Slater & Gordon Limited's (ASX:SGH) ("SGH") lenders have abandoned the company, selling their debt in the distressed legal eagle for a fraction of its true worth.
As reported by Fairfax media, Citigroup and Macquarie have recently sold their share of Slater & Gordon's debt at around 38 cents in the dollar and 45 cents in the dollar respectively.
This means that the buyers, which reportedly include hedge fund Anchorage Capital, paid less than $0.50 for every $1 in debt owed.
Such low prices imply that Slater & Gordon is at risk of going out of business. Even Fortescue Metals Group Limited (ASX :FMG) debt didn't trade that low – back when everyone thought it was going broke – with its bonds being worth about 50 cents in the dollar at their nadir last year.
Slater & Gordon's debt is way outside what is considered normal for a bank lender. ASX-listed companies are normally limited to a net debt position of around 3.5x their Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) and, with SGH having $600 million in debt and minimal EBITDA, it is not surprising that bankers have dumped their exposure.
I couldn't find mention of any specific covenants with lenders in Slater & Gordon's most recent annual report. Its debt arrangements had recently been renegotiated with lenders in order to give the company more time to sort itself out but, even so, Slater & Gordon has a big chunk of debt coming due in May 2018 and the remainder due in early 2019.
The way things have been going, it's looking increasingly unlikely that Slater & Gordon will be able to repay all its debt.
In fact, Slater & Gordon is little more than a giant debt pile at the moment, with Net Tangible Assets (NTA) of negative 25 cents per share and the shares valued at 30 cents apiece.
In effect, for every 30 cents you pay for the shares, you can add another 25 cents in owed liabilities on top of that.
According to Fairfax, insolvency firm McGrathNicol just released a report suggesting that an additional restructure or recapitalisation of Slater & Gordon's debt will be required to get the company back on a stable footing.
A debt-for-equity swap was suggested, but whether lenders will actually want a piece of Slater & Gordon's equity (shares) on the open market is an open question.
What they may want is to force bankruptcy if Slater & Gordon breaches its debt covenants and then look to write off the loss-making businesses, before attempting to sell the profitable businesses for more than they paid for the debt.
In fact lenders to distressed or debt swamped companies have a variety of ways of reclaiming their investment, and none of them is good news for shareholders. It's uncertain if Slater & Gordon is at risk of breaching its covenants, but even a debt for equity swap that left SGH on market would absolutely crush the value of current shareholders' holdings.
With no earnings, a huge pile of debt, and the same CEO in charge that lead Slater & Gordon into this mess, it's tough to see anything attractive in the company and I believe ordinary investors should keep well clear.
