Media General (NYSE:MEG) announced that it reached an agreement for a short-term bridge amendment with its lending group on Friday, February 10. The amendment resets the leverage ratio for first quarter 2012 to 7.60 times as opposed to the original 7.25 times. After the first quarter, the leverage ratio resumes its original schedule, with the second quarter′s leverage ratio set at 6.75 times and third quarter's at 6 times.
Since the announcement, the stock has appeared to find some ground around $5 as MEG management works with Bank of America (NYSE:BAC) to find a solution to its $363 million term loan due in March 2013. Usually positive refinancing news is met with a strong reaction by equity participants but MEG stock has been held back by confusion regarding what the bridge amendment may portend for MEG’s final refinancing package and a laughably timed credit review by Moody’s (NYSE:MCO).
Let’s cover the ratings agencies first. Moody’s is reviewing MEG for a potential credit downgrade given MEG is in the refinancing process and was able to secure just a short-term amendment. MEG’s corporate family rating is at B3, as are its 11.75% bonds due 2017. It’s a little bit of a joke mainly because MCO downgraded MEG in early October 2011 to B3, which led to a stock drop of over 30% in a single day. MCO was followed by S&P which out did MCO by downgrading MEG to CCC a few weeks later. S&P and MCO have been trying to stay relevant since the housing bubble implosion and so have been far more active in screaming “fire” whenever they can. Part of the problem is that their research always seems to lag price action and they embarrass themselves even more.
In the fall of 2011, MEG’s bonds were trading in the $70s, having dropped from prices well above par in June, when MCO and S&P decided to downgrade MEG’s credit. It took a more than 30% decline in MEG’s bonds before the downgrade, and while any savvy investor could care less what S&P or MCO’s credit rating was, there were obviously plenty of squeamish equity investors that fled MEG stock once the agencies downgraded MEG’s credit. The credit agencies served both short-sellers, who were able to capitalize on a random event in terms of timing of the downgrade, as well as opportunistic buyers that could acquire MEG equity and fixed income for attractive prices.
Earlier last week, MCO came along waving the threat of downgrading MEG’s credit, trying to “catch up” to S&P’s CCC rating by placing MEG in the Caa family. This news rattled the stock on Wednesday, February 15, with shares dropping by nearly 16% before rallying sharply to finish the day down roughly 5%. Since that period the stock has continued to climb. MCO and S&P’s October downgrades were a pathetically lagged reaction to MEG’s price action on its bonds and bank debt (which subsequently recovered strongly after the downgrades) and while MCO looks like it now wants to be proactive, the expected credit downgrade will largely be meaningless given that S&P already rates MEG at CCC. The overall question is does this even matter relative to MEG’s stock price?
Market pricing provides far more information than irrelevant credit agencies and MEG’s bond pricing suggests that MEG debt investors are comfortable with where MEG stands from a credit and potential refinancing standpoint. Interestingly enough, MEG’s equity holders seem more cautious than bond holders. First, let’s review MEG’s bond prices. MEG’s 11.75% high yield bonds are unsecured and since late November 2011 have traded above $90. Since MCO and S&P downgraded MEG’s credit, MEG bonds rallied from the $70s to the upper $90s. From December 2011 through February 2012, MEG’s bonds have consistently traded in the mid to upper $90s with recent trades as high as $97 (February 13 2012). This implies a yield to maturity of 12.6%.
The fourth quarter 2011 conference call had investors such as Third Point and Knighthead Capital, both familiar and active investors in distressed credit. These investors represent the likely holders of MEG’s high yield bonds and the current pricing of those bonds and the historical track record of MCO and S&P with regard to MEG suggest that equity investors are better off ignoring any changes to MEG’s credit rating by the agencies. The types of holders of MEG’s bonds are not the typical stuffees that would ride the bonds to a hefty loss. Essentially, if MEG bonds are in the upper $90s, unsecured bondholders feel that MEG has little risk of bankruptcy and/or the bonds are close to “money good.” Also, given the high price of MEG’s bonds, current bond investors are more likely to lean towards the former rather than the latter. This is because a vulture investor would want a higher margin of safety on those bonds.
Another reason to be unconcerned with a credit downgrade is because once MEG refinances, it is possible that MEG could be in line for a credit upgrade. The biggest obstacles for MEG in regards to its debt is the $363 million bank debt maturity in March 2013 and the leverage ratio step downs. Ideally, BAC would have amended and extended the existing credit deal but BAC instead chose to provide a short-term amendment. I was surprised by this action but the pricing of MEG’s bonds and broader leveraged loan market suggests that the climate for leveraged entities has been thawing. In this instance, rather than take a “delay and pray” approach, BAC wants to take advantage of this refinancing window and place MEG into the Term Loan B (“TLB”) market.
In my most recent write-up, I expected BAC to amend and extend MEG’s $363 million loan. I thought BAC would hit MEG up for a high 1-1.5% in amendment/extension fees or basically $3-$5 million and price the debt at L+700 with a 150 basis point LIBOR floor. The fees would be a proxy for a typical original issue discount meaning on a combined basis, the fees and interest expense would represent a higher overall yield. BAC instead is working with Capstone per the MEG 8-K in arranging a TLB but the all-in cost to MEG may not be that different.
