Octus’ Analysis of 7 Select Drop-Downs Measures Value Moved Away From Non-Ad-Hoc Group Secured Creditors to Junior Creditors or Company to Fund Cash Burn; Recent AMC, Del Monte Transactions Appear Most Aggressive

 

In this article, Octus, formerly Reorg, analyzes seven select drop-down transactions that have occurred since the start of 2022, which are summarized below:
 

Octus concludes that the AMC and Del Monte transactions are the most aggressive of these seven deals. We ranked the aggressiveness of these transactions on the basis of how lenders that were not in the ad hoc group but chose to participate were treated, while noting that lenders that elected not to participate frequently lost all of their value. It should also be noted that the amount of value participating lenders lost, as shown below, may have been higher in these transactions if more creditors had participated.
 

More complex transactions. such as Envision and Trinseo. involved intercompany loans that further dilute recoveries for non-ad-hoc group term lenders. Additionally, many of these deals involve value “moving to the company.” as the new money raised was used to fund near-term operating cash burn.

Given the financial position of these companies prior to these transactions, these may be viewed as simply short-term solutions. Two of the seven companies, Envision and Instant Brands, filed for bankruptcy about six months and one year after their respective deals. Additionally, Trinseo has announced several refinancing transactions in the 18 months since its September 2023 drop-down and exchange transaction.

It is important to note that in this analysis, we are only looking at the value transferred at a fixed point in time and before accounting for the drop-down and/or exchange’s benefit to the company’s financial position. The purpose of this analysis is solely to allow for comparisons between select drop-down transactions under similar controlling assumptions and not to determine the appropriate price reaction of individual securities.
 

In July 2024, AMC announced a comprehensive refinancing in which it dropped down valuable domestic theaters (representing 53% of AMC’s domestic reported LTM EBITDA) along with certain intellectual property, including the AMC brand name, into a newly formed unrestricted subsidiary called Muvico.

Concurrently, AMC launched a debt exchange in which first lien term lenders and certain second lien noteholders were able to exchange their holdings into debt at Muvico at par. This debt was also guaranteed by the existing guarantors of first lien debt, improving the lenders’ collateral package.

The transaction did not raise any new money but did allow the company to push $2.4 billion of debt due in 2026 to 2028 at the earliest. All term lenders, including the 42% not held by the ad hoc group, participated in the deal, while only two-thirds of second lien noteholders were invited to participate. First lien noteholders were excluded from the deal, and an ad hoc group of first lien noteholders sued the company and junior notes agent Glas Trust in September for violating the company’s intercreditor agreement in this transaction.

The transaction terms are summarized below:
 

We estimate that holders of AMC’s 7.5% first lien noteholders lost 6% to 9% of their value while excluded holders of AMC’s 10% second lien notes lost all of their value as a result of the exchange effectuated through the drop-down.

This value was moved to the participating holders of AMC’s 10% second lien notes both those that exchanged into Muvico first lien term loans as well as those that exchanged into Muvico second lien exchangeable notes.

In order to account for potential marshaling issues – with the Muvico debt sharing a first lien on the U.S. Remainco collateral in addition to its Muvico collateral – Octus illustrates two waterfall scenarios and notes that the value moved in both scenarios is similar on the basis of Octus’ valuation estimate.
 

Although value was moved away from AMC first lien noteholders and the now lien-stripped second lien noteholders that were excluded from the deal, debt prices for both securities have risen since the deal announcement and trade at 85 and 100, respectively, as of Feb. 11, reflecting the temporal seniority of the lien-stripped second lien notes, the company’s improved credit outlook following an extension of the company’s maturity wall and the company’s continued use of cash on hand and proceeds raised from the equity markets to reduce debt.
 

In August 2024, Del Monte Foods announced that it had raised $240 million using a drop-down of substantially all of its assets into Del Monte Foods Corp. II, or DMFC, a newly created unrestricted subsidiary. Concurrently, the company launched a debt exchange in which an ad hoc group of term lenders holding 57% of the pre-deal term loans were allowed to exchange their term loans into new first lien second-out term loans at the unsub at par.

Other term lenders were allowed to: (i) exchange up to 30.5% of their holdings into new first lien second-out term loans at DMFC at par and (ii) exchange the remaining 69.5% of their holdings into new first lien third-out term loans at DMFC at par. Octus estimates that about 65% of the non-ad-hoc term loans participated in the deal.

