Praktiker Bond 5 7/8% 2016 (DE000A1H3JZ8) – what level would be interesting ?

Those investors who bought the 2016 Bond at par early this year will most likely be not happy with the current distressed price levels.

I had covered Praktiker several times and said that the bond will only be interesting at 40-50% of par. As the chart shows we are now at ~38%.

Let’s put ourselves into the shoes of an “evil” activist distressed debt investor or “Heuschrecke”:

If one looks deeper into the bond prospectus, one can find some interesting items there besides the already posted “change of control” clause:

– the bond has a “negative pledge” covenant. This means that Praktiker cannot easily pledge assets (for instance the participation in MAx Bahr) as collateral for new funding. In my understanding a pledge for a plain bank loan would not trigger this covenant but it makes the planned funding measures much more difficult

– additionally, there is a relatively strong “cross default clause” included, which prevents Praktiker from not paying bills for certain unprofitable subsidiaries because this would also trigger an early repayment.

Although those provisions are not really a “hard protection”, they represent a significant amount of “annoyance factor” for the management with regard to major restructurings and refinancing activities.

As an “activist” distressed debt investor one could follow the following strategy:

– buy up as much of the bond at the discounted price, preferably >=50% of the outstanding bond
block any attempt of the management to renegotiate the terms of the bond
– accumulate shares on the way down until majority is reached
trigger the bond repayment
– which results in direct bancruptcy
– take over the company through the bancruptcy process as most senior creditor
– renegotiate leases etc.
– emerge from bankruptcy after 2-3 years as a smaller but profitable DIY chain or sell to competitor.

For this strategy, an investor needs theoretically 51% of the shares and as much of the bonds as possible.

With this in mind, we can do some kind of reverse calculation:

The “activist” investor will have to invest the following amounts:
51% of the shares (40 mn EUR at current prices)
plus all of the bonds at current market prices
plus the net 50 mn bank debt on top of the bond
plus any amounts which have to be paid net (after operating CF) for breaking leases reorganizations etc. They were flagged as 300 mn EUR by the new CEO

If we assume that Praktiker after a trun around can earn 100 mn EUR EBITDA per annum and the final sale will happen at 6xEBITDA or an EV of 600 mn EUR, we can now calculate a hypothetical return for an activist investor over a 3 year holding period:

Investment: (-40-95-300) =-435
Payback with exit at 6x EV/EBITDA (600-50) = 550

This would result at current prices in an IRR of only 8% p.a. over a 3 year holding period. Compared to the risk, this is way to low, a typical distressed activist invetsor would want to see an IRR of 30% for such an investment.

Even if the shareprice goes to zero this doesn’t change a lot, the same goes applies for a lower bond price.

So the real problem is the 300 mn EUR required capital expenditure which the CEO indicated in the last conference call to turn around Praktiker. However, this amount is based on a “non bancruptcy” scenario. In a bancruptcy scenario as mentioned above, one could expect lower costs for closing stores etc.

So if we reduce the expenditure by 50% to 150 mn EUR, we would get a return of 24% p.a. for the activist investor which looks much mor attractive.

However, I have absolutely no idea what a realistic amount is required for turning around Praktiker. In order to assess any margin of safety to the bond under a bankruptcy scenario, one would have to dig much deeper.

Summary: For me it is really difficult for Praktiker to avoid bankruptcy if they really need 300 mn net new capital to turn around the company. So in any case it is not realistic to value Praktiker as a “going concern”. Due to the uncertainty with regard to the leases, it is extremely difficult to come up with a “hard” valuation of the bond under a bankruptcy scenario without digging much deeper into a potential turn around case. For the time being I will not consider the Praktiker bond for the portfolio.

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4 comments

  • I have not much experience in distressed bond investing, and concentrate on stocks most of the time. So your thoughts about specific issues are really interesting to me to learn more about bond investing.
    Thank your for that!

  • Hi. I am predominantly an equity and derivative investor. But in that I find the articles you do on High Yield bonds highly informative. Please keep it up. Given that I spend a lot of time on cashflow and balance sheets I should be comfortable with corporate bonds – however it is the legal framework that often frightens me away, (i.e as you point out the covenants and clauses). It strikes me that if an asset is undervalued, then an equity may not always be the best entry into that asset. I need to learn much more. Thanks.
    John

    • john,

      I started outthe same way but kind of “discovered” bonds in 2007/2008. I found bonds very interesting because it combines value investing and game theory,especially in distressed situations.

      Another nice feature is the fact that you always have a catalyst, which is the maturity date.

      Very few investors bother toread the bond prospectuses, so it is relatively easy to gain an advantage here.

      mmi

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