In my original scenario of BAC hitting MEG up for $3-5 million for amendment/extension fees and pricing its new debt at L+700 with a 150 basis point LIBOR floor, MEG would be looking at $31 million on the new loan, $5 million in fees, and then $35 million in interest expense tied to its high yield bonds totaling $71 million in annualized financing expenses. The TLB option could work out with a similar total expense or perhaps even lower. Given where MEG’s high yield bonds trade, a TLB should be priced better than the approximately 13% implied yield on those bonds. MEG’s bonds are unsecured while the new TLB would be senior secured. The TLB should also have a better credit rating than the CCC/B3 (eventual Caa area) the bonds are assigned because of the seniority and asset coverage the term loan would have.
While there are not many perfect comps for what a new MEG deal could look like, there is one recent deal that may provide some valuable insight on where MEG’s TLB could shake out. In late January, Spanish Broadcasting System (SBSA) announced a refinancing of its term loan with 12.5% in $275 million in secured notes priced at $97 maturing in April 2017. The yield on these notes was 13.3% and the notes were rated B-/Caa1, pretty much the the same as MEG’s bonds if its S&P and MCO ratings were reversed with the exception that SBSA’s notes are secured and MEG’s are unsecured. I think MEG could obtain better terms than this for a number of reasons.
First, SBSA is all radio assets while MEG is primarily considered a television broadcast/newspaper company with the majority of its value driven by its broadcasting division. Broadcast TV is a better credit than radio and will be reflected by better pricing for MEG. SBSA had more difficult timing as well given its loan matured in the early part of 2012. As a result, it raised its notes via a 144A private placement which prices at a premium. MEG’s TLB will be a syndicated loan and this is another area which should result in better pricing for MEG relative to the SBSA deal. Another area where MEG would be better than SBSA is its total leverage profile.
SBSA reported $45 million in LTM pro forma EBITDA which added back as many one-time charges as possible (severance fees, uncapitalized transaction fees, legal fees, etc.) when it announced its refinancing. SBSA has $387 million in total debt when accounting for $275 million in secured notes and $111 million in preferred stock and accrued preferred stock dividends. With net cash of $33 million post refinancing net debt is $353MM so SBSA is levered at 8.6 times gross debt and 7.9 times net debt. SBSA also appears to have little room for error as well with $45 million in EBITDA, an expected $36 million in interest expense and $10 million in CapEx. The company will need to improve its operating results to avoid being free cash flow negative out of the gates. Yet despite all of this, it was able to quickly issue a significant amount of capital at pretty attractive pricing. If there was not a looming maturity issue, SBSA could have potentially had even better pricing.
In comparison, MEG should have EBITDA close to $95 million in first quarter 2012 as it prepares to refinance with the possibility that EBITDA for 2011 eclipses $120 million. It has about $663 million in total debt and about $640 million in net debt equating to 7.1 times gross debt/EBITDA and 6.8 times net debt/EBITDA. More importantly, SBSA’s secured debt is 6.1 times EBITDA while MEG’s secured debt translates to 3.9 times estimated first quarter 2012 EBITDA. This is another significant difference for where MEG’s $363 million TLB should yield better pricing relative to SBSA.
In comparison to SBSA, MEG has better assets from a credit/pricing standpoint, better approach to market via syndication as opposed to a 144A, better total leverage ratios, and better total senior debt leverage ratios. With MEG’s unsecured bonds trading in the high $90s and yielding less than 13%, the debt market appears to be saying that MEG’s TLB offering should price quite strongly yet equity participants appear much more cautious. In this context, BAC’s actions in a short-term amendment make sense.
The credit markets have continued to improve and a fresh TLB could also do better in terms of matching MEG’s cash flow profile. A fresh TLB could be a 5 year offering, longer than what BAC would want to extend MEG’s existing term loan for. This means the TLB would be due in early 2017 which would be ideal for MEG. One issue with BAC providing a modest three year extension would be maturity in an off political year (2015) which would make deleveraging difficult and a shorter extension problematic. However, a fresh TLB could bring maturity to early 2017 which would coincide with the end of a presidential election year in 2016 which would typically yield MEG’s strongest operating performance and cash flow.
While there is still near-term uncertainty regarding MEG’s refinancing efforts, equity holders can look to recent deals such as SBSA that set a floor in terms of what MEG could obtain. In comparison to SBSA, MEG has better assets which receive better pricing for leverage, better leverage ratios, better approach to market via syndication and since January, when SBSA priced its offering, an even better climate for its offering. The TLB should secure a rating in the Bs given the asset coverage and seniority relative to MEG’s high yield bonds, which should further influence better pricing. As a result, while equity investors appear rightfully cautious regarding MEG’s refinancing efforts, they should also feel that things may work very well due to fortuitous timing with regard to a thawing credit market, in spite of a horrific, grossly incompetent management team.
DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG MEG
About the author:
Amit Chokshi is the founder and owner of Kinnaras and affiliated companies and is responsible for security analysis, selection, portfolio management, and Firm operations. Prior to founding Kinnaras, he worked as an associate at the Royal Bank of Scotland ("RBS") in the firm's Corporate Advisory Services group, which provided corporate finance and mergers and acquisition ("M&A") services to the firm's clients with a particular emphasis on private equity firms. Amit also worked at Morgan Stanley and received a B.S. in Finance from Bryant University and an MBA from Emory University. In addition to passing the NASD Series 7, 63, and 65 exams, Amit is also a CFA Charterholder and on the Board of the Stamford CFA Society. Amit has appeared on Bloomberg Radio and has also been quoted in various publications regarding Firm-specific holdings.