Adler - Crystal Balls
All,
Please find our unchanged analysis of Adler here.
Back in summer, we had been planning to review our positioning in October. It’s November now and while timing was a month off, most people's crystal balls have been accurate: German RE remains illiquid and we have to fix the balance sheet. We recall below the challenges under WpHG, the opportunities in the structure, the asymmetries among holders, the coercive elements to get it done anyway, the alternatives, BaFin’s effect and the time plan ahead. We are anticipating the maturity of our Consus position and will be reallocating that cash elsewhere in the structure.
Intensive Discussions:
- It’s too late to bail in the Consus bonds. They will be repaid at the end of the month.
- At some point in the last six weeks Adler have given up trying to sell their assets in this market. As a result, the company has approached bondholders for fresh cash and/or to find a solution around its maturity profile. Discussions are intense.
- This is a timely decision because if management want to stay out of insolvency and have everything documented before the end of April, Adler needs a term sheet by Christmas.
- Two deadlines loom at the end of April and within only three days from one another:
1) The ADO bonds require audited financial statements and no auditor is in sight. Adler will need a waiver.
2) The €500m April 23 bonds mature and without asset sales Adler do not have enough cash.
Two options:
- As maturities are beginning to roll in, Adler needs either fresh cash to pay down these liabilities at par, or it needs to materially extend maturities. The solution may be a mix of both.
- Fresh cash would amount to paying out short-term existing creditors at par as they fall due. Paying par for any of Adler’s liabilities is not what most of us have in mind, but for a limited amount of the short-dated liabilities this may be unavoidable. Obvious candidates in line for par exit would be the Consus converts (due in a month), the 2023s and any secured bank debt with negative pledges that might represent structural hurdles.
- Maturity extensions represent an uneven economic hit to the different liabilities involved by maturity and type. Safe for coercive elements below,it would represent a transfer of value from participating creditors to non-participating creditors and from short-term to long-term creditors.
Two legal avenues:
- The StaRUG scheme remains relatively untested in Germany and therefore carries a risk we would rather avoid. Also, the negative news and uncertainty inherent in filing for such a scheme would further brand Adler a forced seller. Activities at Consus would cease altogether and destroy even more value. However, the flexibility the scheme would afford Adler in allocating creditor classes and forcing cross-class cram-downs represents a powerful backdrop before which to have meaningful restructuring negotiations aimed at avoiding the scheme in the first place.
- A restructuring under German bond law WpHG in turn is more cumbersome, requiring 75% of every bond issue voting in favour. The 2026 maturity of ARE’s NY law bond, which is not subject to WpHG and would require 90% consent might set a natural limit for how long the extension would be.
- We understand the X-Holder group to be approx. €3bn in size. It’s a large group, but it is far from being able to act on its own - certainly with respect to providing a “big solution” as discussed below.
Small or big fix:
- If Adler cannot garner the support of 75% of all its German Law bonds (all but one) then it could still avoid insolvency if it can opt for a small solution that allows just enough fresh cash creditors to take security, so as to cash out its April 2023 bonds. This would still leave the company with a problem around presenting audited accounts, but waivers for that should be subject to lower simple majority thresholds. Adler would enter a subsistence from one hurdle to the next, which can be attractive for the larger bondholders who can command a premium in return for bailing out Adler from one time to another.
- Alternatively, all involved parties take the opportunity now and vote all bonds and any other required creditors in favour of an agreed plan and lock up for the formalities. Removing the urge to sell assets at a discount in this market should equally provide upside to bondholders and uniformly across small and large. This more equitable treatment should support a solution under WpHG.
- Between now and Christmas, we expect the company to be pushing for a big solution. There seems ample room.
How to do it:
- Take Security: Coming from an IG background, the vast majority of Adler’s liabilities are unsecured. Fresh cash injections in the form of new bonds or (more likely) loans will be offered security over unencumbered assets, of which there are many and all over the group.
- Create structural seniority: We seem to be alone with this, but we would prefer to Digg down into new SPVs on which we’d be not only sr. sec, but alone. We understand however that such structural movements (see Steinhoff) are not currently on the menu.
- Coercive: Combine fresh cash and favourable votes with exchange into new second-lien bonds. We anticipate a combined proposal by Adler to existing bondholders to voluntarily accept security and inject fresh cash. Anyone holding out would be left with unsecured paper, and effectively become subordinated on future proceeds.
Post restructuring:
- Fresh cash would rank Sr. Sec. On assets scattered throughout the group. Many assets are already encumbered by bank debt, including many Consus developments, but also ADO and ARE yielding portfolios. Brack has its own bank debt, as do several developments under Brack. To access a sufficient pool of assets backing such fresh cash, it may be necessary to buy out / redeem certain bank debt that benefits from negative pledges.
- Bondholders who provided fresh cash would have their holdings swapped into new secured paper ranking 2nd Lien on those assets, thereby layering holdouts.
- Hold-outs and creditors that are not part of the solution would continue to rank unsecured and become only third in line for proceeds. We imagine the incentives for participating in the restructuring will be strong.
- We expect to receive large PIK coupons on the restructured debt which should one day allow bondholders to swap for equity and - market permitting - capture more than par. This should provide in particular ARE holders with attractive upside.
2023s:
- The nettle that the x-holder group will have to grasp to stay out of StaRUG will be the hold-outs in the 2023s organised by K&E. If that group held a blocking minority (of 25% - see above), we’d have heard of it. But the opportunity of receiving par now is all too obvious and Kirkland will rock up on the voting day with their full size, leaving the outcome uncertain. A restructuring proposal under WpHG could however split the 2023s into a portion that will have to be paid at maturity in cash and those x-holders who are happy to fold these bonds into the wider restructuring and receive 2nd lien paper in return.
BaFin:
- Alleged covenant breach: Bafin has found that at the end of 2019 ARE, who at the time indirectly held a 33% stake in ADO, had already kicked off the process that would see it being reverse acquired by ADO in 2020. BaFin argue that Adler had therefore already lost control over ADO and should not have fully consolidated ADO on its balance sheet.
- The result of de-consolidating ADO at the end of 2019 would have put ARE into covenant default and unable to raise further cash. It is possible to reason from there that the reverse takeover of Adler would not have taken place and it’s all downhill from there.
- Adler have wisely challenged BaFin’s findings in court. The challenge should allow for sufficient time to secure retroactive waivers as part of the restructuring and even if that would not be effective, would give bondholders further incentive to take security and vote in favour of the restructuring.
- Adler continue (also wisely) to emphasise their cordial relationship with BaFin. However, after reading BaFin’s own press release on the subject we are not convinced the love is mutual. BaFin’s text is clearly trying to make the maximum of what seems to be an almost technical question.
- We are saying almost because the ramifications are at least theoretically significant and could result in damages claims.
Investment Rationale:
- We expect to receive principal and interest on our Consus convertibles at the end of the month and are looking to re-allocate the proceeds across ADO and ARE bonds. In the summer, we had originally anticipated reviewing a position around last month already.
- Our crystal ball shows a successful restructuring under WpHG, carried by the strong coercive elements that a plan can propose and by the relatively minor opposition of the K&E group in only one bond. We continue to see ARE bonds fully value covered and see very material upside in the Group bonds too. Beyond a technical uplift from a successful restructuring, it is hard to say when German RE values will recover, but the sheer magnitude of discounts on the bonds seem to reflect that adequately.
- Ultimately, most of that upside will materialise only with a normalisation of the market. But a successful restructuring in April should already send bonds rising. A term sheet by Christmas would be the start of that. Failure to agree on a term sheet by January would probably have us selling again.
Happy to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk