Claire’s guidance sets off new strategies as bondholders examine default scenarios

14 July 2016

by Reshmi Basu, and Madalina Iacob

 

Claire’s Stores’ unexpected release of preliminary 2Q16 earnings guidance set off a new round of chess moves by players involved in the distressed retailer’s capital structure. With the bonds in a tailspin after the weak numbers, investor expectations are mounting for some sort of near-term liability management transaction, said multiple sources.

 

The disclosure has also prompted holders of both the second lien and unsecured paper to explore whether the company will be in breach of a 6.75x net secured leverage covenant in the credit facility, given guidance for a sharp EBITDA decline in 2Q, said multiple sources. However, pinpointing leverage involves a number of unknowns, including the magnitude of addbacks permitted for covenant compliance purposes along with the borrower’s cash profile.

 

On Monday (10 July), Claire’s released a Regulation FD disclosure guiding for 2Q16 EBITDA to collapse to USD 37m-USD 41m, compared to USD 59.9m in the prior-year period. The SEC filing triggered a debate in the market as to whether the disclosure was a cleanse and if so, with whom was the company negotiating.

 

Even more curious, the company’s fiscal 2Q quarter hasn’t even wrapped up, as it ends on 30 July. To that end, some investors have viewed this early preliminary release as a means to drive the bonds down and therefore apply pressure on bondholders.

 

With regard to covenant compliance, the issuer reported covenant leverage of 6.42x at 1Q-end against a 6.75x net leverage covenant. But it’s a stretch to get to that ratio based on reported numbers, sources noted. The company’s own earnings report – including USD 216m of LTM adjusted EBITDA, roughly USD 1.45bn of first lien secured debt, and USD 49m of cash – implies net leverage of 6.49x, they noted.

 

Looking ahead, assuming the USD 39m midpoint in 2Q16 EBITDA, LTM adjusted EBITDA would stand at USD 196m, pegging net secured leverage at 7.1x, assuming the cash position is unchanged from 1Q.

 

Meanwhile, before the disclosures a group of first lien bondholders had engaged Kirkland & Ellis as legal advisor, and is expected to propose a restructuring plan to sponsor Apollo Management, said two sources familiar with the matter. However, the group has not yet initiated discussions with the sponsor.

 

A host of legal and financial advisory shops are looking for their piece of the pie in the likely restructuring talks, with various firms angling to get involved across all levels of the capital structure. Jones Day, for one, has made inroads with a loosely-formed crossholder group, said a three additional sources familiar. Additionally, hedge fund Oaktree has taken up a large position in the capital structure, which includes a stake in the second lien loan, noted two of those sources familiar.

 

Mobilization comes as bondholders fear that the company and Apollo could pursue aggressive balance sheet machinations. On 5 May, Apollo announced it would swap its USD 174m position in the borrower’s 10.5% sub notes for a new PIK note with the same ranking, interest rate and maturity date, leaving a USD 85m stub outstanding. The move makes clear that Apollo has the final say as how to how the near-term 2017 maturity is addressed.

 

Besides the 10.5% sub notes, the company has more than USD 1.5bn of notes coming due in 2019, split between a USD 1.125bn 9% first lien note and USD 450m 8.875% second lien note. Then in 2020, the company will need to address a USD 210m 6.125% first lien note and a USD 320m 7.75% unsecured note.

 

Chief among fears is that Apollo could transfer foreign assets by creating an unrestricted subsidiary, which the sponsor could in turn utilize to issue debt for an exchange for its holdings.

 

Claire’s has never been a seamless trade, as its bonds have zigzagged amid a slew of inconsistent earnings and as leverage keeps heading north. Alarm bells began to ring in late May when the company announced it had fully drawn down its USD 115m revolver due 2017 in 1Q16. Since then, Claire’s has been negotiating with revolver lenders regarding its financial tests and pushing out the maturity, said a third source familiar. However, some lenders are playing hard ball, given the lack of ABL collateral, the source added.

 

The issuer’s USD 1.125bn 9% first lien note due 2019 changed hands yesterday to 57.125, while the USD 320m 7.75% note due 2020 last traded yesterday at 7.75, according to MarketAxess.

 

CLICK HERE for Debtwire’s most recent legal analysis on Claire’s.

 

Messages left with the company and with Jones Day were not returned. Representatives at Apollo and Oaktree, respectively, declined comment.