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Mood Media : Restructured

Late last year, the BDC Credit Reporter-which is in the process of being revamped-wrote the following about Mood Media, a portfolio company of several public and non-traded Business Development Companies. In the interim we lost the thread of the Mood Media story till we read a press release on April 14th 2017, which we’ll discuss in great detail below. This article will be of interest to any shareholders of any of the BDCs involved in the company (see the Advantage Data table) and to those readers interested in how BDCs treat  investments that go off the rails, and what that might mean for the future value of Mood Media but also dozens of other companies that have gotten into trouble, been restructured and slipped back into a fund’s portfolio in recent years. 

 

THAT WAS THEN-Written in November 2016

“Mood Media, Inc. brings piped in sounds to retailers worldwide. The Canadian publicly-traded company (ticker:MM) is in the midst of a two year turnaround in a highly competitive sector that has been undergoing rapid technological change. Moreover, the Company is highly leveraged. However, with both public status and publicly rated debt, information is readily available. Several BDCs  have exposure in the form of secured and unsecured debt due in 2019 and 2020 respectively for an aggregate of $125mn. That’s according to Advantage Data records at September 30, 2016:

 

The BDCs with the greatest exposure ($89mn) are FS Investment (FSIC) and non-traded FS Investment II. As of September 2016, the secured debt was marked down just marginally, but the 2020 Unsecured Notes have been discounted by a fifth. Still, that’s an upward trend from the prior 3 quarters when the discount was up to 35%.

Management has been claiming success in improving sales, EBITDA and free cash flow on recent earnings calls.

However, the BDC Credit Reporter is not convinced, and we have the benefit of the latest earnings release (IIIQ 2016).   Revenues were down on prior year, as was EBITDA for the quarter and for the year vs expectations. Free Cash Flow is up but only due to lower capital expenditures, and remains at barely break-even over the year. As a result the Company has made no progress on reducing a debt load of $620mn which begins to come due in 2019. Liquidity is only OK with $21mn in cash and $8mn under its Revolver. Back in April 2016 Moody’s downgraded the Company to Caa1 and said the “company’s capital structure may not be viable” without major progress. In November, the Company’s lenders in an amendment left alone an interest coverage ratio that was scheduled to otherwise increase, a sure sign that performance was not on the original plan.

In a Worst Case we calculate a $420mn Enterprise Value for the Company versus $620mn in debt outstanding and the possibility of $200mn in credit losses, principally in the junior debt, or an additional 37% discount from the current level.

We have a Corporate Credit Rating of 4, implying we believe an ultimate loss is more likely than full recovery. Moreover, we are marking the Credit Trend as Down given that both tranches of debt trade and the junior position is at a higher discount than at September quarter end. In our view, the BDC valuations here-both senior and junior-are unduly optimistic and there is much room for potential downside write-downs.”

IVQ 2016 VALUATION

When the IVQ 2016 valuations were posted, we proved to be correct about the increase in the discount on the 2020 Subordinated Notes, which went to 37% from 20%.  Most of the other debt remained marked at par or above as the Company continued to struggle.

 

UP TO DATE

Now we hear from a press release that Mood Media has agreed to a restructuring which will drastically change the Company’s ownership, and which will rejig its balance sheet.  Apparently Apollo Group affiliates and GSO Blackstone (on behalf of the FS investments Funds amongst others presumably) have both been lenders to the Company and will be converting debt to equity and gaining an equity interest, along with HPS Investment Partners.

The lenders/new owners will buy the outstanding shares of the public Canadian company for C$0.17 a share. (That’s twice the price mentioned above late last year but sharply off the C$ 4.12 reached in 2012).

The C$0.17 cash price per common share represents a 162% premium over the closing price of the common shares of Mood Media on the Toronto Stock Exchange (the “TSX”) on April 12, 2017 and a 149% premium over the 20-day volume weighted average trading price on the TSX for the period prior to and including such date.

WITH THE OLD PUBLIC SHAREHOLDERS OUT OF THE WAY…

Here are the main details of the restructuring spelt out, almost unintelligibly, in a press release. We’ve attached the full version (some companies like to send out a Dummies version and a comprehensive one).  We are told the recapitalized company will have a lower amount of debt than the $637mn outstanding at year end 2016. However, there’s no reconciliation table available and despite reading both the Dummies and the Advanced press releases we still had to work out for ourselves what the total debt level will be going forward. We know that there will be a $315mn Revolver funded by HPS Investment Partners, which will repay the existing $250mn Revolver and the $50mn of 2023 Unsecured Notes owed by a Mood Media subsidiary. The existing $350mn of Senior Unsecured Notes will be converted into $500mn face value of second lien debt, but half of that will be converted into equity. However, some Note Holders may choose not to invest in the Company and will receive different terms, which includes the forgiveness of 50% of their revised debt obligation in what is called the New Company Notes. The main terms of what looks like  $250mn in New Company Notes  are as follows:

The New Company Notes will (i) bear interest at LIBOR plus 14% (6% cash and 8% payment in kind) with a LIBOR floor of 1%, (ii) mature seven years after completion of the Transaction, and(iii) be callable on theone year anniversary oftheir issuance at 102% of par, on the two year anniversary at 101% of par and on the third year anniversary at par.
NEW DEBT LEVEL. MAYBE .
If we’re right (and we’ve rarely been so uncertain after reading a press release ten times), the new Mood Media (which will make the transfer across the border and become a Delaware corporation, coincidentally a very favorable jurisdiction to company owners) will have $565mn in debt outstanding, less up to $50mn in cash and will be owned by its current 2023 Unsecured Note Holders and HPS Investment Partners (although that’s never spelled out). We know Apollo Global and GSO affiliates are getting additional shares for underwriting the new equity capital being offered up.
ACCOUNTING QUESTIONS
How this will all play out on the balance sheets of the various BDCs involved in the IIQ of 2017 (assuming a judge approves the plan) is hard to fully fathom. Presumably FSIC and FSIC will get repaid at par, plus accrued interest on the 2023 Notes. Likewise Hms Income Fund and Main Street Capital, who appear to be invested in the Senior Secured Revolver, should get repaid in full, or $30mn. A slight discount of fair market value to cost should get written up. The most intriguing will be how the bulk of the capital at risk: $88mn in the 2020 Subordinated Notes (which will become the New Company Notes) will be valued. Will the two FS Investment funds involved (including FSIC) write off a major portion of their original investment given that they are converting a good portion into equity in what is still a leveraged and under-performing company ? Or will the original cost be spread amongst the New Company Notes and the new equity, both purchased and granted, and no loss recognized ?
NO TICKER TAPE PARADE YET
The most important point the BDC Reporter would like to make is that the ambitious restructuring of Mood Media by no means implies the Company, or the current structure, will ultimately be successful. If we’ve understood what’s going on the total debt on the Company is not being very greatly reduced and the New Notes remain very expensive (14% !). Furthermore, our review of the IVQ 2016 financial statements-probably the last glimpse at the Company’s performance we’re going to see in a long time- underscore that the business is flat and that Adjusted EBITDA and cash flow outlook remain challenged. Sales were down by 2% in 2016 over 2015 and Adjusted EBITDA was off too, and by a bigger percentage.  The Company projects only that Adjusted EBITDA will be “stable” in 2017 versus the just completed year, suggesting EBITDA will remain below $95mn. We know it’s Old School to look at regular earnings numbers rather than “Adjusted” results but for anyone who cares, Mood Media still lost ($56mn) to the bottom line before taxes in 2016. Moreover, the business does depend on major spending on capital expenditures at times to maintain its customer base.  Debt to EBITDA appears to remain high and if we were told the likely maintenance capex requirements of the business we’d guess that the Debt to EBITDA Less Capex level is close to 10x.
BEST AND THE BRIGHTEST
Clearly some very clever investors have had access to much more comprehensive financial and business information than the BDC Credit Reporter and have decided to double down on the Company, and must have had good reasons. However, the prima facie evidence here is that Mood Media is not out of the woods, nor even close to be.  The restructuring and new equity infusion may yet turn out to have been a false re-start for the Company, its lenders and investors (including a still substantial amount from FSIC’s shareholders).  The restructuring is another stellar example of the trend we discussed in a much ignored Daily Update on April 13th, warning about how BDCs can become investors in the companies that they are lending to, and that the end result may be higher losses and a much drawn out process which benefits the External Managers but not necessarily the shareholders.
DOOM, DOOM, DOOM
The day of reckoning may not occur on a widespread scale till the Next Recession. Then some BDC shareholders may find that many of the constituent companies in their apparently highly valued portfolios might have been held together for some time  by spit and baling wire.  If we can end with an analogy: U.S. investors may look over at what’s happening in Greece and knowingly opine that the poor country will never have the resources to pay off its creditors and every IMF/EU restructuring is just “kicking the can down the road”. However, BDC investors may have dented cans in their own backyard to worry about.  With non-bank lenders subject to very few checks and balances-notwithstanding the mountain of filings they produce and that we read on your behalf-and the economic incentives to not recognize losses, plus a very liquid and optimistic capital market environment, there’s a risk that there are many kicked cans hiding in plain sight.  Just some food for thought.