UK pub company Punch Taverns finally completed its marathon restructuring on Wednesday, bringing to a close a protracted, complex and often ill-tempered case study in how the restructuring of highly structured deals with multiple counterparties shouldn’t be done.
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After fighting against it for years, the company has finally signed off on a debt-for-equity swap with its junior lenders that reduces total net debt by £600 million – including mark-to-market on interest-rate swaps – in return for the issue of 3,771,151,200 new ordinary shares to junior lenders in the firm’s securitized debt. These, together with the existing ordinary shares, will be consolidated on a one-for-20 basis into new consolidated ordinary shares.
The gross securitized debt of Punch Taverns via its two securitizations (Punch A and Punch B) now stands at £1.6 billion. Gross debt outstanding under Punch A is now £966.4 million, down from around £1.4 billion, while gross debt in Punch B is £637.9 million, down from £914 million, giving the firm a net debt to ebitda ratio of around 7.7 times – down from nearly 11% beforehand.
The deal is the culmination of nearly four years’ worth of negotiations. Punch hired Blackstone to advise on a potential restructuring in November 2010. At that stage, the Punch A and Punch B securitizations, which had been restructured once, had a combined outstanding balance of £2.7 billion and were struggling as earnings were hit by changes to consumption habits in the UK pub sector.
Punch also held its Spirit managed pub estate in a 1,222-pub cash-trapped securitization.
Following the results of a strategic review in March 2011, the company decided to spin off the Spirit estate rather than undertake a wholesale restructuring. This took place in July 2011.
Bowed to inevitable
However, after yet another capital structure review in October 2012, it bowed to the inevitable and announced restructuring proposals in February 2013. At this stage, it still had £2.4 billion outstanding in the securitizations, which were effectively being kept alive by equity cures to pay the coupons on the debt.
The structure of the proposed deal set the stage for what was to become a pitched battle between different lender groups and between the debt and equity holders. This was complicated by the fact that, at least in the junior tranches, the debt and equity holders were often the same.
By the time the restructuring was announced in February, distressed buyers had been building up their positions in the junior debt and equity of Punch B for the previous six months. Five funds – Glenview Capital Management, Octavian Special Master Fund, Luxor Capital Group, Alchemy Special Opportunities Fund and Avenue Capital Management – held more than 50% of the share capital and most of the junior debt at this stage.
Indeed, two funds – Glenview and Luxor – are understood to have held 10% of the PLC equity apiece.
It was for this reason the initial restructuring proposals focused almost solely on Punch B and were so favourable to the junior lenders in that deal. The equity holders were more motivated to work on a restructuring of Punch B, as they didn’t want to be diluted via a debt-for-equity swap.
“Punch’s proposal in February 2013 made it obvious that Punch B was the only securitization that was being properly restructured,” says a source close to the negotiations at the time. “The plans for Punch A resembled a massive amend and extend. A number of major shareholders in the PLC also held junior notes in Punch B, so they were more incentivized to see a restructuring of Punch B than Punch A.”
| This was a marathon not a sprint because of the sheer number of parties that had to give their consent Source close to the deal |
The plan was to pay down Punch B junior debt and extend the senior debt in both vehicles by five years. However, the company was proposing to buy the Punch B junior notes back at around their market price (between 63 and 65) and also hand the junior lenders £93 million in cash and new notes worth £56 million. The idea of equity dilution was dismissed out of hand.
The junior-friendly deal infuriated senior bondholders, who had hired Rothschild to advise them and formed a committee under the auspices of the ABI. Despite the company’s repeated threat it would default on the debt if the deal was not accepted, it backed down and returned to the negotiating table.
The situation at Punch was made doubly difficult by the fact there were 17 different classes of lender to the company and any proposal had to get the approval of all of them. The senior debt was in the hands of a group of large institutional investors, including Aviva, Kames Capital, M&G, Legal & General, BlackRock and Standard Life.
The seven principal junior lenders were the five funds named above joined by Warwick Capital Partners and Angelo Gordon. The latter had purchased Lloyds Bank’s £200 million stake in the M2 tranche of Punch A in early 2013 at a price believed to be in the 60s. Before this, Lloyds, which also provided a liquidity facility to the company, was the largest single creditor to Punch Taverns.
In January, the company proposed a scheme whereby the Class A notes in Punch A would be reinstated, but the junior M to D tranches cancelled while new Class B3 notes were proposed for Punch B to replace the existing junior tranches.
It was after the bondholder coalition’s rejection of this latest proposal that the concept of a debt-for-equity swap was finally put on the table for the first time. By this stage, most of the large PLC equity holders that had held out against it had realized that the strategy was not going to work – and indeed had been building up their positions in the junior debt to hammer out just such a deal.
By June, a proposal was on the table that most senior and junior bondholders were signed up to, although some junior holdouts had to be dealt with.
“By August 2014, there was 75% approval or more of each bondholder category and it ended up being 80% to 90% support in most categories,” explains the source close to the deal.
When liquidity providers Lloyds and finally RBS agreed to it in October, the deal could take place under which lenders have taken control of 85% of the company. Its announcement saw Punch Taverns’ share price sink to 8.25p a share – a 21-month low.
“This was a marathon not a sprint because of the sheer number of parties that had to give their consent,” explains the source. “In many similarly leveraged situations, you have a more coherent structure with a relatively straightforward syndicated senior facility, even if there are also second lien and mezzanine, that would be governed by an intercreditor agreement, enabling the junior lenders to be crammed down – that didn’t apply on Punch.”
Under the structure of the securitizations, an intercreditor agreement only kicked-in after default.
Sobering illustration
This deal is a sobering illustration of how complex cross-holdings by investors can distort incentives in a restructuring. Punch Taverns had securitized 97% of its entire pub estate and when earnings started to suffer it would have been extraordinary for default to have been avoided without some form of equitization of that debt mountain.
The fact the company spent so much time and energy trying to avoid this outcome demonstrates the power that investors can wield when they take multiple positions in the capital stack.
The restructuring was also hampered by the fact this was a whole business securitization – an unusually complex structure to unpick.
“A defining feature of this restructuring was that Punch Taverns PLC was not a borrower or guarantor under any of the debt,” points out the source. “This meant that the directors of the PLC didn’t owe a duty of care to any of the lenders in the securitizations and the lenders had no recourse to the PLC. Consequently, it took a long time to get the concept of a debt-for-PLC-equity swap on the table.”
The only other major restructuring of a whole business deal was that of the Four Seasons healthcare group in the UK – a deal that took two years and came to be known as Eight Seasons.
The constant threat by Punch Taverns management to push the securitized vehicles into receivership began to ring hollow very quickly, and only served to antagonize the lender groups. Perversely, however, this is where the securitized structure of the deal could have been to some of the bondholders’ advantage.
“In administration, the receiver would have been responsible for running the pubs and disposing of the borrower’s business,” explains the source. “They would have paid down noteholders in order of priority. However, because of the legal separation between the borrower and the issuer, this process could have carried on for a while because the issuer could have paid interest on the notes from the liquidity facility for maybe 18 to 24 months.”
This was not to be sniffed at: the Class C notes in Punch A were paying coupons of 6.5%. That level of coupon payment over two years would have gone some way towards softening the blow.
