Service King faces a daunting 2021-22 maturity schedule that will be difficult to address with a regular-way refinancing given its high leverage and dwindling cash, said four sources familiar with the matter. However, trading levels across its capital structure imply the company has levers to pull, and that in a restructuring its unsecured bonds could capture equity upside.
Some investors take the view that the company should embark on a global refinancing or restructuring sooner rather than later, since it will have a hard time refinancing its 2021 term loans into paper that matures outside the unsecured notes due 2022.
“The company can’t deal with the term loan and revolver without addressing the bonds that are coming due a year later,” one of the sources said.
However, others note that the company could pursue a multi-stage liability management strategy that could buy it some time to grow back into its capital structure – though such a strategy could still require additional support from its sponsors, Blackstone Group and Carlyle.
Moreover, the chasm between the company’s reported EBITDA and its COVID-19-adjusted EBITDA sets up a potential case study in how to value companies considering a balance sheet workout in large part due to the pandemic’s disruption.
The company posted USD 61.2m of adjusted LTM EBITDA as of 30 June, while COVID-19-adjusted EBITDA is more than double at USD 140m, as reported. The latter figure factors in volume margin normalization, labor savings as well as COVID-19 adjustments.
On an unadjusted basis, leverage balloons to 11.7x through the first lien and 17.8x total through roughly USD 1.09bn of total debt. Giving credit for a total USD 78.8m of addbacks, leverage is 5.1x through the first lien and 7.8x total.
The company’s USD 375m 7.875% senior unsecured notes due 2022 last traded on 3 August at 78.25, down from trades at 81 on 14 July before the earnings report, according to MarketAxess.
The USD 600m Libor+ 275bps (1% floor) first lien term loan due August 2021 is quoted today in the 87.359/89.563 context, down from quotes at 89.038/91.2 on 28 July, according to Markit. The company also has a fully tapped USD 100m revolver due August 2021.
The company could ask existing lenders to extend the 2021 maturity, while raising an add-on secured loan or bond to pad cash for the next year or two. That could give it time to show an earnings rebound from the depths of the COVID-19 environment before addressing the bonds.
But even if real EBITDA grows back to the COVID-19-adjusted estimate of USD 140m, leverage would still be high. Assuming a theoretical USD 100m in add-on debt on top of Service King’s existing USD 1.09bn in debt, leverage through the bonds would amount to an elevated 8.5x.
At those metrics, Blackstone – which purchased a majority stake of the company from Carlyle in 2014 – could be incentivized to inject additional cash to facilitate an extension or refinancing of the bonds in order to preserve equity value, two of the sources said.
Current bond trading levels around 80 don’t offer much opportunity to delever via distressed exchange. They do imply that if the company can’t raise any cash in the near-term and is forced to contemplate a full balance sheet restructuring, the bonds could obtain a full recovery – even if via equitization.
Using the unadjusted EBITDA of USD 65m and a 10x EV multiple – factoring in a discount to larger peers Boyd Group Services (13x) and O’Reilly Automotive (16x) – Service King’s valuation is just USD 650m, or not enough to cover the current USD 700m in bank debt. Giving credit for the full COVID-19-adjusted EBITDA of USD 140m implies USD 1.4bn in value, or enough to cover all the debt and leave some equity value.
One source suggested an appropriate EBITDA level to reorganize around is the USD 115m area, which gives partial credit for COVID adjustments. At a 10x multiple that would cover most of the debt, with the bulk of the bonds’ recovery in the form of equity, assuming reorganized leverage no higher than 5x-6x.
As of 30 June, Service King had USD 111m of cash on its balance sheet – after fully drawing the remaining availability on its USD 100m revolver during 1Q – but only about USD 33m of that is unencumbered cash, two of the sources said.
The remaining balance is linked to a prebate from the company’s paint supplier Axalta and cannot be used for a debt paydown but can be used for operating expenses, the sources added.
One source estimates that the company will burn roughly USD 25m-30m in 2020, based on USD 65m of run-rate EBITDA, USD 25m-30m of capex and USD 65m of interest expense.
Another source estimated that going forward, the company will likely burn up to USD 10m in 3Q and roughly break even in 4Q.
Either way, Service King would face a tight liquidity picture next year, the sources noted. The company is currently exploring a reduction in some of its lease payments, said one of the sources.
For the quarter ended 30 June, the company reported an EBITDA decline of 109% year-over-year to negative USD 29.1m, as reported. On last week’s earnings call, the company didn’t hold a Q&A session – for the second consecutive quarter, two of the sources said.
On its advisory roster, the company has hired PJT Partners and Kirkland and Ellis to assist on strategic alternatives, as reported. Meanwhile, an ad hoc group of lenders added Evercore and Gibson Dunn to their roster to prepare for potential negotiations. A bondholder group has also formed with Houlihan Lokey and Akin Gump.
Service King did not respond to a request for comment. Blackstone did not respond to a request for comment.