Nesco Rentals pitched its return to the high yield market on a rosy sales outlook as utility and telecoms clients build out networks. But some buysiders are wary, given the issuer’s ill-timed attempt to ride the energy boom earlier this decade, said seven sources.

The transaction, which will fund Nesco’s acquisition by a SPAC, is the borrower’s first foray into the bond market since a USD 525m second lien deal in 2014. The borrower experienced a bout of distress in 2015 amid a liquidity crunch driven partly by the oil and gas downturn.

Led by JPMorgan, the company earlier this week began marketing USD 475m of Caa1/B second lien secured notes due 2024. Pricing whispers started in the low 9% area, but official price talk emerged today (26 July) at 9.75%-10% area, before the deal was eventually priced at 10% and par.

Alongside the wider pricing, the issuer also announced changes to the covenant package, including tighter restricted payments language and extra limitations on secured debt, the sources said.

The notes will fund Nesco’s take-public via a merger with NYSE-listed Capitol Investment Corp and refinance the company’s outstanding debt. Capitol is contributing USD 200m of equity to the deal.

Energy Capital Partners, which acquired Nesco from Platinum Equity back in 2014, will maintain an equity stake in the company, according to deal documents. It will also continue to support the company with board representation.

The deal leaves Nesco 5.3x levered through USD 647m of total debt, based on USD 123m of LTM adjusted EBITDA as of March, according to deal documents. Accounting for a USD 28m ABL draw and USD 132m of run-rate adjusted EBITDA as of 2Q19, leverage is 5.1x.

The revolver draw in the second quarter funded investments in the company’s fleet. Liquidity is USD 191m based on remaining availability under the company’s USD 350m ABL and USD 4m of cash.

Rising demand

Nesco provides heavy-duty equipment such as bucket and digger trucks, cranes, and other specialty tools and parts, which are primarily used for building out electricity, telecom and rail networks.

Since the company is in growth mode, it is unlikely to generate positive cashflow until 2021, as it increased capex spending to expand its fleet and satisfy customer demand, the sources said.

In 2019, Nesco is expected to burn USD 4m of cash, using the sources’ projections of USD 137m adjusted EBITDA and USD 91m of capex, plus USD 50m of interest expense based on current price talk.

The sources said they expect EBITDA to reach USD 160m-170m in 2020, but also for capex to increase to USD 117m. That could lead to a cash burn of up to USD 7m, or up to USD 3m of free cash flow.

Nesco is expected to complete its fleet ramp-up by 2021, potentially leading to free cash flow of USD 46m-USD 74m, the sources said. That’s based on USD 170m-USD 198m of adjusted EBITDA, lower capex at USD 74m and USD 50m of interest costs.

The company’s equipment rental and sales business generated 88% of revenue in 2018, with the remainder coming from parts, tools and accessories. Nesco expects to grow its equipment fleet by more than 40% over the next three years to meet rising client demand, according to company documents.

However, the sources approached the company’s growth optimism with caution, citing its slide into distress during the energy sector downturn in 2015 and 2016.

“The company is marketing the deal on earnings and fleet growth, supported by end markets with demand,” one of the sources said. “While that’s a good point, they said that in 2015 and fell into distress not too long after.”

In 2015, Nesco’s growth plans pushed it into cash burn territory. In response, the company aimed to slash capex and reduce its reliance on the ABL facility. Leverage at the time was roughly 7.5x, based on USD 98m of EBITDA and USD 732m of total debt.

But the company’s bonds plummeted two months later on weak preliminary earnings, ultimately leading to a credit facility amendment. Nesco’s USD 525m 6.875% second lien notes due 2021 dropped to 65 for a 16.86% yield, from quotes in the 86-87 context in May of 2015.

This history has made the sources wary of the company’s latest push for growth, despite strong tailwinds in the equipment rental sector that have benefited recent issuers such as Herc Rentals and United Rentals.

However, some buysiders noted that Nesco’s distress in 2015-2016 was driven by its focus on energy clients, arguing that the sectors it now sells into are less cyclically vulnerable.

“They’re not betting on one horse anymore and it seems like they know that they need to continue expanding in other end-markets, hence the shift to telecom and rail since the last time they came to the market,” one of the sources said.

Diversification

At the time of its descent into distress, Nesco was highly reliant on its transmission and distribution business, which sells mainly to clients in the energy and utilities space. That division’s contribution to revenue has since decreased to 68% in 2018, according to deal documents.

The company is benefitting from a shift towards renewable energy and gas—particularly given the rising popularity of electric cars and heating technology, which the US Energy Information Administration says requires an extension of the power grid. Private sector utility companies are expected to invest roughly USD 89bn on transmission facilities between 2018 and 2021, according to the Edison Electric Institute.

Nesco also plans to expand its parts, tools and accessories (PTA) segment—introduced in 2015 when the company was in distress—to further diversify its earnings. The company intends to grow to six PTA locations nationwide by 2020, from two locations currently.

Demand from telecom clients is also expected to grow as companies roll out 5G networks. Nesco’s equipment is well suited to service the typical deployment locations for 5G equipment on telephone poles, streetlights and buildings facades, according to three of the sources.

Based on the deal’s 9.75%-10% price talk, Nesco’s secured deal is set to trade at a significant premium to the unsecured debt of peers such as United Rentals and Herc. The sources said this reflected Nesco’s smaller size, lower ratings and its history of distress.

United Rental’s USD 750m 4.625% senior unsecured notes due 2025, rated Ba3/BB-, traded last week at 101.099 to yield 4.255%, according to MarketAxess. Herc’s B3/B+ USD 1.2bn 5.5% senior unsecured notes due 2027 trade at 100.625 to yield 5.375%.

For a comp at the secured debt level, the sources pointed to Williams Scotsman’s B3/B USD 490m 6.875% senior secured notes due 2023, which last traded on 19 July at 104.875 to yield 5.132%—again, significantly tighter than the high 10% whispers on Nesco’s offering.

The deal offers an almost 400ps pickup to the average yield of 6.09% for B rated bonds, but a discount to the 11.89% average yield for bonds rated CCC, according to the ICE BofAML high yield index.

JPMorgan and Nesco did not respond to requests for comment. Capitol did not respond to a request for comment.

2019 Debtwire