Orpea - further pain ahead
All,
Please find our unchanged analysis here.
Finally, the Company has spoken after the bonds and shares were suspended by the AMF earlier in the week. Very little detailed information has been released, but management have acknowledged that they are likely to pursue a debt-for-equity swap in order to reduce Orpea SA debt burden. At this moment, the bonds haven’t settled on a price, but even in the low 30’s, we do not find them attractive. We have given a broad valuation of the business and its real estate, but the downward operational trend in performance calls into question our base case free cashflow, and with that suggests we are still optimistic when arithmetically we arrive at 27% recovery. We don’t think a Sauvegarde process is well suited to solving Orpea’s problems and unless a common ground can be found during Conciliation restructuring could take well into FY24.
Event:
- Orpea Management have released a statement (prompted by the AMF earlier in the week) announcing that the Company are entering into a new Conciliation Procedure, with the aim of renegotiating its debt with financial creditors.
- The Company received approval yesterday (Tuesday) from the President of the Nanterre Commercial Court to open the amicable conciliation procedure to enables Orpea SA to engage in discussions with its financial creditors.
Why are we here?
- Orpea has previously concluded a Conciliation Procedure in May 2022, which enabled the Company to obtain additional financing of €1.5bn plus another €1.7bn to be used for upcoming maturities. The new financings where predicated on the Company undertaking asset sales, namely €1bn by December 2023, increasing to €2bn by December 2025.
- Given recent market turbulence, the real estate transaction market has deteriorated endangering this commitment without taking significant discounts to market value. To date, the Company has only managed to sell €126m of assets, resulting in an initial receipt of €94m in September of this year.
- However, the main reason for entering a further Conciliation Procedure is the likely failure of financial covenants in December 2022.
- However, a waiver is not sufficient and it is abundantly clear that the new management sees the business as fundamentally over-leveraged. As stated in the press release "The purpose of this preventive procedure is to reach amicable solutions with ORPEA S.A's main financial creditors, under the aegis of a conciliator, in order to achieve a sustainable financial structure by drastically reducing its debt and securing the liquidity necessary to continue its activity”. (Our emphasis)
- Orpea believe the options available to them include equity conversion of Orpea’s unsecured debt, the amendment of the above financial covenants, and the loosening of other financial covenants attached to secured borrowings to enable the Company to raise additional secured debt.
Financial Covenants:
- Some of Orpea’s debts are subject to two financial covenants (R1 & R2), namely Net Debt (excluding real estate debt)/EBITDA excluding IFRS16 payments - 6% of net real estate debt (R1), and Net financial debt/ Equity and quasi equity ratio (R2).
- Orpea has financial covenants on a portion of its financing lines, representing in total €3.3bn of borrowings. To put into context, as of 30th Sept 2022, Orpea had €9.5bn of debt outstanding. It should be noted that the new borrowings under the May Conciliation Process, (€2.25bn as of 27th September) are not subject to these financial covenants.
- Orpea has clarified what we already suspected, that the borrowings under German law, “Schuldschein bonds”, are subject to the financial covenants. In addition, the Company state that bilateral bank loans as well as certain bond issues are also subject to the financial covenants. We had assumed (and from our initial reading of the three main bond documentations) that the (non-Schuldschein) bonds would not be subject to the covenants.
- The R1 ratio, effectively net debt/EBITDA, is likely to be in breach due to the inflationary pressures on the business, namely energy and catering. The downward trend in margin shown in the H1 numbers is continuing into H2, further deteriorating the denominator in the ratio.
- The R2 ratio, a gearing ratio, is also likely to be breached in December. The driving force of this breach is the significant impairments that is likely to occur to Orpea’s balance sheet. The impairments are twofold. Firstly the real estate assets are likely to be written down by c.€1bn due to evolution of business plan. There may be further reductions in real estate valuations due to higher yields. The second impairment is a write-off of intangible assets, namely goodwill and operating licenses. This is as a result of changes in the business plans and the change in the risk-free rate.
- All impairment assessments are subject to the review by the statutory auditors as part of the audit process for full year accounts.
- As a failure to comply with R1 and R2 covenants could result in the acceleration of repayment of the relevant borrowings, this has also compelled Orpea to enter a further Conciliation Procedure.
Position of the Schuldschein Debt:
- As of June 22, Orpea had €1,767m of outstanding Schuldschein debt. This is classified as both “other borrowings and debt” and as unsecured debt in various segments of Orpea’s disclosures.
- They are subject, as stated above, to financial covenants, namely R1 and R2.
- Although not secured, we are of the view that the Schuldshein loans are extremely difficult to cram down under a debt-for-equity proposal, and may in fact be excluded from any proposal. This is based on our understanding that under German Law, the Schuldshein debt can’t be restructured involuntarily. Since the introduction of Germany’s StaRUG, which contains a new mechanism to restructure Schuldscheine, it may be possible to have a restructuring of Schulcscheindarlehen under Sauvegarde recognised in German courts. However, we doubt that the company is looking to pursue such an unproven opportunity. This makes it more likely that in the forthcoming plan only the bonds are supposed to equitise.
Fundamentals:
- Ultimately, any restructuring discussion has to start with a broad agreement on valuations. The Company stated that they have c. €7bn in real estate value post the likely write-down in the December accounts. Note that the purpose-built nature of Orpea’s properties reduces the alternative use valuation, further complicating realisation and ultimately valuations. Using a 4.5% capitalisation rate, this equates to c. €320m of interest payable (rent).
- Our optimistic model estimates a €430m FCF run rate in FY24. Using this, net of the €320m rent, leaves c. €110m FCF at the OpCo, at c.5-6x multiple, equating to €600m OpCo valuation. Combined the EV is c. €7.5bn.
- The business has €4.4bn of secured debt and a further €600m of structurally senior unsecured debt.
- EV less Structurally senior and Secured debt equals €2.5bn versus unsecured creditors at Orpea SA of €4.4bn. Simple maths equates to a recovery of 56%.
- However, as stated above, the Schuldshein debt will be difficult to restructure involuntarily and may not be required to equitise. This leaves the €1,767m of Schuldschein whole, reducing recovery on the remaining unsecured creditors (mostly bonds) to c.27%.
Legal Avenue:
- Orpea’s problem is not one of lack of liquidity in the main, but essentially one of over-leverage. A route via Sauvegarde, where unsecured creditors are termed out, offers very little upside to the Company. The interest bill payable by Orpea is not excessive and with a relatively low portion of the capital structure unsecured, the secured debt would also need to compromise. In addition, it is unclear under Sauvegarde how Schuldscheindarlehen would be treated. This could leave Sauvegarde an extensive 18-month process with uncertainty over the outcome. During that process, and for the first 2yrs following its conclusion, creditors would earn no interest.
- The alternative, Redressement Judiciare (RJ) is also not very palatable. However, under RJ the Schuldscheine may be treated as pari passu with the other unsecured creditors - notably the bonds. What can the Company offer bondholders to avoid RJ?
Practical Steps:
- The Company has appointed Rothschild & Co and Perilla Weinberg Partners as financial advisers and White & Case and Bredin Prat as legal advisors. Unsecured lenders are invited to organise themselves in order to facilitate further discussions with the Company. The appointed conciliator, Maître Hélène Bourbouloux, invites financial creditors to contact her at orpea@aetherfs.com
- Q3 revenue will be announced on the 8th of November after market close. Subsequently, on 15th November, Orpea’s transformation plan by the new management team will be presented.
Investment Considerations:
- We are not taking a position at this time but continue to monitor the situation.
- The negatives are numerous in relation to any potential investment, namely the opaqueness of all the corporate structure and some pre-existing finances, the significant cost pressure the business is facing and lack of transparency (albeit improving under new management) on basic operational metrics such as occupancy rates and regional profitability.
- Moreover, it is difficult to assess the legal process of any restructuring and if the Company resort to Sauvegarde or RJ if Conciliation Process fails to materialise an agreement.
- Although our quick recovery analysis points to a recovery in the high 20’s, the length of any restructuring process needs to be adjusted for.
- Finally, management have not disclosed their optimal financing model and may pursue an OpCo PropCo structure as part of any restructuring.
Happy to discuss further.
Tomás
E: tmannion@sarria.co.uk
T: + 44 (0)203 744 7009