The yieldy compensation on Service King’s proposed secured loan offering has helped entice investors who foresee a post-COVID-19 turnaround – or strong recovery value in the secured paper if the turnaround fails to live up to expectations, according to five buysiders and two sellsiders looking at the deal.
The collision center operator pitched the new loan, a crucial refinancing of near-term debt, as a bridge to next year’s earnings rebound when the negative effects of the pandemic begin to wane. But blaming the pandemic – and using extensive ‘COVID-addbacks’ – partially obstructs the extent to which the company faced operational and cash flow problems beforehand, four of the sources said.
Even so, if Service King ultimately has to restructure its balance sheet in the years after the pending loan closes, the secured debt has strong recovery prospects, the more bearish sources acknowledged. Service King is owned by Blackstone and Carlyle.
Led by Bank of America, Service King circulated talk last week on its proposed B2/CCC+ USD 700m term loan due 2025 at a hefty Libor+ 700bps (75bps floor) with a 98.5 OID, as reported. Commitments are due 15 December.
BofA told accounts earlier this week that it already had roughly USD 800m of commitments, including USD 325m spoken for via reverse inquiry before the official launch, said two of the sources.
As an indicator, quotes on the existing USD 586m L+ 275bps (1% floor) first lien term loan due 2021 jumped to the 98.3/99.9 context soon after the BofA loan announcement, from 94.9/96.6 prior to the launch, according to Markit.
Not surprisingly, the company is offering potential investors a hyper-inflated pro forma adjusted EBITDA figure of USD 148m, similar to the LTM pro forma adjusted figures that it reported with 3Q20 results last month. That would put leverage at about 4.7x through USD 700m of first lien debt, and 7.3x through USD 1.075bn of total debt.
However, through 3Q20 ended 30 September, the company also posted unadjusted LTM EBITDA of negative USD 16.9m, along with two other incrementally adjusted figures (including USD 89.5m of COVID-19 adjustments).
Investors who agree with the borrower’s pitch classify Service King as a necessary and robust business that can achieve its highly adjusted EBITDA figures once car traffic returns to normalized levels next year.
However, some investors note that given the company’s struggles prior to the pandemic, it needs more than just a bridge to “normalized” times.
Case in point, in December 2019, Service King’s USD 375m 7.875% senior unsecured notes due 2022 traded in the mid-80s for a yield around 14%, according to MarketAxess.
Then on 31 January, Moody’s changed the outlook on Service King (rated B3 at the time) to negative from stable due to a depletion in margins, EBITDA and free cash flow related to pricing pressure from certain carriers and higher costs. At the time, Moody’s expected the company to continue executing efficiency initiatives and increase its store count to offset labor pressures and support earnings growth.
Instead, once government-mandated social distancing took hold, the company wound up closing some stores and revising the purpose of others, said four of the sources.
Cash flow-wise, the company has posted negative funds from operations every quarter since 2Q19, two of the sources said.
The unsecured notes dipped as low as 60 in mid-April – but have rebounded recently and last traded in size at 85.125 to yield 17.717% on 30 November.
The new loan facility will contain a springing maturity at 90 days before the unsecured note maturity in October 2022. Clearlake Capital owns a significant majority of the outstanding bonds, as reported.
Pro forma the deal, liquidity will total nearly USD 200m through USD 112.5m of cash and a new undrawn USD 91m revolver. This compares to an all-cash liquidity of USD 94.5m at 3Q20-end and USD 111m at 2Q20-end.
Earnings-wise, even the more optimistic sources don’t give the company credit for all of its addbacks. On the high end, sources predicted the company could generate USD 100m of adjusted EBITDA annually after a return to normal driving conditions, four of the sources said.
That performance would lead to leverage of 7x through the secured debt and 10.75x total. And at the current talk on the loan, the company’s USD 85m in annual interest expense would eat through most of the EBITDA, sources noted.
In terms of valuation, using the USD 100m in EBITDA and a 10x EV multiple – factoring in a discount to larger peers Boyd Group Services (18x) and O’Reilly Automotive (14x) – Service King’s enterprise value is roughly USD 1bn, or almost enough to cover the entire USD 1.075bn debt stack without any revolver draws.
On the optimistic side, giving credit for the full pro forma 2021 adjusted EBITDA of USD 148m implies USD 1.48bn in enterprise value, or enough to cover all the debt and leave some equity value.
“The yield makes it a no-brainer, especially with the springing maturity. You buy in and get paid, or you [clip the coupon] until you get completely repaid in a restructuring,” one of the sources said.
Still, some investors may opt to wait and pick up the loan in the secondary if it trades down from its issue price, another source noted.
Service King burned USD 94.3m of cash for the nine months through 30 September, based on negative USD 82m of cash from operations and USD 12.3m of capital expenditures, as reported.
However, in October the company provided a cash flow update detailing improving trends. Monthly cash burn contracted to USD 0.2m in August, from a USD 6.8m burn in July and a USD 10.6m burn in June.
Service King included going-concern language in its 3Q20 earnings report, tied to the upcoming revolver and term loan maturities. The existing revolver is set to come due in May 2021 if the company does not address its term loan (due August 2021) by then.
Bank of America declined to comment. Service King did not respond to a request for comment.