Distressed M&A is increasingly vogue in Europe. Since the turn of the century it has spawned an ever-growing band of bondholder activists, hedge funds, restructuring management consultants and hordes of US law firms still piling into London to service them.
But four years on, the question is: just how distressed does a company have to be before that little lot get interested? As distressed as, say, J Sainsbury?
Certainly, Sainsbury’s can be a distressing place to shop, with the frequent absence of any kind of bread-based product or fresh fruit you might actually want to eat. But that probably won’t be enough to arouse the interest of your average vulture fund.
Last week J Sainsbury chief executive Justin King told the City that, for the first time in its history, the company may go into the red this year thanks to exceptional write-offs. Ratings agency Standard & Poor’s (S&P) also put Sainsbury’s on its lowest investment grade, just one step above junk.
Although at the time of writing the other ratings agencies had not yet followed suit, S&P had left Sainsbury’s on review for a possible further downgrade – something that would send bondholders and hedge funds into a frenzy.
So, although Sainsbury’s has cut its dividends, sell-side analysts at the investment banks will be looking at how much money it actually has to service its debt.
That said, we’re not talking about an absolute dog here – Sainsbury’s has a huge real estate base and, although it is struggling, it is still in operational profit.
Its position is incomparable to technically insolvent companies such as British Energy or TXU, which have been targeted by angry bondholders in the past.
Sainsbury’s troubles are also nowhere near as advanced as those of debt-laden advertising agency Cordiant, which was targeted by vulture fund Cerberus Capital Management last year. The fund made millions in a contested takeover when it piled into the debt, first backing rival bidder Publicis and then selling out to the eventual winner WPP.
Sainsbury’s principal debt funding is through euro medium-term loan notes (EMTNs), with a redemption value of £2.25bn, plus a further €1bn (£695.2m) from a commercial paper programme. The bondholders are principally European and US financial institutions.
The terms of the covenants in EMTNs are the first thing any hedge fund considering a punt is going to look at.
You would hope the bondholders know what they mean already. But then it’s just as likely they don’t – which is why the likes of bondholder lawyers such as Cadwalader Wickersham & Taft’s Andrew Wilkinson or Bingham McCutchen’s James Roome can make so much money.
Bondholders, incidentally, are fighting for greater transparency and investor protection in bond covenants. A group of financial institutions, with the backing of their trade body the Association of British Insurers (ABI), went on a charm offensive with investor bodies earlier this year to drum up support for reforms.
Few would argue against the aim of greater transparency, but it is worth noting that greater transparency generally results in lower fees for lawyers.
One lawyer looking at the Sainsbury’s EMTN offer document says: “This is a good, modern sort of bond, and this is the kind of term which is often now included.” He explains that bondholders have a “put”, ie they are entitled to be paid out at par should what is described as a ‘restructuring event’ occur.
The exact definition of what constitutes a ‘restructuring event’ is one of the issues that lawyers representing bondholders, shareholders, banks and the company could argue about all night, although the lawyer added: “One example would be a takeover accompanied by a ratings downgrade, or a disposal of a substantial part of the company.” Further details would be given in the terms of the bond.
Another observer comments: “Taken together, clauses about ratings downgrade, material disposals and the privilege clause [which means Sainsbury’s cannot prioritise other debt over the notes] could give the company serious issues to think about in a restructuring without necessarily being enough to give bondholders a case.”
So what happens now? One lawyer in the industry says: “The bonds are still investment grade and there hasn’t been any default on them yet, so there won’t be anything dramatic immediately.” However, he adds: “Give the investment banks and the sell desk analysts 10 days to noodle up and find out whether there’s any angle in these covenants which can make them money.”
Another lawyer concurred. “If there’s volatility in the market, something will happen,” he says. “The distressed debt desks will have their own plans.”
And what do the lawyers do if the company gets close to a default, or if a loophole is found in one of the covenants? Well, the descriptions of bondholder lawyers’ tactics vary, depending on who is giving them.
Ask the sort of banking lawyer who defends corporates, and they will say these lawyers speculatively phone around every bondholder in town claiming to be acting for most of the other bondholders in order to put together a committee. Ask a bondholder lawyer and the term used will be “discreet phone call to a couple of people we know”.
The truth is somewhere between the two, but one well-established bondholder lawyer admits that he was aware of one competitor who recently sent an unsolicited speculative email to bondholders touting for work.
Bondholder lawyers have had to be more cautious following Judge Jacob’s ruling in the Colt Telecom case almost two years ago. Colt bondholder and US hedge fund Highberry, represented by Cadwalader, tried to put Colt into administration, claiming it was heading for insolvency due to a decline in share price and operating losses. Jacob ruled: “There is not, and never has been, any substance whatever in this petition.”
The other issue is that the investment banks and hedge funds are desperately short of deals at the moment and are looking around to generate something. Rumours about movements on a troubled company are inevitably self-perpetuating. And there are plenty of idle brains out there with an interest in perpetuating them.