Merlin CDS Comes Into Play as Investors Assess Orphanage Risk for SUNs Reference Entity Ahead of Looming 2027 Maturity; Inverted Curve With 2Y CDS Wider

Investors are assessing whether CDS referencing Motion BondCo DAC, the issuer of Merlin Entertainments’ 2027 senior unsecured notes, could become orphaned if a transaction is engineered that allows those notes to be repaid at par, sources told Octus. While CDS activity on Merlin was muted until recently, it picked up substantially last week, showing an increased interest from buy-siders on trading the instruments and figuring out the potential routes to an orphanage, sources said.

A CDS orphaning trade is a position in which protection sellers expect the debt sitting at the CDS reference entity to be repaid or removed without the CDS transferring to a new obligation, leaving the contract referencing an entity with no meaningful debt outstanding. As such, CDS sellers would make money from selling the instrument without having to pay out CDS buyers as the credit default swaps could no longer be triggered. In Merlin’s case, that matters because Motion BondCo DAC is the issuing entity for the €370 million and $410 million SUNs due 2027, with no further debt issued out of it. The five-year CDS referencing Motion BondCo DAC trades at around 318 bps, while the euro notes are quoted at 95.5, yielding about 8%.

The crux of the trade is that Merlin needs to address the 2027 SUNs before they create a broader maturity problem elsewhere in the structure. The SUNs are subordinated to the group’s senior secured debt, but they are trading materially tighter than the secured bonds because of their temporal seniority. If the 2027s remain outstanding, Merlin’s RCF springs forward to July 15, 2027, while the rest of the senior secured debt springs forward on Aug. 15, 2027. As a result, the market is pricing the SUNs as debt that the company has a strong incentive to take out, rather than as junior paper that simply reflects where value breaks.

Pricing Dislocation

The pricing dislocation is clear across both bonds and CDS. The euro 2027 SUNs issued by Motion BondCo DAC are quoted at 95.5, yielding about 8%, while the euro 2030 senior secured notes issued by Motion Finco Sàrl are quoted at 84.5, yielding 12.42%. CDS pricing shows a similar distinction, with CDS on Motion BondCo DAC around 320 bps, compared with a five-year spread of 1,050 bps on Motion Finco Sàrl.

This reflects the market’s view that the subordinated 2027s may be taken out before the senior secured debt becomes current. However, for the CDS orphaning trade to work, the form of that takeout is critical. A clean redemption or refinancing at par could orphan the Motion BondCo CDS. An exchange, amend-and-extend or discounted liability management transaction would instead lead to the CDS to travel to a continuing obligation and remain outstanding as a result.

Pari-Plus Route

One potential route to a clean takeout is a pari-plus financing raised elsewhere in the structure. Under this type of transaction, value or security could be stripped from existing senior secured creditors and moved outside the restricted group. Merlin could then raise new financing that benefits from the original security package plus the additional security that had been moved away from the existing SSNs. The result is new debt that is pari passu with the SSNs on the existing collateral, “plus” additional collateral that the existing SSNs do not share.

If the proceeds of that financing were then used to redeem the Motion BondCo DAC 2027 SUNs at par, the CDS orphaning thesis would remain intact. The SUNs would disappear from the reference entity, while the new financing would sit elsewhere in the group and would not represent a continuation of the Motion BondCo obligations.

That distinguishes a pari-plus-funded redemption from a pari-plus exchange. If SUN holders were exchanged directly into new secured or enhanced-collateral paper, CDS may follow the exchanged obligation, depending on the transaction structure and successor mechanics. A par redemption funded by separate new money is therefore cleaner for orphaning purposes than an exchange of the reference obligations.

The key question for the Merlin CDS trade is not whether the 2027 SUNs are addressed, but whether they are addressed through a clean par repayment. A pari-plus financing, asset sale, sale-and-leaseback, secured financing or sponsor equity injection could all support the orphaning trade if the proceeds are used to repay the SUNs at par, sources noted. By contrast, an amend-and-extend, discounted exchange, uptier or exchange into pari-plus paper could keep the CDS alive and expose protection sellers to widening risk. In a scenario where holdouts are coerced into exchanging, or in the event of a mandatory extension, the CDS would also remain alive and be triggered, they added.

Background

On top of the £616 million-equivalent of SUNs, the group has £3.265 billion of senior secured debt, comprising a £428 million RCF due in May 2029, and €1.02 billion and $1.273 billion of term loan Bs due in November 2029. As well as the senior facilities, the group has €700 million of SSNs due in 2030, $500 million SSNs due in 2031 and $410 million SSNs due in 2032. The senior secured debt is quoted in the low 80s and yields above 10%.

The looming maturity on the SUNs comes amid continued weakness in the group’s operational performance and reliance on shareholder support to manage cash burn.

Kirkland & Ellis advised Merlin on its original financing package and has been long-term legal counsel to the group, according to sources.

The company completed the sale of its LEGO Discovery Centres and Legoland Discovery Centres to the LEGO Group in February for a cash consideration of £221 million, which provided it with more than £200 million of liquidity, as reported.

Proceeds from the sale were used to repay drawings on the RCF and cover cash burn during the quarter, sources said earlier. The transaction, while signaling shareholder support, was not transformative.

The market has been pricing in a liability management exercise risk, as indicated by stressed price levels for the secured debt. Octus analysis on Merlin’s LME options is available HERE.

On the first-quarter earnings call, management refrained from providing any guidance on its refinancing plans or whether it may consider an option that would impair creditors. It noted that shareholders remain supportive and that the company is actively evaluating refinancing options and continues to monitor capital markets closely with a clear focus on maintaining an efficient and well-balanced maturity profile.