The remaining 15% of term loans declined to participate in the deal, and term loan collateral agent Black Diamond Commercial Finance filed a suit in October primarily arguing that the asset transfers underpinning the drop-down were not allowed and that certain guarantees were not able to be released.
 

Participating lenders also had the option to provide $210 million of new money in the form of $236.4 million of first lien first-out term loans, implying about 12% of original issue discount and/or fees. Octus assumes, for illustrative purposes, that an incremental $30 million of new money was provided by Del Monte Foods’ parent, Del Monte Pacific, in the form of subordinated notes at the unsub, which was part of the disclosed transaction.

Although it is unclear how the $240 million of new-money proceeds were used, Octus assumes 50% was used to fund near-term operating cash burn amid the company’s pack season, with the remainder going to the company’s balance sheet. Octus expects the company will also need to execute on its inventory reduction plans to enhance liquidity beyond the pack season.

Octus estimates that non-ad-hoc group participating lenders lost 64% of their value and nonparticipants lost all of their value. Since it is unclear what percentage of the new money was funded by each lender group, Octus shows the implied value from OID and fees received by participating new-money lenders as a separate line item for each applicable transaction.
 

As of Feb. 11, the first lien, first-out, or FLFO, term loan traded at 100, the first lien, second-out, or FLSO, term loan traded at 66 and the first lien, third-out, or FLTO, term loan traded at 25, according to Solve. The remaining existing term loan traded at 65 as of Feb. 11, down from 76 before the transaction announcement but up from a low of 35 in late August.
 

In March 2024, Rackspace announced that it had raised roughly $275 million of new money effectuated by a drop-down of substantially all of its assets. Concurrently, the company launched a debt exchange in which an ad hoc group holding 73% of pre-deal term loans and about 65% of pre-deal 3.5% secured notes exchanged their debt holdings into new first lien second-out debt at a blended exchange ratio of about 82%.

Other first lien debtholders were allowed to participate in the deal and exchange their holdings at a blended exchange ratio of about 70.5%. About 89% of the non-ad-hoc term lenders and 76% of the non-ad-hoc first lien noteholders participated in the deal, while the remaining holders elected not to participate.
 

Participating lenders also had the option to provide their pro rata share of $275 million of new first lien, first-out term loans issued with a 1% original issue discount. The company used over half of the new proceeds to fund near-term operating cash burn and the purchase of $69 million of 5.375% unsecured notes at an implied price of about 45 cents, with the remainder going to the balance sheet.

Octus estimates that non-ad-hoc group participating first lien noteholders lost about 19% of their value while holders who chose not to participate lost all of their value.
 

As of Feb. 11, the FLFO term loan traded at 104, the FLSO term loan traded at 58 and the 3.5% FLSO secured notes traded at 54, according to Solve. The remaining pre-transaction term loan traded at 36 as of Feb. 11, down from 45 before the transaction announcement.
 

In September 2023, Trinseo announced a $1.077 billion new-money term loan that was facilitated, in part, through a drop-down of its American Styrenics, or AmSty, business, which Octus estimates represented around 35% of Trinseo’s normalized annual adjusted EBITDA. Relative to the existing Trinseo lenders, new-money lenders got a structurally senior claim on the AmSty business as well as a guarantee from previously nonguarantor assets, which Octus estimates represented 15% of Trinseo’s normalized annual adjusted EBITDA.

The $1.077 billion new-money term loan was funded by Apollo, Oaktree and Angelo Gordon with an original issue discount of 2% and injected into the credit group in the form of a $125 million equity contribution, to help effectuate the dropdown and a $948 million secured intercompany loan to the obligors under the original term loan.

Octus summarizes this transaction in two steps to isolate the impact of the drop-down.
 

Proceeds from the new-money loan were used to pay down all of Trinseo’s term loan B-1 due 2024 and $385 million, or 77%, of Trinseo’s senior unsecured notes due 2025. The transaction allowed Trinseo to push out over $1 billion of near-term debt maturities to 2028.

Octus estimates that lenders of the company’s term loan B-2 due 2028 lost nearly 50% of their value on account of the transactions comprising 34% from the drop-down and 15% from the additional guarantee provided to the new-money lenders.
 

In 2024, Trinseo completed a series of transactions culminating in a transaction support agreement announced in December that extended its debt maturities and improved liquidity.
 

In May 2023, U.S. Renal Care announced that it had completed a drop-down of 124 of its clinics representing $60 million, or 35%, of the company’s 2023 full-year projected EBITDA, into a newly created unrestricted subsidiary, which coincidently raised a $328 million new-money term loan.

In July 2023, the company announced a debt exchange, which it characterized as the second part of the drop-down transaction, in which an ad hoc group of term lenders holding 83.5% of term loans exchanged their pre-deal terms loans due 2026 into new Remainco term loans due 2028 at 85 cents, with similar terms open to all term lenders.

Additionally, holders of $344 million, or 68%, of U.S. Renal Care’s 10.625% unsecured notes due 2027 exchanged their holdings into new 10.625% Remainco first lien notes due 2028 at 35 cents and received an additional 20 cents of cash consideration. The company also repurchased $78 million, or 15%, of its unsecured notes at a price of 40 cents. The remaining $83 million, or 16%, of unsecured notes were excluded from the deal.
 

The $328 million new-money term loan was funded by lenders including Centerbridge and King Street with an original issue discount of 2%. Octus estimates that about 50% of proceeds were transferred to the Remainco balance sheet, with the remainder used for the unsecured notes exchange cash consideration, the unsecured notes redemption, and transaction fees and expenses.

Octus estimates that term lenders lost about 20% of their value as a result of the drop-down transaction owing to the value raised by the drop-down assets that was provided to structurally junior creditors or used to fund cash burn.
 

As of Feb. 11, the new Remainco first lien term loan due 2028 traded at 93 and the new 10.625% first lien notes due 2028 traded at 86, according to Solve. The 10.625% unsecured notes traded at 71, up from 22 prior to the initial deal announcement likely due to the capital injection and their temporal seniority following the transaction.
 

In January 2023, Instant Brands transferred all of its tangible assets, estimated to be worth $200 million, to newly formed unrestricted subsidiaries, which used them as collateral for a $55 million loan from sponsor Cornell Capital Partners. Instant Brands used the cash for working capital and to free up liquidity under its ABL facility but ultimately filed for bankruptcy in June 2023.

Octus estimates that term lenders lost about 30% of their value as a result of the drop-down transaction.
 

In November 2024, the trustee of the litigation trust formed in the company’s bankruptcy sued the sponsor and several former company officers for fraudulent transfers pertaining to both the dividend recap completed in 2021 and the January 2023 drop-down transaction. The suit alleges that the value of the transferred assets dropped by nearly 75% to $54 million from $200 million during the bankruptcy process.
 

In April 2022, Envision announced it had raised a $1.1 billion new-money first lien term loan that was facilitated through the drop-down of 83% of the equity of its ambulatory surgery business, or AmSurg. The new money was funded by Centerbridge and Angelo Gordon as new lenders, along with Pimco, King Street, Sculptor and HPS as existing Envision term lenders.

Additionally, these lenders (along with Partners Group, as reported by Octus) effectively exchanged their holdings into a new $1.35 billion second lien term loan at the entity holding 83% of the AmSurg equity, as summarized below:
 

As a result of the second lien exchange, AmSurg extended a series of secured intercompany loans to Envision totaling $1.35 billion. The intercompany loans provided collateral support to the new-money AmSurg first lien lenders and the second lien term lenders as it was pari passu with Envision’s other secured debt immediately following the transaction.
 

To analyze this transaction, we use the market value implied by pre-deal secured debt pricing and reported EBITDA to deduce an implied enterprise value / EBITDA multiple for the company. Octus then applies that same multiple to both the unsub and Remainco to value each silo, although we reiterate that it is possible, and even likely, that investors would attribute different multiples between the unsub and Remainco.

Envision reported $516 million of consolidated adjusted EBITDA in 2021 and $60 million of adjusted EBITDA in 2022. The drop-down transaction was announced in April 2022, and as such, Octus has normalized Envision’s consolidated adjusted EBITDA by taking the average of reported 2021 and 2022 figures, as shown below:
 

According to cleansing materials viewed by Octus, Envision obtained a fair market appraisal of the AmSurg business, dated as of March 11, that determined the fair market enterprise value of it to be $3 billion. However, Octus’ implies that AmSurg was worth around $2.64 billion and Envision Remainco assets were worth approximately $940 million at the time of the drop-down transaction on the basis of the simplified multiple methodology described above.

