Altice’s dropdown is a warning for European creditors

For European investors, media firm Altice’s brewing fight with creditors could be a sign of things to come.

In March, the French company became the first borrower in Europe to carry out a so-called liability management exercise, in which a troubled borrower moves assets beyond the reach of some of its creditors.

Altice’s controversial ‘dropdown’ transaction effectively shifted assets worth €2.3 billion ($2.5 billion) outside the scope of covenants that are meant to protect the interests of creditors.

Bondholders were hoping Altice would use proceeds from the sale of the assets to repay debt. Now, those lenders may have no claim over the assets at all.

The controversial exercise was possible because of a drab, easy-to-miss eight-word phrase in the company’s bond documents. Analysts at Moody’s reckon the same exemption exists in perhaps a fifth of all European high-yield debt issued since 2022.

Exemption

It’s normal for such documents to allow borrowers to make so-called ‘restricted payments’ under certain conditions. The term is legal jargon for a set of specified actions, including the re-designation of restricted subsidiaries as unrestricted, such that covenants no longer apply. 

Such allowances were intended to help companies grow. A firm might wish to sell some of its business units or pay dividends or repurchase equity, for example.

The payments are supposed to occur only within narrow parameters, however. A standard test requires a company to stay below a given leverage threshold.

Over the past 20 years, as lending covenants broadly have loosened, controls relating to restricted payments have loosened too. The amounts payable and the safeguards to stop the abuse of such payments have weakened.

Altice, then, took advantage of a so-called ‘build-up basket’ – a kind of budget for potential restricted payments that accumulates over time. And thanks to the eight-word addition to its documents, the media company was able to access this capacity more easily.

The extra language in the company’s restricted payments covenant exempted actions termed ‘restricted investments’ from any leverage test, which allowed the firm to redesignate its subsidiaries as unrestricted before their sale. A standard test requires a borrower to keep leverage below four times Ebitda. Altice’s leverage was 6.4 times at the time of dropdown.

Altice was a likely outlier in terms of the volume of assets it was able to move. Build-up baskets can be created with so-called ‘starter amounts’, as if a company had accumulated capacity in the basket for a period already. And Altice’s was backdated 10 years, versus a market norm of one.

The exemption from the leverage ratio test, though, is not uncommon, reckons Moody’s. 

What’s more, recent deals show that investors continue to accept loosely drafted documents. Packaging producer Ren de Medici, gambling firm Gruppo Lottomattica and medical diagnostics firm Synlab have all issued debt in recent months with terms that permit the borrower to set up unrestricted subsidiaries without first passing a leverage ratio test. 

Other recent issuers have gone further. Technology company Garrett Motion, theme park operator Merlin Entertainment and furniture retailer Mobilux are exempted from passing a leverage test when making any kind of ‘restricted payment’ at all.

Some also contain backdated build-up baskets of up to four-and-a-half years. Many provide starter amounts. Garrett can make restricted payments of around $700 million from day one.

Going forward, companies have no obligation to tell investors the amount of capacity in their build-up basket – and, therefore, their scope to drop down assets. Jen Pence, senior credit officer covering covenants at Moody’s Ratings, describes that as “surprising”.

“Due to loose covenants, the documentation has not prevented these transactions from happening,” she goes on. 

What does this mean for creditors? Thinning protections in loan documents are leaving investors exposed to “death by a thousand paper cuts”, Pence says.

Editing by Rob Mannix