I have been running “legal blacklines” of Word documents for a long, long time. Their power to predict the future plans of a borrower, or to make a relative value analysis between issuances, when applied in the context of a repeat issuer or refinancing, cannot be underestimated.
Last night, I ran a blackline of Fedrigoni’s new senior secured notes (the May Notes) against January’s (the January Notes), and found two important features – one of which can be used to make a relative value comparison between the two series.
- The May Notes contain two valuable redemption features for the borrower, with a third additional kicker folded in, that the January Notes do not have, making the January Notes more economically protective for investors.
- The May Notes and the January Notes back-date the builder basket to the start date for the builder basket of the bonds that are being refinanced, but fail to disclose the built-up capacity under that basket, making it a kind of “hidden” source of capacity.
New Redemption Features in the May Notes
The May Notes contain both a 10% at 103% redemption provision and an equity claw, which the January Notes do not have. Further, the equity claw contains language that will allow the borrower to benefit from a lower blended redemption price when used together with the make-whole, a borrower-friendly feature that makes taking out the bonds in the event of an LBO much cheaper.
I have copied below the additional language, highlighted in the blackline:
The “unless all Senior Secured Notes are redeemed substantially concurrently” language will allow the borrower to use the equity claw (which is a misnomer, as the borrower can use the proceeds of debt securities to redeem the bonds under this provision) together with the make-whole redemption provision, thereby benefiting from a lower blended redemption price.
Since the January Notes do not contain these features, they are more valuable for investors in this context due to the redemption provisions providing stronger protection of upside.
Back-dated Builder Basket Capacity
Though not as egregious as the one in Altice, which back-dated builder basket capacity to bonds that had been redeemed several years before, the May Notes and the January Notes both back-date the builder basket to the bonds that are being refinanced with this offering – see the highlighted language in the blackline below:
I realise there are differences in opinion among market participants about the sensible approach here, but my view is that a borrower should not be able to create a portable builder basket by repeatedly back-dating it to bonds that are no longer outstanding.
There are two more transparent solutions. Either create a new basket containing the full amount of the back-dated builder basket, or disclose the built-up amount in that basket so lenders know what capacity is there. Otherwise, issuers are benefiting from some level of essentially hidden capacity, and may continue to do so for years to come (which is what Altice did).
In this case, the “Original Issue Date” is October 25, 2022, so there isn’t even two years of back-dated capacity here, but given that the fixed amount of all of the baskets have increased slightly in line with the EBITDA growers, the issuer’s business is profit-making, which means that there is likely some capacity here.
The built-up capacity could be used for various things, like paying dividends to the sponsor, or investments in Unrestricted Subsidiaries. Investors should know what capacity is available for these actions.
How to run a legal blackline
Given their value to covenant analysis, I suggest that all lenders take this approach. It’s very easy using the bog-standard version of Word.
- Convert the PDFs into Word documents
- Cut out only the Description of Notes section (otherwise you will crash your computer when you try to run the legal blackline); create a new document with only this section in it
- Select Review – Compare – Compare two versions of a document (legal blackline)
- Be prepared for your computer to crash a few times– mine did on this one! Persist – it’s worth it
- Voila! After a few minutes, you will have a legal blackline on the screen with a review pane of the two word documents alongside
- Print – Print PDF – save and open in Adobe Acrobat (this will avoid repeated computer crashing!)
- Review and delight in the ease of finding differences that could contribute to a solid relative value analysis among different bond issues
I teach students in FLT’s covenant analysis courses this trick and lots of others that I learned over my two decades of working with covenants. If you’d like to find out more about our courses, just get in touch using the Request a Demo button on our site!