Orpea - Skeleton argument
All,
Please find our updated model here.
We have spent a significant amount of time contemplating the recapitalisation of Orpea SA and the required debt conversion and new money requirement. The operational guidance shared by the Company is even more pessimistic than our projections. Initially, we envisaged the Company’s plan of 100% conversion as an opening gambit, but we are convinced it needs to be 100%. The business is grossly over-leveraged and it can’t sustain its current debt structure. Additionally, it requires further new facilities, totalling €800m to meet its short-term liquidity.
With 100% conversion now a certainty, the focus changes to the level of dilution to existing shareholders and subsequent dilution required to raise the €1.4bn of new equity. Arithmetically we arrive at bondholder recovery of 41% plus the new money/rights discount which is potentially worth a further 15%.
We are considering the credit from two perspectives: firstly capturing the technical uplift from the restructuring process, and secondly, the investment in the underlying business.
Recapitalisation:
- The business is over-leveraged and while we had previously contemplated scenarios where not 100% of debt is equitised, we now concur with management’s view that full equitisation is required.
- The question for unsecured holders is no longer about how much is equitised, but what level of dilution will the current shareholders incur upon equitisation and subsequently, what further dilution is required to raise the additional liquidity the business requires.
- On the basis of 100% equitisation, allowing current shareholders to retain 5% of Orpea SA, assuming a 40% rights issue discount, we mathematically arrive at a 41% recovery in shares and 15% new money rights for current unsecured creditors.
Bondholders continue getting screwed:
- Since the opening of the Conciliation Process, Unsecured debt at Orpea SA has been reduced by €637m, with a further paydown of €39m of unsecured debt at subsidiaries. This is replaced with c.€700m of Secured Debt across the structure.
- This appears to be unsecured bank debt that is replaced by new Secured banking facilities.
- At Orpea SA only €157m of unsecured bank debt remain to be potentially equitised.
Operational Projections:
-We are adjusting our model to take into account the lower conversion of beds in construction. As of June 2022, Orpea had 982 sites in operation with a theoretical 90,000 beds. Orpea disclosed in their Annual Report that they had a further 25,000 beds under construction, yet despite the CAPEX spend over the coming years, the projections included in the Transformation plan only reach 97k beds in FY25. This has a massive impact on our projections, and the lower bed count ultimately leads to lower EBITDA and cash flow.
- We had previously reduced our EBITDAR margins to account for higher wages and other costs, but even this assumption appears optimistic relative to the Company’s 800bps reduction in margin for FY22 and FY23 (versus FY21) and only modestly recovering to 500bps lower in FY25.
- How much of the Company’s conservative projections are to assist it in negotiations with unsecured lenders to seek 100% conversion of their debts is of course an open question.
Operating Cashflow (OCF):
- OCF is expected to be €136m, €295m and €471m in FY23, FY24 and FY25 respectively. This compares to €59m in FY22 and c.€400m historically.
The lower EBITDA and cashflow are partially explained by energy costs, which have increased from c.€100m in FY21, to projected €157m, €218m, €188m and €161m in FY22, FY23, FY24 and FY25.
- Operating Cashflow is defined as EBITDA pre_IFRS 16 minus Changes in WC less maintenance and IT CAPEX and Taxes.
Development CAPEX:
- Cumulative CAPEX for the period 2022-25 is €1bn for Greenfield sites and €532m for renovation and extensions. The c.7k increase in beds for €1.6bn in development CAPEX appears extremely low return on capital.
- The Greenfield CAPEX is front-loaded, with €584m in 2022, and €500m in FY23 reducing to €8m in 2025. The increase in beds should be visible in the early years further highlighting the low bed increase figures to CAPEX spend.
- The above figures do not include the €700m cumulative maintenance and IT CAPEX separately underway.
Balance Sheet as of year-end:
- The Company repeatedly use different dates to define their balance sheet etc but has disclosed the expected Cash Balance as of Dec 22 to be c. €350m.
- Gross Debt at end of November 2022 is expected to be €9.5bn, with an estimated €100m to be repaid in December. (We are using a cash figure of €450m as a pro-forma November 30th estimate). The €100m consists o €84m of Unsecured subsidiary debt due plus €16m of Secured Debt (location unknown).
Upcoming Liquidity:
- Per 2nd of November the Group estimates it had €831m in cash. This is pro-forma for the drawdown of Tranche B and C which had already been agreed upon but excluding €200m of Tranche A4.
- Separately, the Group estimates year-end cash to be €350m. The difference of €481m is made up of €100m debt repayment (€84m Unsecured debt at subsidiaries and €16m Secured debt at Orpea SA), with the balance c.€380m due to general cash outflow from operations and/or CAPEX.
- Starting from €350m at year-end, the business is expected to generate an additional €84m in operating cash flow, and spend €300m in Development CAPEX, €426m in Holdco debt repayment and €272m debt repayment at subsidiaries over the subsequent 9 months (until September 2023). This leads to a shortfall of €564m.
- This explains the requirement of €800m, as the business can’t run with zero cash.
- It is likely to be funded via €200m draw down of Tranche A4 plus a new €600m secured debt on assets funded in February 2023.
Investment Considerations:
- We are working through our operational model to incorporate the details released earlier this week. We remain cautious on the name overall due to the underlying performance in FY22 guidance significantly below our original estimates. Energy and staff costs are obvious pressures but the underlying reduction in occupancy rates is lower and longer than we had anticipated.
- The lengthy presentation highlighted the lack of management control at Orpea in recent years and that culture will be difficult to reverse. The timeframe of a return to “normal” profitability is likely to be a long process, demonstrated by the slow recovery in profitability under the Company’s projections.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk