First Brands Group After The Fall: The Only Way Out Is Through

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Credit Research: Jared Muroff, CFA

It has been quite a couple of weeks for First Brands Group. While it was exciting for those of us lucky enough to be watching from the sidelines, folks involved in the case certainly could be excused for wishing things were a little more quiescent.

In light of all the news flow, including the appointment this week of Martin De Luca of Boeis Schiller as examiner, and volatility in prices, we continue to see only one path out of this morass – a good, old-fashioned corporate restructuring with the lenders that are willing to provide additional capital bearing the risks and reaping the rewards from a reorganized debtor.

Last week the new-money DIP fell into the 30s before finding a level in the low 50s with reports abounding about how some investors had closed their positions higher and new investors reportedly getting involved. This week brought word of the potential for a follow-on DIP, surely to take priority in some way, shape or form over the existing one with the new-money portion indicated in the high 20s, according to IHS Markit.

We suspect that those new investors and those par-investor term loan holders-cum-DIP lenders who are still white-knuckling it through the bankruptcy process are going to come to learn what Robert Frost taught us: “The best way out is always through.”

For us, as hard as we look from our perch above Fifth Avenue, we see only one way out of this morass. The copious advisors and lawyers need to dig through what books and records there are to unwind this mess, and that is going to take as long as it is going to take.

It is easy to sympathize with the poor souls assigned this Herculean task as they are really up against it. The biggest issue is that in situations like this people are looking for someone to yell at, and our guess is Patrick James is just not picking up those phone calls right now.

The company gave it the old college try last week, announcing three new managers the morning of Dec. 9; holding a call with investors that afternoon, on which the need for additional capital was flagged; and then announcing “Initiatives and Long-Terms Paths to Create Value and Drive Growth” midday on Dec. 12.

All this is well and good, but unfortunately does not resolve the investors’ main gripe, which, to quote Tom Cruise in “Jerry Maguire,” comes down to “Show me the money!” At the end of the day, investors just want to know how they are going to get paid, and how much they will be paid.

Even with that in mind, we believe there remains only one way out of this mess – using the bankruptcy process to effectuate an operational restructuring with a reorganized debtor emerging at some point in the future. In this way, FBG may be an exemplar of what we’ve been seeing more broadly, which augurs well for those of us bored with prepacks and LMEs.

Some may ask, Why can’t First Brands just start selling off the businesses now, whether piecemeal or as a whole? To answer this question, it makes sense to put ourselves into the shoes of a potential buyer of FBG’s business(es). We expect that buyers can be broken into two broad groups, strategic and financial.

Imagine for a moment that you have a company that makes brake pads, air filters and/or wiper blades, and an investment banker pitches you on buying one of the brands from the FBG menagerie. What exactly is it that you are being pitched and more importantly, what is the pitch to your investors? You’ve likely spent a good fraction of your time preaching the importance of supply-chain management in running your business efficiently to anyone who will listen. You’re also likely used to expecting synergies with such a merger as duplicative systems and staff can be made redundant.

For all the talk of a world-class system for supply-chain financing, we’ve yet to hear folks crow about FBG’s supply-chain management system. After all, should we believe that the company took the time and effort to accurately generate this list (which calls this to mind) provided to the inventory lessor? Allegedfraudsters aren’t necessarily renowned for their record keeping, and in most cases, the fewer people involved in such things, the better (for the perpetrator). After all, there is a reason the advisors are so thick on the ground at FBG and having trouble reporting results.

In addition to the cloudy nature of the company’s current operations, not to harp on the lack of income statements and balance sheets in the most recent monthly operating report, this is the rare bankruptcy where the operating results likely should not be thought about net of the restructuring fees. Normally, when analyzing a bankrupt company, analysts will assume that the restructuring expenses are those associated with the bankruptcy case (lawyers, advisors, etc.) and will fall away quickly once the company exits bankruptcy.

In this case, we would argue that some fraction of those costs – how much we won’t hazard a guess – are likely due to the lack of strong systems and controls at FBG, something that will not hold once the company exits bankruptcy. One way to think of this is that in the case of FBG, advisors are a cost of doing business, not a cost of bankruptcy.

Thus, as a strategic buyer, you are looking at bringing on a whole bunch of additional work to gain what, exactly? Again, if we stipulate that the inventory and accounts receivable management systems leave something to be desired, then you are buying a brand and employees and one could imagine some technical knowhow. Is a purchase like this worth the effort, or does it make more sense to use the disarray at a competitor as a chance to increase market share. Said differently, what is the upside of getting involved in the business at this point if you are not already exposed to it?

That leaves us with a financial buyer. The financial buyers sure love rollups, and we would imagine they are likely going to want to take over all of FBG. Although it’s possible some junior analyst somewhere can opine on why brake pads are a better business than air filters, we don’t trust anyone’s opinion on this unless they have grease under their nails after a hard day at the office, and scale is the name of the financial sponsor’s game.

Although a financial buyer is going to suffer all the issues laid out above, Wall Street loves nothing more than making a return by setting a company right, and FBG is likely to prove no exception. That said, it becomes a question of who is going to make that return. We would imagine this is exactly the discussion that is being had in the conference rooms of the new players as they purchase stakes in the DIP.

One could imagine that they are entering the trade with their eyes wide open, understanding that there may indeed be a need for additional capital at the company, which no doubt they are more than ready to provide. It is an open question whether the potential return in an FBG turnaround will be enough for both these DIP buyers and a future financial buyer of the whole business to pencil out an appropriate return.

We would also question whether the folks putting new money to work in FBG last week would be willing to allow a different buyer to make a return that they might rightfully view as theirs. As always, he/she who risks it, gets the biscuit and distressed investing is often about finding the security with equity-like returns. Thus, we would see last week’s trading as a sign that FBG may already have been “sold” to some extent in that tranche A DIP holders, both new and existing alike, are underwriting the trade for equity-like returns that only come from owning the company.