Takko - Winter is coming

All,

Please find our updated analysis of Takko here.

We've been here before. In 2004, following the German Labour Market Reform, sales dropped, trade insurers walked out and the LCs had to be arranged with haste. Shortly after a precarious refinancing led by Simon Mansfield's ESSG of GS and involving Mezzanine, 20% PIKs and warrants, Takko recovered almost as quickly as it had run into trouble. There are two big differences today, however: 1) the LCs already exist and merely require extension and 2) German consumers are sitting on bumper savings. Still, it is time to bundle up.

Debt Capacity:

- We see Takko generating approx. €40m of trough FCF next year and expect a recovery from there that will see a return to €70m by 2025. Depending on how many one-offs the market will be ready to credit the company with, That should allow Takko to reinstate between 300m and up to an aggressive €400m of the bonds (we’ve modelled the aggressive case - feel free to play with the recap model on page 1).

- Above €40m of FCF are based on a trough EBITDA of €113m. We have factored in COGS inflation, FX headwinds, German minimum wages rising to €12k this month, continued high logistics costs and more. Crucially we have also modelled a pick-up in demand next year from higher wages, setting in with a two-quarter lag.

- Perhaps wrongly, we have not been overly aggressive on the forecast drop in demand. German nominal household income is rising fast, which is reflected in Takko’s recent growth rates. While real income is certainly falling, we expect it to be softened with the current significant rise in minimum wages and by the fact that the consumer is sitting on significant net savings made over the pandemic.

LCs:

- They are not capital - yet - and they won’t be. Huh? Given our estimates that Takko will be FCF positive throughout next year, we see no reason why the LCs would not be rolled for a price. Therefore they will not have to be cash funded by Takko Liabilities and will continue to represent nothing but trade insurance, which we do not commonly factor into our cap stack.

- If there were a conceivable liquidation scenario, we would have to consider the LCs but they are not capital of a going concern.

- As a result of the LCs, unlike at Matalan, we are not expecting large cash outflows for Takko.

Distressed Disposal:

- Like Matalan’s docs, Takko’s include an automated Distressed Disposal, which provides for a contractually agreed mechanism to enforce the share pledge, transfer the shares to a NewCo and capitalising that. However, we are not sure how this would be lived in relation to Germany’s insolvency law and if this process would still have to be routed through the courts. If so, and we expect so, Takko would have to have a valuation and restructuring opinion IDWS6 to establish relative recovery levels, which can take a long time to produce, but importantly is more shareholder-friendly than the put-up-or-shut-up mechanism in the UK.

- We, therefore, see significant nuisance value accruing to Apax, who have so far not been engaging with bondholders and are looking to address the Super Sr. layer first.

Investment Rationale:

- We sold our position in Takko earlier in the year and are thinking about when to get involved again.

- While at 70c/€ we are not sure the bonds are particularly cheap, we are expecting positive news flow between now and February. Because the Super Sr. Facilities expire in May, we expect to hear of an extension early enough to avoid complications - ideally this year. Because these facilities are easily value covered under any scenario we do not expect a haggle over price to drive the process to the wall. Management further indicated that sales were continuing at double-digits above 2019 levels through September, making October the only unknown - aside from margins that is… We see Q3 margins closer to Q2 before Q4 weakens.

Happy to discuss,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk