Distressed funds circle Spain's Cortefiel

LONDON (Reuters) - Vulture funds are finally saying debt from Spanish retailer Cortefiel is now cheap enough to buy, after waiting for months to see prices of the struggling company's debt fall further.

The funds, which have raised billions of dollars to invest on the hopes that a worsening global economy will depress debt prices, are closely monitoring the Spanish group whose debt trades at about 42 percent of its face value.

"At these levels, you have to start thinking," said a hedge fund manager, under the condition of anonymity.

Cortefiel, owned by private equity firms Permira, CVC and PAI Partners is struggling as the Spanish economy slows in the wake of the credit crunch after a real estate bubble in the country burst.

The company's owners are trying to ruthlessly cut costs, at a pace of about 44 million euros per year, according to a person familiar with the situation.

CVC declined to comment, while PAI Partners and Permira did not return phone calls seeking comment.

Cortefiel borrowed 1.3 billion euros in June last year in a recapitalisation of its 2005 buy-out debt, when the three private equity firms bought the company.

Cortefiel's debt is now about 1.080 billion euros, another source familiar with the situation said.

Its trading company holds 650 million euros of debt, while another 450 million euros were borrowed by a holding company in Luxembourg, which own 85 percent of Cortefiel through another holding company, the source said.

The debt held by the Luxemburg vehicle was paid out to the private equity owners, the source also said.

Private equity firms have been criticised for heavily indebting the companies they own in order to pay themselves bonuses and to boost the enterprise value -- which adds the value of equity and debt -- of the companies.

Cortefiel's estimate is to generate between 180 to 190 million in annual earnings before interest, taxes, depreciation and amortisation (EBITDA), but a source told Reuters in July that it is well behind on meeting those targets.

VULTURE FUNDS

Distressed funds buy parts of corporate loans hoping that the price will go up following a market improvement.

Another strategy, known as loan-to-own, is to buy the debt and wait for a covenant breach, hoping that a debt-for-equity swap will land the funds an equity stake in the company.

Cortefiel's net debt-to-EBITDA ratio was at 6.2 times in early July, still well below a cap in bank covenants of 7.6 times, a source said in July.

But at about 2 times, the EBITDA-to-interest cover ratio was nearer a covenant mark of 1.9 times, the source said.

But even though prices are dropping, distressed investors do not always have access to the assets, which are sometimes tightly held by original bank lenders, other times widely traded in the secondary debt markets.

Cortefiel's debt holders include JPMorgan (JPM.N), Societe Generale SOG.PA, ING (ING.AS), and some Collateralised Loan Obligations (CLOs), the person familiar with the situation said.

CLOs that have been active in Spain include Avoca Capital, New Amsterdam and Elgin, another person involved in Spanish restructurings said.

Many vulture funds now sit and wait, watching further sales of Cortefiel's debt at significant discounts.

"As the price drops, this opens the game for new players, more aggressive players," a banking source said.

"This is now a time of transition."