Octus estimates that 61% of Envision’s value was transferred away in the drop-down, since approximately 83% of AmSurg value was transferred to unrestricted subsidiaries. We want to reiterate that the purpose of this analysis is to evaluate the value moved away from secured lenders and not to determine the fair market value of assets and security prices.

The AmSurg second lien exchange transaction was supported by an ad hoc group that Octus estimates held 29% of Envision’s term loans due 2025, 73% of Envision’s incremental term loans due 2025 and 8.5% of Envision’s senior unsecured notes due 2026.

Non-ad-hoc group term lenders were excluded from participating in this deal, and Octus estimates that they lost about 53% of their value as a result of the drop-down transaction on the basis of our methodology, discussed above.
 

Although a small portion of this value was moved to ad hoc group lenders, the vast majority of this value was moved to the company through the $1.1 billion new-money AmSurg first lien term loan. This money was transferred to Envision Remainco, and Octus assumes this amount was fully spent.

In addition to significant operating headwinds highlighted by the $443 million year-over-year decline in the Envision Remainco silo’s EBITDA to negative $146 million in 2022, surging interest rates in 2022 likely significantly increased Envision’s debt service burden. Octus estimates that Envision Remainco’s cash burn could have approached $1 billion in 2022. Despite this transaction and the one discussed below, Envision and AmSurg filed for Chapter 11 bankruptcy in May 2023.

In August 2022, Envision completed an uptier exchange transaction within the Envision Remainco silo in which it raised a $300 million new-money first-out term loan and sought to exchange all of its remaining $3.8 billion of combined term loans and incremental term loans into new second-out and new third-out term loans.

Parties including Blackstone that held roughly $2.1 billion, or 56%, of the remaining Envision term loans backstopped the $300 million new-money first-out term loan and exchanged their term loans into new second-out term loans. Of the remaining $1.7 billion of Envision term loans, roughly 91% participated in the deal, exchanging $507 million, or the maximum 30%, into new second-out term loans and $1.03 billion into new third-out term loans.
 

Holders of the remaining $153 million of Envision term loans elected not to participate in the deal, thus creating litigation risk for the company. In August 2023, after Envision filed for bankruptcy, these holders filed an adversary complaint against the debtors regarding the Envision uptier transaction. These lenders’ litigation rights in regard to the AmSurg drop-down transaction were settled during bankruptcy proceedings in 2023.

A Note on Methodology

Octus uses a standardized methodology with simplifying assumptions to evaluate these transactions:
 

• We use the market pricing of secured term loans and secured bonds immediately prior to the first deal announcement to get an implied market value for the company.
   
• We then run a pre-deal waterfall to get illustrative recoveries for each security.
   
• We use the market value determined above to determine how much value was dropped down by using a market implied EV/EBITDA multiple (implied market value divided by LTM reported EBITDA or Octus normalized EBITDA in some cases) and applying that same multiple to both the unrestricted subsidiary and Remainco.
   
• We determine the value of the assets at Remainco by using the pre-deal implied market value and adding any net new money transferred from the unsub to the Remainco (unless otherwise stated by the company, we assume that the company is taking some of the value from the new money as it burns cash).
   
• We then run a post-deal waterfall through the pro forma capital structure to get illustrative recoveries for each security.
   
• Finally, we compare recoveries under the pre-deal and post-deal waterfalls to determine the value moved.

We note that this is a gross simplification of the dynamics of these unique transactions, but believe it provides investors with a rubric that is helpful in understanding where an individual transaction may fit within recent history. That said, market participants would be well served by understanding that our process is looking at value based on pre-transaction market prices and not considering how prices moved following the announcement of the deal.

Further, we assume a similar EV/EBITDA multiple across all aspects of a business, which is a gross simplification as it could be assumed that more highly valued (that is, higher multiple businesses) are more likely to be used in a drop-down. That said, this simplified assumption allows us to avoid having to estimate multiples, making comparisons across deals more meaningful.

Our process is also predicated on market prices prior to a transaction’s announcement with the understanding that these prices might already be discounting the possibility of a drop-down transaction. However, again, this is the only way to avoid having to make specific calls as to when a company’s securities started reflecting a potential deal.

Finally, there may be certain backstop and/or commitment fees that may not have been publicly disclosed, which could be understating the amount of value moved away from non-ad-hoc group participants and nonparticipants.