Emeco’s proposed three way merger with other equipment hire companies provides a sustainable way forward for the company as a going concern
Emeco has announced that it has signed a binding restructuring support agreement with peer unlisted equipment hire companies Orionstone and Andy’s Earthmovers
The agreement establishes a framework for the proposed recapitalisation of Emeco, a three way merger between the companies and a $20m equity investment from existing Emeco shareholders through a $20m rights issue. The merger is subject to bondholder and shareholder approval and is expected to be finalised in December. As part of the transaction, Emeco expects to refinance its asset backed loan facility (a key source of liquidity) which matures in December 2017.
In our opinion, the merger and restructuring looks like the best possible result for all stakeholders based on the information provided by the company. Emeco’s high financial leverage was unsustainable and the merger will allow cost and capital synergies to be realised across three complementary businesses.
What is in it for bondholders?
If the merger does proceed, bondholders will receive a proportionate share of new bonds and Emeco equity which we currently estimate delivers around A$364m in value versus A$370m of bonds outstanding (or a 98% recovery on bond principal). On our estimate, the recovery level looks relatively high when you consider the bonds were trading at around ~US$60 levels prior to the merger announcement (that is the bonds were only pricing a recovery level of 60%).
If Emeco were to do nothing, it is likely that the bonds would default and bondholders are usually better served with an issuer as a going concern than having to deal with the complexities of administration and recovery.
For existing Emeco bondholders, we think the best course of action is to hold the bonds and vote to approve the restructuring and merger unless an attractive offer to exit comes before the merger is finalised. We note that 45% of Emeco’s bondholders by face value have already approved the agreement and 75% of total bondholders by face value need to approve the transaction under a creditors’ scheme of arrangement which is scheduled for December. We expect the bonds to rally from recent ~US$60 trading levels following the announcement, however the bond trades very thinly.
Proposed merger and restructuring
The three way merger is complex and involves a restructuring of each of the company’s debts. We are primarily focused on the position of Emeco’s current bondholders before and after the merger, which we have set out in the table below:
| | Position pre merger | Position post merger* | Comments |
| FY16 EBITDA | A$54m | A$110m | The merged entity would have double the earnings after allowing for cost synergies
|
Net debt / EBITDA ratio
Interest cover ratio | 7.2x
1.3x | 4.4x
2.5x | Material improvement in credit metrics with further deleveraging expected as capital expenditure requirements for the merged entity drop
|
| Emeco bondholders | US$282.7m bonds outstanding (A$370m) | Bondholders existing claims will be extinguished and replaced with:
- 63%* of new A$473m 5 year 9.25% senior secured bond (A$298m) plus
- 34% of the equity of the merged company (valued at $66m at 8c per share valuation implied by the rights issue)
- Total value: A$364m
| Emeco bondholders are replacing a A$370m bond position (based on current spot currency rates) with A$364m of value in the form of new bonds (82% of value) and a sizeable equity ownership stake (18% of value) in the merged entity, implying a 98% recovery on AUD principal Note this recovery is subject to changes in currency, the Emeco share price and new bond price post issue and also the finalisation of the merger
|
| Emeco shareholders | - Share price: 5.3c
- High probability of total loss of equity value
|
- $20m rights issue at ~8c per share (or 51% premium to last traded price prior to merger)
- 30% to 35% share of the merged business
| Emeco shareholders are given a lifeline post merger, albeit with a significantly reduced (30% to 35%) ownership stake
|
*FIIG estimate, after allowing for synergies
Selective default
From a rating agency perspective, S&P will treat the restructure as a ‘selective default’ and rate Emeco as ‘SD’ after the merger proceeds. Emeco will be treated as a default in their default studies because bondholders will not receive their full scheduled interest and principal in line with the original bond profile. However, at this stage we believe the ‘SD’ rating and treatment by S&P is unimportant because the new bond will likely attract a better rating than Emeco’s ‘CCC’ rating prior to the announcement of the merger.
For those considering an investment in Emeco, there are a number of factors to consider:
- You won’t get the bond yield to maturity as your holding period return
- Your payoff will include a share of the new bond and a share of Emeco shares, so there will be increased volatility in the return profile
- Emeco may be unable to refinance the asset backed loan
- There remains a risk the merger does not proceed
We think it’s a high risk play suitable for very sophisticated investors (like institutional / hedge funds) and some of these risks are not suitable for the individual bond investor. For the typical bond investor, we think its best to wait for the new bond to be issued by the merged entity and consider that as a standalone credit without the complexities of the restructuring.
A link to the announcement is available here.
Please contact your FIIG representative for further more information and current pricing levels on Emeco.