
      2. LTM Revenue = 0% YoY growth. LTM EBITDA = 0% YoY growth
      3. Look at the financial history of the Company -- it's never had a negative FCF or EBITDA year.

      What mess has been fixed? How can you attribute anything to Current Management's restructurings? The lost Planners revenue was high margin, so holding profitability flat is worth something, but I wouldn't call this a "pat-on-the-back-for-a-job-well-done" recovery.

      Why bother with Bankruptcy?

      It shouldn't be that hard to understand why Current Management prefers 10% of >$200m equity value vs. 1% of $20m equity value.

      You'd go through a lot of brain damage in Bankruptcy Court too if you could capture $20M in value.

  6. Well Gentlemen, now the fight begins -- SCHS filed for Chapter 11, $50m DIP provided by our friends at Bayside and a Stalking Horse Bid of $95m, also from Bayside :)

    With the $50m DIP now in front of us (only $15m drawn), there will need to be one or more big unsecured holders to push for a rights offering. Given the openness of the credit markets, I expect distressed HF's to be swarming all over this.

    I haven't seen any trades yet for the converts, so will be interesting to see what level these fall to today.

    This will be an extremely interesting court case to follow.

    Happy investing

    1. Yep. Particularly interested in Bayside's moves in this game. I'm going to try to pick up some of the converts.

    2. Some good commentary here on Bayside --

      Which broker / prime are you executing your trades in?

      This is playing out exactly as I expected. The major risk I see here is that the unsecureds don't get organized well enough to protect their interests. And given the amount of distressed capital still in this space, I think this is a very low probability outcome.

      Please post a link to the court docket here if you find it first.


    3. I use UBS

    4. where did you get 95M bid?


    5. Look at either the 8-k filed today or the Declaration by Gerald Hughes in the 1st Day Pleadings.

      Btw, Red -- did you look at the rates on the DIP? L + 1400 w/ a LIBOR floor of 1.5%. Talk about face-rippingly outrageous.

      This trial is going to be a real fireworks show.

    6. I saw that. Honestly, I can't help but feel sorry for the long-term holders of the equity. They've been badly served by management. It's worse, even, than Meruelo-Maddox as was.

    7. I'll take it one step further -- if your name isn't Wells Fargo or Bayside/HIG, you've been badly served by Management.

      It's interesting that there was ~zero discussion re: the circumstances surrounding the May 2012 Financing. Perella Weinberg frames everything about the DIP financing negotiations w/ the various parties purely in the context of October-onward.

      It seems to me that everything boils down to the propriety around the process by which the Company negotiated the May 2012 Financings w/ Bayside. The outrageous terms begin there...

    8. so 95M, equity holders get nothing; do we know how much the converts are getting paid?


    9. Looks like unsecureds are pretty organized. Quite an interesting situation.

  7. TBonesam -- can you hit me on bloomberg? I'm

  8. For anyone interested in this name, if you're not following @DDInvesting on twitter, you should.

  9. 2 words: Equitable Subordination

    1. i took a brief look at your case; and in case i was missing something; it seemed like the YMC case doesnt particularly apply to the SCHS case..

  10. If you're betting on equitable subordination, you will most likely be disappointed. Near impossible to prove. For every 1 Yellow Mountain Club, there are a dozen that go nowhere.

    Having said that, I can understand why someone would want to take at a stab at the bonds here.

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  11. sorry all; im not sure if i am comprehending this properly

    so; bayside will try to purchase the company for 95M in the form of a credit bid plus cash to pay off the obligation existing under the ABL lenders

    the 95M will pay for all assets of the firm and also buy out the 3.75% convertible subordinated debentures? so how do i find out how much the CSDs will be getting paid?

  12. I've taken a look here- can't seem to wrap my head around "why someone would want to take a stab at the bonds". Not saying I'm correct, just saying I'm clearly missing something.

    To answer the above (Anon @ 2:12pm) if the Bayside bid is the winning bid, the recovery on the converts would be 0; which is part of reason I'm having a hard time getting interested... what am I missing?

  13. You're not missing anything -- if Bayside's bid wins, the converts will be worthless.

    However, the Bayside bid, at 2x three year average EBITDA may be (far) too low a valuation.

    The first day pleadings suggest that convert holders are organized. The prospect of other, more realistic bids is not perhaps an unreasonable one.

  14. What are you using to arrive at 2x estimate?

    From what I can see Bayside bid is 95 plus ABL/other debt plus any DIP drawn in the case (could be up to 50). Simple math taking:

    * 95 (pre-petition Bayside, argument here over make whole), plus
    * 50 (full DIP), plus
    * 45 (pre-petition ABL, argument here about what "normalized" ABL might be), plus
    * 10 (cap lease)

    Gives you an implied EV of 200. On EBITDA of ~45 this is 4.4x, which may still be low but not 2x low?

    1. I'm using 15 for DIP and and three year EBITDA average of ~65. A 2.5x multiple, I should have said.

    2. Thanks for the clarification -- I follow the math, though I'd worry about using only 15 for the DIP. Even if my scenario is high (entirely possible) they probably end up drawing at least the 28.9 (end of March) + some closing fees as contemplated in the new DIP budget (filed as Exhibit A to Docket #86).

