Distressed Debt Research: Nebraska Book Bankruptcy

This morning Nebraska Book filed for bankruptcy in Delaware and announced an agreement with a number of creditors in a negotiated restructuring. For those that are interested, you can view the docket here:

Nebraska Book Bankruptcy Docket

In his affidavit to the bankruptcy court, Alan Siemek, CFO of Nebraska Book described the reasons for the bankruptcy filing, as well as the negotiated restructuring the company hopes to move forward with. For those that have not followed Nebraska Book ("NBC" or "the Company"), the company operates two divisions: 1) Its Bookstore division operates nearly 300 managed, leased or owned college bookstore selling new and used textbooks and 2) Its Textbook division which distributes textbooks nationwide. The company was purchased by its current equity sponsor, Weston Presidio in early 2004 with a small equity check and a substantial amount of debt.

Why did the company file? Their trade creditors tightened up on them in the face of a large, unanswered 2011 debt maturity coming due. According to the affidavit:

"Further compounding the Debtors’ refinancing efforts, the Debtors’ business model typically calls for publishers and other merchandise vendors to provide approximately $200 million of new books and other merchandise on normal credit terms in July and August in advance of the back to school" rush. These normal credit terms, which may not be available to the Debtors during the 2011 "back to school" rush because of the uncertainty regarding the refinancing of their debt structure, usually allow the Debtors the opportunity to sell the textbooks (or return them) and sell other merchandise priorto having to pay for the items. This trade credit has been less available to the Debtors in the last several months as publishers and vendors became increasingly concerned about the Debtors’ refinancing process. Absent some action by the Debtors to de-lever their capital structure, the Debtors believe that it is highly unlikely that the publishers and vendors will extend the normal credit terms during the upcoming "back to school" rush. In fact, in the weeks leading up to the Petition Date, all five of the Debtors’ largest suppliers of new textbooks requested that the Debtors pay cash in advance for new textbook orders."

When trade starts asking for cash up front, most debtors fates are sealed.

With the writing on the wall, NBC and its advisors approached interested parties and stakeholders to explore debt restructuring options. It seems the debtor has reached an agreement with 95% of its senior sub note holders and over 75% of their 11% senior discount notes. For reference, here is the corporate and capital structure before the filing (taken from the prospectus of the 2nd lien notes):

As of the filing date, $26M was outstanding under the $75M ABL credit facility (including LOCs).

Under the plan:

• The company has secured a DIP facility comprised of $75M revolving DIP facility and a $125M Term Loan (DIP Term Loan: L+700, 1.25% Floor - take that Dodgers!)
• Trade creditors will be paid in full
• 1st Lien ABL credit facility will be paid in full
• 10% Senior Secured Notes due 2011 paid in cash with adequate protection (more on this later)
• 8.625% Notes will receive a combination of $30.6M in cash, $120M new unsecured note, and 78% of the new company's equity (the cash coming from a new second lien note the company plans to issue)
• Holdco notes will receive 22% of the new company's equity
• Westin Presidio (the sponsor) will receive warrants to buy 5% of the company at a $550M enterprise value (if they agree to support the contemplated restructuring)

In addition, NBC announced that its FY 2011 results (ended March, 31st) with revenues of $598M and EBITDA of more than $60M. For reference, the company generated $75M in EBITDA in FY2010 and $72M the year before.

Near the end of the day, JPM put out markets for the bonds

• 10% Senior Secured Notes: 98.75-99.75
• 8.625% Senior Subs: 70.5-72.5
• 11% Holdco Notes: 5-10

While it hasn't been detailed yet, let's try to figure out the capital structure of the company post the restructuring:

Uses of Cash

1. ~$26M cash to ABL
2. ~$200M cash to Senior Secured Noteholders
3. ~$30.6M cash to Senior Sub Noteholders
4. Administrative fees

Sources of Cash:

1. New contemplated Second Lien Note offering
2. $125 Exit Facility (let's assumed rolled from DIP Term Loan)
3. Current Cash Balance ($20M) + free cash flow generated throughout the bankruptcy

You will note I did not add the new unsecured note as a source of cash as it looks like they will be receiving that without putting up new capital. If we assume free cash flow generated through the bankruptcy will pay down the DIP revolver usage and pay admin fees, the post restructuring balance sheet will look something like this:

• $125M rolled senior secured exit facility
• ~$100M second lien note
• $120M unsecured note

Or total debt of $345M. This seems high relative to $60M of EBITDA or 5.75x. The $345M is approximately equal to the prepetition debt less $150M (from the petition: "The RSA contemplates a pre-arranged restructuring in chapter 11 through which the Debtor will remove approximately $150 million in debt from their prepetition balance sheet while paying general unsecured creditors in full")

There are $175M of subs outstanding as of the petition date. At a current market price of 72 cents on the dollar, the market value is approximately $125M dollars. Remember the subs are getting $30.6M of cash and a $120M unsecured note and 78% of the company's equity. In essence, the market is saying that the unsecured note will trade well below par and the equity is near worthless.

Admittedly it is hard for me to say the company's equity is worthless: Assuming an onerous rate of 7% on the exit, 12% on the second lien and 18% on the unsecured notes, total interest expense will, at worst case, be around $40M. And with $5M of maintenance capex and negligible taxes, EBITDA would have to decline to $45M from $60M (higher if you adjust for PF cost saves), before the company burned cash.

With all that said, I prefer the margin of safety in the pre-petition Senior Secured (second lien to ABL) Notes as well as the DIP Term Loan (and possibly Exit Facility depending on the covenants). The Senior Secured Notes will be taken out at par with cash on the effective date of the restructuring. In addition, according to this filing, an Ad Hoc group of Senior Secured note holders will be receiving MONTHLY interest payments (at the non-default rate) as adequate protection as well as payment of ordinary fees / expenses.

The Senior Secured note holders were not even entitled to this under the pre-petition intercreditor agreement (section 5.4 of the intercreditor provides the only form of adequate protection Second Lien Note holders may seek are replacement liens and superpriority claims that are junior to the superpriority claims of the First Lien lenders). The filing states that the reason for the adequate protection payments in the form of cash money is to avoid litigation.

Please note: The document above only references the Ad Hoc group of Senior Secured note holders. I have yet to find something that supports retail or non Ad Hoc members receiving the same kind of treatment in terms of cash payment.

There is upside here as well if the plan falls through and second lien note holders somehow become the fulcrum, creating the company at a very low valuation. The downside is the plan completely blows up, the company liquidates, etc, something I view as unlikely. At a ~9-10% yield that seems very safe, it definitely looks compelling. The sub notes to me are a more speculative investment but still have an interesting situation with the package being granted. If I had to choose, I'd definitely play higher up in the capital structure in either the DIP Term Loan or Second Lien Notes of Nebraska Book.