The Hidden Cost of Covenant Flexibility: Lessons from Altice and Ardagh

Covenants are meant to act as a safeguard for creditors by keeping borrowers in check. But what happens when those protections turn out to be weaker than expected? The recent turmoil surrounding Altice France and Ardagh offers a harsh reminder that covenant loopholes can create serious risks, sometimes in ways investors don’t anticipate.

The Fox Legal Training webinar, “The Hidden Cost of Covenant Flexibility”, examined these two high-profile cases, where bondholders suffered substantial losses in value because of unanticipated covenant flexibility.

Here’s a breakdown of how these loopholes caused losses, why it matters for investors, and what you can learn from it.

A Costly Discovery: The Impact on Bondholders

Altice France, a multinational telecoms company, and Ardagh, a leading packaging producer, both became cautionary tales for bondholders when covenant loopholes went unnoticed until they caused serious unforeseen problems.

Here’s how it unfolded:

Altice France Bondholders:‍

• Bondholders lost an estimated 13-14 points of value after covenant loopholes facilitated financial maneuvers that weakened the bonds' protections, triggering a price drop due to the uncertainty surrounding the shifting of billions worth of assets out of lenders’ reach.*

Ardagh Bondholders:

• Ardagh investors faced an even steeper decline of around 30 points of value, similarly linked to unexpected covenant flexibility that allowed the borrower to shift assets to an unrestricted subsidiary in order to conduct an exchange offer.

For bondholders, these sudden losses underscored the importance of thoroughly understanding the fine print in finance agreements. Covenants often contain gaps that allow borrowers to take actions detrimental to creditor value.

Covenant Flexibility: Double-Edged Sword

Covenants are intended to limit company behavior, protecting bondholders from excessive risk. However, as Altice and Ardagh illustrate, overly flexible or ambiguous wording can lead to outcomes opposite to what creditors expect.

Key risks include:

• ‍Loopholes in Definitions or Calculations: Companies might use creative definitions of key financial metrics, such as EBITDA (earnings before interest, taxes, depreciation, and amortization), to flex provisions.‍
• Unrestricted Subsidiaries: Covenants allow companies to transfer assets or liabilities to “unrestricted subsidiaries” outside the purview of bondholder protections – knowing capacity here is key.‍
• Ability to Issue Additional Debt: Covenant loopholes permit borrowers to incur significant additional debt, diluting the value of existing bonds and priming existing lenders.

In the cases of Altice France and Ardagh, these vulnerabilities were exploited, ultimately leading to steep losses for lenders.

Lessons for Investors: How to Spot Hidden Risks

To protect themselves from the next Altice France or Ardagh, investors should take a proactive, detail-focused approach. Here are some keyways to manage risks related to covenant flexibility:

• ‍Scrutinize the Covenant Language: Pay close attention to how terms are defined and calculated. Watch for ambiguous language or metrics that give companies excessive discretion.‍
• Understand Permissible Actions: Carefully review what actions borrowers are allowed to take, such as transferring assets, issuing debt, or diverting cash flow.‍
• Consider Legal Training: Empower yourself with the skills and knowledge of covenants to uncover potential loopholes that might otherwise be overlooked.‍
• Look to Precedents: Recent examples, like Altice France and Ardagh, serve as powerful reminders of what can go wrong. Analysts can learn from their structures and outcomes.

The Bottom Line: Don’t Underestimate Covenant Risk

Covenant flexibility is a double-edged sword. While it might offer companies breathing room in times of uncertainty, it can leave bondholders vulnerable to unexpected events.

The Altice France and Ardagh cases underscore just how costly those risks can be—potentially 13-14+ points of value lost for some Altice bonds and 30+ points for Ardagh bondholders.

For investors, the message is simple: Caveat creditor. Don’t just take bond agreements at face value—dig into the details. When it comes to covenants, what you don’t know can—and will—work against you. Stay alert, stay informed, and keep this in mind: the worst surprise is the one you didn’t plan for.

*According to Debtwire, the current deal being considered by bondholders (the cash payment and takeback paper) would translate into a recovery of roughly 86 cents to 87 cents on the euro. See Altice France reaches historic cross-border deal with secured creditors

‍