A month or so ago, I wrote a post about my predictions for high yield and default rates in 2011. I did note that there are still enough situations for the average distressed investor to stay busy throughout the year, despite my opinion that default rates will approach 2% this year. In January 2011, we've seen a few defaults (Orchard Brands - Highland, Canyon, and Aladdin involved, ). In addition, we've seen announcements of new fund launches targeting the distressed debt strategy (Daniel Posner at Golub - who I would like to get in contact with FYI). And of course, we've seen some bonds fall like rocks:
The above chart references Harry and David's 9% notes due 2013 (HNDUS for all those on Bloomberg). As of today, this is the worst performing bond in the U.S. high yield / stressed / distressed market that I am aware of - please correct me if I'm wrong. What caused such a dramatic drop?
Before we get to that, what is Harry and David? Harry and David is a specialty retailer. And to give you a sense of what they sell, you can go to these websites:
- www.harryanddavid.com
- www.wolfermans.com
- www.honeybell.com
In addition, the company operates approximately 120 stores across the United States. For quick reference, the total number of stores has declined each year since 2007.
On January 18th, Harry and David issued a press release titled "Harry & David Reports Disappointing Holiday Results - Hires Advisors to Explore Recapitalization Alternatives" ... With a title like that, no wonder the bonds dropped. And boy did they drop. Traders from across the street were making comical markets - UBS was making a 25-40 1x1 market. They promptly tightened it up to 30-40 1x1 (you guys stay solid!)... Things stayed active, UBS stopped trying to poach the weak holders, and bonds settled around 40 at the end of the day. As of Friday night, the market was probably 43.5-44.5 on the 9s of 13.
The press release also disclosed the hiring of Rothschild as financial advisor and Jones Day as legal advisor to explore recapitalization alternatives. In addition, the jugular, as it were, of the press release, was this gem:
"While the Company believes cash on hand is sufficient to fund short-term operations, based on the Company’s current working capital and anticipated working capital requirements and results of operations, the Company will not be able to finance continuing operations without securing new capital and restructuring its obligations. The Company intends to conduct discussions with its revolving credit lenders, bondholders, other creditors and owners in an effort to recapitalize. There can be no assurance that these discussions will be successful."
Net/Net, things seem pretty dire. To give you a sense of the miss, see below (Note 2Q ends 12/31):
In addition, and this could be the first time I've seen this, on the press release, the contact for the "Investment Community" was a restructuring banker at Rothschild.
As can be seen on the chart above, EBITDA for the quarter was down 46%. In addition, in the disclosure, the company noted that EBITDA for the 12 month ended 12/31/2010 was -$17M vs. $21M last year. Going into the quarter (i.e. looking at 9/30 inventory over the past few years), it does not seem like inventory was out of wack:
Sept 2005 Inventory: $117M
Sept 2006 Inventory: $124M
Sept 2007 Inventory: $106M
Sept 2008 Inventory: $100M
Sept 2009 Inventory: $83M
Sept 2010 Inventory: $83M
Comparing inventory / sq foot and inventory / stores presents a slightly worse picture:
As can be seen above, it looks like inventory was 10% higher on an apples to apples basis for Harry and David's footprint. This leads me to believe heavy discounts were put in place to move inventory out the door - hence the lower cash flow margins.
Harry and David is owned by funds by Wasserstein Partners, Highfields Capital, and certain members of current and former management. It was acquired in 2004 for ~$250M ($85M of capital committed with the balance financed with debt). In FY 2005, the company issued the aforementioned senior notes to refinance LBO debt and fund a dividend of $82M meaning that sponsors were effectively playing with "house money." They also paid themselves an annual "sponsor fee" and a few dividends a long the way. After weakening results, a failed IPO, and a covenant amendment, Wasserstein's Chairman Steve Heyer was appointed Chairman and CEO of HNDUS.
So what is this thing worth? Well, before we get to that, we have to point out one salient fact rolling around the markets. For your reference, please see this disclosure from the most recent 10K:
"We own approximately 3,400 acres of land in Oregon, of which approximately 1,900 acres are planted orchards geographically dispersed throughout the Rogue Valley of Southern Oregon at varying elevations and micro-climates. This dispersion has historically allowed us to successfully mitigate the risks associated with frost, wind, hail, storm damage and other inclement weather as well as dependence on any single water source. Also included in our 3,400 acres is our 93-acre campus in Medford, Oregon, which houses our 54,000 square foot bakery, confectionery and chocolate complex dedicated to the production of baked goods, chocolates and confections, our 646,000 square foot fruit packing and gift assembly complex including cold storage, our 72,000 square foot year-round call center and various other distribution and storage facilities. Our owned acreage also includes housing for our seasonal agricultural workforce. We also own a 51-acre campus in Hebron, Ohio, which houses our 275,000 square foot fruit packing and gift assembly complex including cold storage and our 55,000 square foot call center and office space. In the fourth quarter of fiscal 2010, we initiated a plan to shut down our Hebron call center and utilize a third party service provider to complement our Medford call center. The shut down of the Hebron call center was completed during the first quarter of fiscal 2011 and the transition to a third party service provider is in progress. The building which included the call center will still be utilized to support our Hebron distribution operation."
So this company has real estates versus most specialty retailers. Its hard to get a sense for what this acreage is worth. I called a few brokers and Oregan orchard acreage is going for $7500-$10,000/acre but that only gets your to $10-$20M of value. And then you also have to value the Medford and Hebron Campus as well as the non orchard acreage. I find this a very difficult analysis.
On the flip side, you can try to figure out a run rate EBITDA estimate for this company and then apply a conservative multiple. Given that EBITDA margins for this company are all over the place, this too is a difficult analysis. But let's give it a stab.
Before that though, let's figure out our claims pool assuming no leases are rejected in bankruptcy.
Admin Claims:
- Legal / restructuring fees at 3% of total debt = $6M
- DIP to continue operations at average AP through a fiscal year = ~$20M
Unsecured Claims:
- 9% Notes due 2013 = $140M * 1.045 [to account for accrued...i.e 1 missed payment] = $145
- FNRs due 2012 = $59M * 1.025 [to account for accrued based on last floating data ] = $61M
- Underfunded Pension = Underfunded by $30M in June 2010. Assume cap market appreciation in excess of service costs = Pension claim of $25M
- Other GUC = $20M = eyeballing guesstimate.
Some people will ask why I've included underfunded pension. If you do some research on this company you will see vital it its to its community. I do not think they full reject the pension to the PBGC.
You will also remember from above that the company is entering its 3rd quarter with $67M of cash. In each of the last 3 years, the company used a significant amount of cash its its 3rd and 4th quarter - AP is paid down, unearned revenue flows through, etc. I would give the company credit for 50% of its cash balance so say $35M entering bankruptcy.
Using various run rate sales figures and EBITDA margins, we can forecast EBITDA going forward:
As you see I've highlighted the "lower quadrant" of cash flows given my concerns for this business. The average of those numbers are $18M. Specialty retailers trade all over the place right now, but for this type of business I think using 4-5x cash flow makes sense. This translates into the below waterfall:
At these levels, unless I find out the the company is going Chapter 7 and its hard asset value is worth a substantial amount, its hard to get comfortable at these levels. If bonds dropped to the high 20s it would pique my interest. I will keep you all updated as events unfold in this distressed debt case.
I think you're likely understating the cash needs - AP alone is historically around 10MM by the Spring. Also your sales number is optimistic given the continued declines this holiday season when others showed strength; its clear they need to increase price to improve margin, which will depress top line. Good snap shot overall.
ReplyDeleteHunter, good snapshot. I had not looked at the bonds before but know of the company. The problem as you pointed out may be that H&D may be a lot like a vineyard in that you just don't get a great return on replacement cost. At some price, I would guess you could separate the land value and sell off the brand equity of H&D but it definitely does not seem like a slam dunk at these levels given what I know about the business. I had not seen it drop like a rock though so thanks for flagging! - Adrian Meli
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