Distressed Debt Investing - AbitibiBowater

First of all, thank you all for participating in the Distressed Debt Investing Poll.  Your feedback has been helpful in allowing me to better guage our reader's interest.  As you can see from the poll results, Distressed Debt Investing is going to start zeroing in on distressed debt concepts and distressed debt case studies.

In that regard, a reader has sent me a very interesting write-up on AbitibiBowater's Bankruptcy.  I have been following the situation for quite sometime and present to your some thoughts on the bankruptcy, the valuation, etc.

First off, here is the link to the AbitibiBankruptcy U.S. Docket: ABH U.S. Docket as well as a link to ABH's Restructuring Information on their website.

Warning, this post is highly technical and complicated and this case is a complicated one. But that should not stop us from probing to see if we can find some hidden value. To simplify things, we are going to focus solely on one debt instrument here.  In future posts, as we continue to dig into the situation, we will expand the analysis to include other debt instruments.

To start, some background. From the company's website:

"AbitibiBowater produces a wide range of newsprint, commercial printing papers, market pulp and wood products. It is the eighth largest publicly traded pulp and paper manufacturer in the world. AbitibiBowater owns or operates 23 pulp and paper facilities and 30 wood products facilities located in the United States, Canada, the United Kingdom and South Korea. Marketing its products in more than 90 countries, the Company is also among the world's largest recyclers of old newspapers and magazines, and has third-party certified 100% of its managed woodlands to sustainable forest management standards."

On April 16, AbitibiBowater Inc. (ABH) and its primary subsidiaries, Bowater Inc. (BI –U.S. assets), Bowater Canada (BCFPI – Canadian assets), Newsprint South (NS – U.S. assets), Abitibi Consolidated (ACI –Canadian assets), and Donohue (Dcorp – U.S. assets) filed for protection from their creditors in a complex cross-border filing under both Chapter 11 bankruptcy in the US (Delaware case #09-11296) and the Companies’ Creditors Arrangement Act in Canada (Montreal). 

For those reviewing the company for the first time, think of ABH as holdco for the Abitibi and Bowater groups of the business (separate legal, capital and cash flow structures). The Abitibi group controls the ACI and Dcorp entities while Bowater has BI, BCFPI, and NS.  (Didn't I tell you this could get confusing!)

After various exchange offers made to bondholders earlier in the year failed, the clock ran out on ABH.  It found itself simply over-levered (nearly 12x levered), unable to raise capital for debt maturities, and stuck in secularly and cyclically declining newsprint and specialty paper businesses.  

ABH’s challenge is now to execute a textbook reorganization in hopes of extracting value to its most meaningful stakeholders at this time – creditors and employees.  The equity is out of the money with little or no chance of recovery.  Operationally, ABH will need to restructure around its core, low-cost paper mills, close unprofitable facilities, and complete several announced and valuable (hydro) asset sales while pursuing others (timberlands).  Of ABH’s 16,000 employees, 11,000 reside in Canada.  

Management recently reminded an investor audience that they employ more people in Canada than GM and it may not be coincidental that the government of Quebec has both indirectly bid on ABH’s valuable Quebec hydro assets and provided a below-market guarantee for ABH’s incremental DIP.  In doing so, it helps support the timing and process of this critical asset sale while providing additional super-priority funding to help ABH pay for some of the costs to close facilities, pay advisors and maintain adequate working capital.

Here is a listing of  ABH's debt securities, and how what assets (per entity) secures that debt:

For this post alone, we are going to be focused on the 13.75% Secured Notes.

You ask why this particular instrument? In 2008, ABH had their backs against the walls and needed to do a refinancing of maturing debt. To accomplish this, the company needed to pledge virtually all of its available fixed assets to the new securities. And that is exactly what they did. The 364 day Term Loan (we will post on that one soon) got working capital and the 13.75% Senior Secured Notes due 2011 got the fixed assets (the paper mills and the hydro assets).

More specifically, the secured notes ($413M principal plus $28M accrued) are secured (actually second to up to $87 million priming DIP lien – motion currently in front of court) by hydro assets with an announced sale value $540 million plus a first lien in 11 of ACI’s paper facilities with a book value of $1.4 billion (3.6M tons of capacity) and estimated 2008 Ebitda generation of $260M.

Assuming a very conservative case of over a 50% drop in EBITDA to $125M and a 4x multiple, gives us a value just on the 11 paper facilities of $500M.  This also equates to a $ per ton value of $139 (500M/3.6M tons of capacity), which in my opinion is quite conservative.  9 of these facilities are operating, and a recent court document suggests that based on 2009 EBITDA, these mills are worth $750M. Nonetheless, at Distressed Debt Investing, we like to be conservative and thus will use the lessor of the two or $500M.

Assuming the mills are worth $500M and the Hydro assets net $540M, there would be $1.040B of value that the noteholders would be able to get their hands on. In front of them, would be the current and future DIP draws (currently $87M) and bankruptcy administration fees (conservative estimate of $75M).  In other words, there is $878M ($1.04B-$87M DIP - $75M bankruptcy fees) vs $413M of notes, or over 2x coverage. However, if the hydro sales do not close as planned or cash restructuring costs mount, coverage will drop. 

In our opinion, ACI’s 13.75% Secured Notes at 85 cents may offer value at a 26% annual yield over a twenty-four month holding period, with a substantial margin of safety.  However, it is unclear whether post-petition interest will be paid in cash or accrue and the extent to which incremental DIP lending with priming liens will be required to affect ACI’s side of the reorganization.

Lastly, uncertainty surrounding exit financing for a difficult business cannot be overlooked.  If all goes well with ACI’s restructuring and the company can successfully pare down around a more profitable core, then the Secured Notes should be paid off or refinanced upon exit from bankruptcy.   If industry conditions continue to deteriorate at the ongoing rate, however, its uncertain how the core will look relative to liabilities to pay.

In future posts on Distressed Debt Investing, we will look at the 364 Day Term Loan, as well as some of the other debt instruments. For now, the 13.75% Senior Secured Notes look to offer the best risk adjusted return.