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Investcorp Credit and Garrison Capital: Portfolio Company Exits Bankruptcy

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We’re re-publishing below a recently posted article from the BDC Credit Reporter about Fusion Connect, a portfolio company of both Investcorp Credit Management  or ICMB  and Garrison Capital (GARS).

Our goal is to inform our readers with an interest in the two BDCs of the change of status of the investment and the likely realized losses to be booked, and investment income forgone.

This is also an opportunity to discuss how BDCs more generally have responded to similar under-performing credits.

Lenders have several options available when credits go wrong and making the right choice can either result in an improvement down the road or compound an already loss making situation, as we’ll show. 

History

The two BDCs became involved with this fast growing publicly traded technology company in the second half of 2018 by investing in its first lien 2023 Term Loan.

Both BDCs were able to buy the publicly traded debt at a discount.

The Term Loan was priced at LIBOR + 750 bps but ICMB in its Conference Call transcript on September 5, 2018 said its yield to cost was 11.6%.

At the time the debt positions were initiated Fusion was in an acquisition frenzy, investing $680mn in the purchase of Birch Communications and MegaPath.

On April 1, 2019 everything came tumbling down when the company fessed up in an 8-K filing to multiple accounting errors in the historic results of Birch Communications. Here’s an extract:

On April 1, 2019, the Audit Committee of the Company (the “Audit Committee”) concluded, acting upon the recommendation of management and following discussions with EisnerAmper LLP, the Company’s independent public accountants (“Eisner”), that due to the Accounting Errors, the previously issued financial statements of the Company for the year ended December 31, 2017, and for the periods contained in the Original Filings and other financial communications for those periods should no longer be relied upon.
 
On April 2, 2019, the Company also filed an amendment to its Form 12b-25 filed with the U.S. Securities and Commission on March 15, 2019 to indicate that the Company will not be able to file the 2018 Form 10-K by the April 2, 2019 extension deadline. This further delay in filing the 2018 Form 10-K is due to the Company requiring additional time to gather information and complete its analysis of the impact of the Accounting Errors. In addition, McNair, McLemore, Middlebrooks & Co., LLC, Birch’s public accounting firm prior to the completion of the Birch Merger, has not completed its audit procedures related to the restatement of Birch’s 2017 financial statements resulting from the Accounting Errors.
 
Although the Company has not determined the precise amount of the required restatements, it currently estimates such amounts to range between $2.3 million and $3.0 million with respect to the year ended December 31, 2017 and ranging from $3.4 million and $4.1 million and $1.7 million and $2.3 million with respect to the quarters ended September 30, 2018 and June 30, 2018, respectively. The actual amount of the restatements will not be known until all audit work is completed. The Company can provide no assurances that the estimates provided above will not change. These adjustments will have no cash impact but will reduce the Company’s EBTIDA for the applicable periods by an amount equal to the required restatements.
The stock price of the company dropped (83%) on the news. 
Shortly thereafter, the company defaulted on its debt and later filed for Chapter 11 bankruptcy, as is discussed in the attached article.
Well Trodden Path
The BDCs involved are dealing with this reverse by following a now very popular game plan adopted by many lenders – both in the BDC community and outside : a debt for equity swap.
In return for a huge debt forgiveness, the lenders to the company take it private and become the owners. 
No Guarantees
This is not a fail safe work-out method.
Typically going from lender to investor also includes providing additional funding to the newly recapitalized company, as is likely the case here.
Moreover,  as we’ve seen in several instances, de-leveraging does not necessarily solve a beleaguered company’s problems.
Twenty Two
That can result in situations like Charlotte Russe, Charming Charlie, Payless and others that a second bankruptcy happens down the road – the infamous “Chapter 22”. 
Or, the restructured company’s equity can still drop in value, as has been recently vividly demonstrated by U.S. Well Services (USWS).
There, the stock price lost two-thirds of its value causing major unrealized losses for the three BDCs that swapped debt for public stock.
That was easy to track because USWS is a publicly traded security.
In The Shadows
However, there are many similar examples where the company involved – like Fusion going forward – is privately held and valuation is dependent on the calculations of the BDCs and their advisors.
In many cases, these new equity positions – as we’ve seen multiple times in the energy space – become what we call “zombie” investments with little value but remaining on the BDC’s books indefinitely.
Ironically, once BDCs take over these companies the amount of information about their financial condition tends to drop off precipitously.
Both Sides Now
Of course, there are happy endings to these tales of credit woe as well. 
The poster child which comes to mind is White Horse Finance’s (WHF) investment in RCS Capital, which went into bankruptcy, changed its name and eventually was sold as Aretec Group.
That resulted in a $33mn Realized Gain for WHF…
Likewise, THL Credit (TCRD) seems to be doing well with C&K Markets and has high hopes for OEM Group.
Unknown Future
If what’s happened to other BDCs at other times is any indication, the Fusion Connect investment by GARS and ICMB could end up going in any number of directions.
In retrospect, we may find these were just early innings, and much could yet change.
As always, we’ll seek to keep readers apprised of the twists and turns in credit performance as they occur. 

The BDC Credit Reporter has written on four prior occasions about Fusion Connect Inc. ever since the “leading provider of integrated technology solutions” failed to make an interest payment on its debt back in April 2019. Subsequently the company agreed to a debt for equity swap with its senior lenders and filed for Chapter 11 back on June 4, 2019. Those senior lenders were owed $574mn. From today’s announcement, we know $400mn of debt has been written off. Furthermore, some existing lenders have agreed to provide $115mn in an “exit financing loan”. We’re not sure if that rolls up the D.I.P. financing in place or is a new facility.

Back in July we’d anticipated the Chapter 11 exit momentarily, so there’s been some delay. In the interim, the company has appointed a new CEO from within.

With the exit, we are upgrading our credit rating to CCR 3 (Watch List) from CCR 5 (Non Performing). We’ll be keeping Fusion in our BDC portfolio company Under Performers database until we learn a good deal more about the company’s long term prospects with its new manager and balance sheet. For the two BDCs involved Garrison Capital (GARS) and Investcorp Credit Management (ICMB), with at least $20.3mn in exposure, a day of reckoning is now nigh. The BDCs should be writing off a portion of the 2023 Term Loan they hold in the IQ 2020 results. Based on the current market value of that debt, we expect a third of the position may be written off. The small DIP positions the two BDCs have is likely to be repaid or continue in the unspecified “exit” facility.

Even at this interim stage, this is a material blow to both BDCs, with ICMB with the greatest exposure on the 2023 Term Loan-turned equity, with $11.4mn at cost and a likely Realized Loss of over ($3mn)GARS has $7.4mn invested at cost in the 2023 debt, but had not taken as big a discount as ICMB last quarter in valuation terms (27% versus 34%). As a result, GARS might have to take an incremental unrealized loss before booking its realized loss of over ($2mn). All the above is just speculation because BDCs have wide latitude on how to value these investments gone wrong and converted into different security types. Undeniably, though, both BDCs will permanently lose much of the $1.8mn of investment income being generated before everything went wrong.

A final word. As Advantage Data’s records show both BDCs got involved in lending to the fast growing (i.e. risky) technology company only in the second half of 2018. ICMB joined the lending group in the IIIQ 2018 and GARS started a quarter earlier. By the IQ 2019, the company was in trouble due to its inability to successfully integrate two major acquisitions and the debt went on non accrual. That’s a very brief period to go from performing credit to non performing. Hopefully for both BDCs the company’s future performance – and the stock that they now own – will offset these early reverses.

© BDC Investment Advisors, LLC 2016 – 2019
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