      Guess converts can hope someone will show up with a strong bid at the auction -- at any rate, should be an interesting case to follow.

  15. To anon @ Feb 1, 1:00 pm --

    No, you’re right about YMC – that decision is still up-in-the-air anyways. Side note: frankly, I think the judge was wrong in assuming ill intentions by Credit Suisse -– my interpretation is that it wasn’t anything more nefarious than simple greed (underwriting fees) and agency / principal issues. This subject has been beaten to death though (ABACUS and now S&P), plus everybody comes at it with religious opinions, so I know I’m not going to convince anybody one way or the other.

    Two things re: SCHS:

    1. Much of this case is going to boil down to discovery re: the May 2012 financing. Equitable subordination, make-whole payment, financing terms… there’s a whole host of issues around the discussions between Bayside and Management.

    2. The fact that the Debtors’ 1st day petition is for a sale vs. a re-org should not be a surprise to anyone based on Management’s actions leading up to filing. Recoveries significantly higher than par are predicated on a re-org. If the unsecured noteholders do not get organized sufficiently to fund a rights offering and arrange for an exit term loan, then yes, recovery on the converts at 38¢ on the dollar will be impaired barring another acquiror steps up.

    My view that whoever ends up holding the equity of this Company -- whether it's Bayside/HIG, the Convert holders, or some other acquiror -- is going to make multiples on their money over the next 5 years is unshaken, however.

    1. Question for you on your point 2 (plan vs. sale): assuming some (but not all) of the convert holders are willing to put in more money, why wouldn't they prefer to do it through the 363 sale process?

      Seems to me that's the risk here for the converts -- for anyone who is looking at buying the company (including any subset of the converts), the 363 process offers a lot of advantages (especially a faster timeline)...

      Agree with you that the sale process doesn't maximize returns to converts, but if I put myself in the mindset of putting in new money the relevant question should be the return on that investment / total return, which may be higher EVEN IF I were a large holder of the current converts...?

    2. It's a good question, but take a look at Docket #0119, Exhibit B.

      You need 2/3 in $ face value and 1/2 in # of holders in the unsecured / convertible note class to approve either a 363 sale or a re-org.

      Unless you believe that the noteholders receive less value in a re-org than a sale (which as I've outlined above, I do NOT believe... but again, reasonable minds can disagree), a re-org will be the more likely outcome barring a much higher 363 sale value (i.e. another bidder comes in and substantially tops the $95m offer).

      Taking a look at the the convertible noteholder list, Zazove stands in the way of any disunity amongst the class. They are a traditional convertible debt manager (and not a distressed player), so one game theoretical concern we may have is Zazove selling to another one of the noteholders.

      That said, Zazove is an economic animal so it will not take a discount to their view of fair value, so another noteholder will have to pay north of the current market price (~40¢) to gain control of the situation.

      Btw, some very good distressed names in the Notes:
      - Angelo Gordon
      - Steel Partners ("Steel Excel")
      - Q Investments ("R2")
      - Hudson Bay
      - One East

    3. Unfortunately, confirmation from the unsecured class is NOT necessary to approve a 363 sale -- it can absolutely move forward without buy-in from the noteholders so long as the judge allows it.

      Certainly the creditors committee (or ad hoc noteholders) can file objections, but if the management says they think a 363 sale process is best it will be tough to overcome -- the judge will typically show deference unless there is blatant bad actions/self-dealing, etc.

  16. but is there a liquidity crises?
    Did company really breached minimum liquidity covenant last month ?
    cash flows are very seasonal but historically Q3 (Nov-Jan) cash flows are very strong and positive due to payment form customers who have purchased goods in Q1 and Q2.

  17. under petition filing filed on Jan 28th, the debtors have checked the box corresponding to debtor estimates that funds will be available for distribution to unsecured creditors i.e iam assuming some recovery to unsecured creditors which included convertibles

    But should bayside buy the company at 95m (credit bid), our forum is estimating no recovery to convertibles. Guys are we missing some thing?

    1. Did you even read the comments we've already made?

      Read Red's comment at February 1, 2013 at 3:43 PM

    2. Thanks Sam, i understand that at 95m credit bid zero recovery for convertibles. But i want to understand what does it mean if company have checked the box corresponding to "debtor estimates that funds will be available for distribution to unsecured creditors" and not the other one which is "Debtors estimates that, after any exempt property is excluded and administrative expenses paid, there will be no funds available for distribution to unsecured creditors"
      Ref: pp 1 of petition filed on Jan 28th

  18. Convertibles are worth 17 cents based on Convertible noteholders proposal i.e 50m Jr DIP facility to be swapped to 75% equity. Minority Convertible holders are crushed under there plan. At EV 250m, Debt of 140m (95m term loan+45m revolver), equity is worth 110m.
    Of which 75% is takenover by Jr DIP lenders and only 25% ie 27m is distributed to Convertible. Which means only 17 cents (27/157) recovery.

  19. i think a 50M dip valuation is fine but the business is EBITDA positive and cashflow positive; the upcoming school season means it might need to cash to build up inventory but when it comes to dec/jan they will be collecting those receivables and then we should count in the cash

  20. Hi there - thanks for the write up here. Very insightful read into the situation and some great points by the commenters. Do you have an update to the latest on the issue here?

    Thanks very much - Dylan.


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