Vallourec - All the Game Theory

All,

Please find our updated analysis and model on Vallourec here.

We have analysed the mechanics, limits and negotiating positions of each party in a (not so) hypothetical Sauvegarde Scenario and have modelled the operations into the future. 

Despite what we believe to be a short term opportunity in the bonds over the next few months, we are still not taking a position for fundamental reasons. While the current discussion is focussed on the game theory of what happens under Mandat Ad-Hoc and how bonds will fare vs the RCF etc, we have attempted to model the future economics of the company in this new oil-price world and have struggled to arrive at any attractive scenario that we would like to be exposed to at any price. We fear that while negotiations commence on the balance sheet restructuring, more attention will be given to the fundamental outlook and any operational restructuring - in France - that the company has so long avoided.

As for the game theory:

Sarria Base Case:

- Bonds and banks to be offered substantially similar terms, involving a haircut, cash and equity.

- No net cash injection.

- Shareholders offered chance to protect their holdings for substantially similar cash amounts as implied in original RI.

1) Mechanics of a no-deal Sauvegarde:

- Sauvegarde can only be requested by the CEO and would require each creditor class to vote on a plan proposed by the company.

- As Vallourec S.A. is itself very small, it probably won’t have to seek the consent of all creditor classes. The consent of the banks may suffice, in which case bonds are at risk.

- Sauvegarde creditor classes are primarily arranged by type of creditor, rather than security. So in Vallourec SA’s case there will likely be two classes: Banks and Bondholders.

- Because the RCF and the bonds are intended to be pari passu and are each senior unsecured liabilities of the SA, the court will likely take the view that a plan should offer both classes substantially similar terms. Assurance for bondholders.

- As ever, Sauvegarde can neither alter the principal, nor the interest on securities, but it can term them out for up to 10 years. 

- Given the usually high discount rates attached to what is de-facto equity, bonds would trade down into the 30s and 20s in that scenario.

- In principle, it is before that backdrop that any negotiation would commence.

- Creditors will have to argue value and debt carrying ability - usually with only scant data, but given the company is seeking a consensus and asks for permission to seek a Mandataire Ad-Hoc, there should be data. 

2) Banks:

- The RI was going to pay down half of the banks’ exposure. But in court the RCF is p.p. with the bonds and heavy write-downs are looming. We hear rumours that the company has not pre-discussed the deal with the banks. 

- The banks will typically expect to remain better off than bondholders although in Vallourec’s case that may only be by a slim margin - especially if the bondholders already signal support for a plan.

- The banks are likely less interested in holding shares and more interested in receiving cash. In our scenario above we have not differentiated the recoveries between bonds and banks, but at the right price bondholders may prefer more equity and leave the cash to the banks.

3) Motivation of shareholders:

- The French State and Nippon each hold 15%. Neither is a financial investor and preservation of employment / control should dictate their movements. The French State does not seem overly inclined to support the company more than it has to. Vallourec have liquidity and as long as the restructuring does not result in mass lay-offs in France, the BPI may consider its job done. Nippon may be looking to maintain its position for strategic reasons, also considering the JV in Brazil.

- Prior to the pandemic / oil drop, shareholders had been willing to inject fresh cash into the company, subject to the RCF banks not withdrawing in full at their early 2021 maturity. So there is a general sense of support for the business as well as an understanding that those who wish to protect their holdings will have to do so with fresh cash. But that will be linked to demands for a haircut at the holdco debt.

- Shareholders have already passed resolutions relating to a RI earlier this year, so there is an option to offer shares in a restructuring. The nominal share price has been reduced to E0.02 / share and management is authorised to issue shares for up to E4.2bn of fresh equity. Ample room to manoeuvre.

- If the bonds remain outstanding / w/o a haircut for 10 years, the shares will not likely trade well and given the minority holdings by the likes of Nippon, that should matter in their P&L. 

4) A deal:

- Surviving debt will have to push out maturity by at least 5 years.

- To avoid a term-out scenario, banks and bondholders will have to agree to a haircut. 

- To protect their interests from dilution, shareholders will have to buy new shares for fresh cash.

- Subject to long-term maturities and haircuts, the current liquidity position of the company may be sufficient. That cash may not have to remain within the company and instead could be offered to banks and bondholders - possibly within a Chinese menu of a stub and any mix of cash and shares. 

- Our scenario above contends that shareholders have effectively received approval for 30% of the E800m original RI = E240m and thus are able to protect their positions to that extent, signing new shares at relatively low prices post D/E swap, but still at the same EV. The implication is that holdco creditors may have to agree a 44% haircut, receive 6 cents in cash, 50 cents of stub bonds (possibly PIYC) and hold some 2/3 of the company at the end at a (still proud) valuation of E2.8bn, but with E1.5bn less debt on the books.

5) Positioning:

- Our base case leaves us some 8 points (~20%) above current trading prices. With banks and bondholders pulling the same end of the rope, it is possible write-offs will be less severe.

- Timing should be mostly dictated by the RCF maturity in February. 

- If it weren’t for our fundamental view of the company, we would take some here.

Tomas and Wolfgang