KME - Too Late
All,
Please find our updated model and analysis here.
Investors have decided that the proceeds of KME’s sale of part of its Special’s business are coming their way. We are not convinced. Net proceeds of the sale are expected to be around €200m, but according to our model, the company needs well over €100m to bolster its working capital position.
Too late:
- If the deal goes through in Q421 and proceeds are being received in Feb 22, then the company has a host of options of what to do with the cash for 365 days. So with Maturity in Feb 23, the entire "Repurchase at the Option of Holders” clause is of little value.
Cash needed:
- The motivation for the sale of the Specials business was primarily liquidity, not indebtedness. If the company turns around and immediately Makes an offer to bondholders it fails to achieve its primary objective.
- Our model has KME cash outflows of €130m as KME builds its inventory position. The copper price has been stable at a high level this quarter, but shows little sign of reversing its sharp rise.
- Factoring utilisation has not risen over the last few quarters despite the lines only being 55% utilised. This will be due to an inability to sell the invoices rather than the lack of desire on KME's part.
- KME could sell the remaining 45% of its stake in the Specials business, but this would hurt the equity value of the business given the growth prospects here.
Language:
- Documentation is somewhat weak, with the intercreditor permitting a sales process involving collateral (Osnabruek) that does not require the consent of the Notes. The “Parent certifies for the benefit of the Security Agent that the disposal is permitted…”
- There is a chance that the sale of the division is structured in a way that does not formally require the release of security over any collateral. Use of the plant and other facilities could be on the basis of a lease for instance.
Application of proceeds:
- The company insists it will use the proceeds to "reduce leverage”. However, throughout its prospectus the company refers to factoring and even the borrowing base facility in the context of leverage and while the cash-drawn part of the former is included in “Net Debt” the latter might befit the description o “Indebtedness of the Company or any of its Restricted Subsidiaries that is secured by a Lien that does not secure the Notes”. If so, the company could for 365 days after raceipt of any disposal proceeds apply the cash against its WC.
- The Notes seem to stand first in line: While the waterfall anticipates Senior lender Liabilities to be satisfied before the notes, non-cash / non recourse liabilities arising from the borrowing base facilities are not included in this category. Little else is visible - on the balance sheet.
- We expect the sale of the specials division to require amendment of the borrowing base facility and the factoring facilities. In each case we expect willing cooperation, but imagine that the banks will ask that as little money as possible be sent to the bonds.
- With or without a Notes Offer, we do not see a full refinancing of the bonds as possible. The existing coupon of 6.25% would not be repeatable, leaving the business struggling to cover interest from free cash flow. The banks have been unwilling to extend their LC lines, so a term loan from that source is unlikely.
Outlines of a deal:
- We do think investors will be offered something, perhaps €50m, but only in return for rolling the stub. If so, bondholders may want wait and see if copper drops, or will want to haggle for some more, but will eventually agree before the background of a Concordato Preventivo. Note that the bond is widely held, which could make it more difficult to negotiate.
- To be sure, if bondholders leave the cash in the company, it should be able to finance its WC needs - assuming we have reached the peak of copper. But the Crown Jewels are half sold now and the remaining business should struggle to carry as much debt (never mind the low multiple).
Positioning:
- We are closing our remaining long and will be moving to short for 5% of NAV on the anticipation that bondholders will be disappointed not to receive more of the proceeds from the sale of the Specials division. We are expecting a difficult refinancing of the bonds with only a some €50m being offered as sweatener. On th downside we expect half a coupon and four points pull to par if the deal is already lined up + some borrow.
Looking forward to exchanging idea with you.
Aengus
E: amcmahon@sarria.co.uk
T: +44 203 744 7055