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Avanti Communications: A Progress Report

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PREAMBLE

This article began as a brief update about the state of Avanti Communications restructuring plans, based on a Tweet we saw from Debtwire. However, after we digged a little deeper, we recognized that our earlier article on March 13, 2018 regarding Great Elm Corporation (GECC) – the largest BDC holder of Avanti’s debt and equity (along with TCP Capital or TCPC) had confused which debt tranche Avanti proposes to convert to equity and which will remain in place. Unfortunately for GECC and TCPC shareholders, the progress towards a sweeping recapitalization of Avanti may cause greater damage to their lenders income and book value than we’d previously calculated. For all the details, read on. It’s a complicated and still evolving picture.


NEWS

Avanti Communications – in a press release attached above – indicated that its  proposed debt for equity scheme was “sanctioned by London High Court”.

The over half a billion dollars of 12.0%/17.5% Senior Secured Notes due in 2023 are permitted  to be swapped into 92.5% of the equity of the satellite operator.

However, the press release also indicated that there are still further hurdles to be cleared before Avanti can complete the scheme:

“Completion of Avanti’s financial restructuring remains conditional upon the satisfaction of a number of conditions precedent, including the approval of certain resolutions by the Company’s shareholders  at a general meeting of the Company (the “General Meeting“) expected to be held during April 2018 required to approve, among other things, the issue and allotment of the ordinary shares to satisfy the debt for equity swap provided for in the Scheme and also an order of the U.S. Bankruptcy Court recognising the Scheme as a ‘foreign main proceeding’ under Chapter 15 of the U.S Bankruptcy Code (the “Recognition Order“). A circular containing, amongst other things, the notice of General Meeting will be published in due course”.


ANALYSIS

For a fuller analysis of the complicated plan at Avanti Communications and the advent of a new CEO who comes on board next month, read the BDC Reporter’s article of March 13, 2018.

VIEWS

This apparent last chance for Avanti to remain solvent long enough to benefit from its long awaited new satellite launch is halfway to being completed.

Recently, the Company announced that its latest satellite launch was slated for April 5, 2018.

If and when Avanti’s shareholders give their blessing, the Company will be partly de-leveraged and its interest expense burden will be greatly reduced.

[Nonetheless – as recent preliminary results reveal – the Company’s financial position is highly precarious even if the new satellite is successfully placed into orbit in early April.

Anyone in any doubt should read Avanti’s outlook in the attached press release from January 25, 2018].

Mea Culpa

However – as the prior article makes clear – GECC and TCPC will both have significantly lower recurring investment income from the debt conversion.

In fact, we realize that in our earlier article we transposed which Avanti debt instrument was to convert to equity and which was having its interest rate reduced and maturity extended.

Unfortunately for GECC the impact on earnings and its NAV may be even higher than we first anticipated if this scheme goes through.

(Matters will be even worse if Avanti fails to clear all its regulatory and shareholder hurdles).

Debt To Become Equity

In fact, GECC holds $54.1mn of these 2023 Notes at a cost of $45.0mn and a FMV of $13.3mn.

(TCPC ‘s numbers are $7.3mn in face value, $4.1mn at cost and FMV of $2.0mn, according to Advantage Data’s record).

Nominally the 2023 Notes bear an interest rate of 12.0% if paid in cash and on schedule and 17.5% if the borrower elects the Pay-In-Kind option.

However – as GECC’s 10-K indicates in a footnote, the interest rates are currently at 14.5%/20.0% due to default interest rates being figured in.

This seems to suggest that GECC was booking annualized Investment Income of $10.8mn from the 2023 Notes in the last quarter of 2017.

That’s $2.7mn in the last quarter of the year and assumes the PIK option was chosen (we doubt Avanti had much choice) and the loan was in default.

According to the 10-K, GECC’s Total Investment Income in the IVQ of 2017 was $9.7mn and Net Investment Income $6.4mn.

Using those numbers, it appears the 2023 Notes contributed over a quarter of GECC’s IVQ 2017 Investment Income and 42% of Net Investment Income.

More…

Unfortunately, there’s more for shareholders in GECC to consider.

The existing Second Lien debt is being retained but Note Holders are being asked to agree to a significant decrease in the interest rates charged.

Currently the debt yields 10.0% if paid in cash and 15% if paid in kind.

Going forward – and back dated to October 2017  (and announced in a December 13, 2017 press release) Note Holders will be paid 9% if in cash or in PIK.

Plus a host of other unfavorable conditions which we’ll quote from the press release:

             “extend the final maturity date of the 2021 Notes from 2021 to 2022;

 

·           permit the issuance of up to $30 million of additional 2021 Notes;

 

·           eliminate the Maintenance of Minimum Consolidated LTM EBITDA covenant contained in the indenture governing the 2021 Notes;

 

·           eliminate the margin increase payable on the 2021 Notes if the relevant Minimum Consolidated LTM EBITDA threshold was not met”

Even Lower Income

Besides not affording the debt holders even the most basic covenant protections, the income to be garnered will be materially lower than before.

GECC holds $34.9mn of the Second Lien Notes, with a cost of $30.4mn and a FMV of $28.8mn.

(TCPC, by contrast, has $4.8mn of this debt at cost and $3.9mn at Fair Market Value).

Going by GECC’s 10-K, we note that the interest rate recorded for the Second Lien Notes in the IVQ 2017 was 12.5%. 

That suggests -though there is no confirming footnote – that Avanti was being charged default interest as the “real rate” is supposed to be 10.0% as mentioned above. 

(What we can’t figure out is if Avanti was opting for the pay-in-kind alternative which would make the interest income even higher).

In the future, with the new interest rate of 9%, interest income booked will be 28% lower than what SEEMS to have been booked in the IVQ of 2017.

Down, Down, Down

In fact, we project that GECC’s quarterly investment income from Avanti will drop to $0.8mn from $3.8mn in the last quarter of 2017.  

That’s an 80% drop and amounts to $12mn on an annualized basis.

Even then all the income received is likely to be in non-cash form.

Off The Books

Furthermore, we expect that GECC’s net book value should take a hit from the anticipated restructuring.

The conversion of the 2023 Notes to equity will – as GECC’s Investment Advisor noted on the latest Conference Call – result in a much lower value given that the stock will be carried at its market value.

With so much new equity being created and with still significant debt outstanding and more projected to be added, GECC is likely to have to book significant Unrealized Depreciation from the restructuring.

Ditto for TCPC, but with less absolute amounts at risk and with a far greater capital base to absorb the hit.

CONCLUSION

The BDC Reporter – by mistakenly transposing which Avanti debt is to be converted to equity and which is to continue at a lower yield – previously under-estimated the likely impact of the Avanti Communications restructuring.

Both GECC and TCPC will be facing materially lower Investment Income from Avanti than what was booked in the IVQ of 2017 when the new structure gets put into place.

(We’re guessing the restructure could be ready to go during the IIQ 2018).

TCPC may be able to offset the likely impact on its earnings from the restructuring from other sources.

Bigger Fish

However, GECC which has 7x greater exposure to Avanti and a much smaller book value is far more vulnerable than TCPC.

As we’ve mentioned before, we expect GECC will have to reduce its distribution once the recapitalization closes given the drastic drop in recurring earnings that we project will occur.

Of course, Avanti could yet survive or even thrive and GECC and TCPC both benefit from their debt and equity stakes.

Cautious investors, though, will worry that Avanti is a house of cards that could yet drag its lenders down,  if its ambitious expansion plans do not work out.


INVESTMENT DISCLOSURE

We have no position in GECC’s common stock but we hold both its Baby Bonds.

We are Long TCPC’s common stock. 

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