Atalian - initiation

All,

 Please find our initiation on Atalian here.

 A history of aggressive M&A, weak FCF generation, untransparent financials, large “exceptional” cash flow items and continued outflows from working capital. We have seen some improvement over the past few quarters, but Atalian entered the coronavirus crisis still in a fragile state.

 - We are considering the bonds of Atalian from a short perspective at this time. We refer specifically to the Atalian EUR625m May 24 bonds at a price of 78 (YTM 11.6%). We do not see the current bond levels as attractive, given the company's significant legacy problems, the lack of a clearly demonstrated ability to generate FCF after interest, the trading history of the bonds, and the vulnerable stage of its turnaround program. Because of the significant exposure of Atalian to highly cyclical private sector activities, we suspect that some investors may have priced it as a services bonds and may be underestimating the impact that the coronavirus will have on both short and medium term results. Finally, we see both disposals and a capital increase difficult to execute in the current environment. In any case a capital increase would not be possible until a clear equity cushion is demonstrated, which will only be achievable once Atalian returns to consistent FCF generation post interest.

 - We estimate that Atalian's current debt structure is not fully covered either on a EV/EBITDA multiples basis (6-6.5x) or on a FCF basis.

- Reported financial debt does not include key items: Atalian's reported net debt on its balance sheet does not include employee tax credit pre-financing, which we believe is a form of secured debt. Atalian on its slides also presents the Non-Recourse Factoring facility of EUR180m as a dotted lined (see chart on debt maturity profile in the liquidity section). As dotted lines usually represent available and undrawn facilities, this can be easily misinterpreted by investors. If we include these two items, Atalian's net leverage would be significantly higher than what the company reports. 

- M&A clouds the picture on organic growth, FCF and capex needs: because of the significant M&A activity over the past few years, it is difficult for an external investor to independently verify the management's claims of continued organic growth over the past two years. FCF, which can be impacted by the timing of working capital around key acquisitions, and by other operating cash flow movements around the timing of the closure of the deal, has also been difficult to adequately assess on an organic basis. Finally, M&A also clouds the picture on replacement capex and therefore steady-state capex - cases such as Monitronics highlight how M&A can be used as a tool to keep reported organic capex at artificially low levels. For this reason, we feel it is right to estimate Atalian's steady state capex at higher than the EUR30-40m of the past few years, and we incorporate this into our forecasts.

- Accounting concerns: the reaction to the delay in audited results in early 2019 has shown that many investors remain wary on the quality and accuracy of Atalian's financial statements. This problem is an inevitable consequence of Atalian's track record of poor cash flow conversion, significant M&A activity, and history of poor execution before 2019. The relative unresponsiveness of Atalian's investor contacts has often exacerbated these concerns. And the service sector has traditionally been one of the most vulnerable to severe accounting manipulation, due to the timing mismatch between cash earnings and accounting earnings, the frequent use of estimates for a portion of revenues and EBITDA, and the perennial risk of overly aggressive contract bidding. 

We are looking forward to exchanging ideas on Atalian with you.

Juliano