LONDON Bondholders who lost the early rounds in the fight with private equity buyers of companies they saddled with debt could bounce back off the ropes if recovery brings new capital to the table.
When credit was cheap and easy, private equity firms bought firms and loaded them with borrowings, putting in little of their own cash. But now those acquisitions are struggling under that burden, some buyout firms are pushing bondholders to swap the debt for new paper at a discount.
Lithuania's UAB Bite Lietuva finished a bond exchange last month with bondholders agreeing to accept new securities worth just 32 percent of the face value of the debt.
Private equity owner Mid Europa Partners paid for the buyback, rating agency Fitch said.
If bondholders refuse a swap and hold out for a better offer, they risk being forced into a restructuring on worse terms if the company moves closer to bankruptcy.
"Creditors are giving up a lot of value to equity because no-one else is willing to show up with capital," said Edward Eyerman of Fitch Ratings.
"Sponsors are taking the opportunity to use relatively small amounts of cash to reduce debt and reset the equity value at a low level," Eyerman said.
Bonds are trading at big discounts because of large losses among all debt investors in the last two years, even those who specialize in distressed assets. Apollo Management LP's APOLO.UL European debt investment fund, for example, lost 79 percent of its value in 2008, the company said on March 31.
Until these investors step back into the market, bondholders have little choice but to accept debt swaps that see them taking a big loss, with perhaps a small cash incentive, or even nothing in return.
"Bite is a good example of a distressed debt exchange because the offer was substantially below par," said Michelle de Angelis of Fitch Ratings.
"We took the view that the restructuring of the balance sheet was the only viable solution for the company," she said.
But when NXP Semiconductors concluded its heavily discounted debt swap last week, only a fraction of the $1.9 billion in bonds it hoped to retire changed hands, allowing it to shave just $465 million off its $5.96 billion debt mountain.
Bondholders critical of the deal said they were unhappy that NXP's private equity owners were not offering more cash. The lenders hope the company's owners will come back with a more generous offer.
ONLY WAY OUT
Standard & Poor's estimates that the European companies it rates will need to repay or refinance 329.9 billion euros ($446.5 billion) of debt in 2009, and a further 253.3 billion euros in 2010.
The best-rated companies have regained access to the bond markets, or are conducting bond buybacks of their own, but weaker companies are struggling to refinance debt. This gives private equity owners of these companies the opportunity to launch bond exchanges, particularly if there is no better offer from distressed debt investors.
Bondholders are heavily exposed to the risks that companies will not be able to refinance their debt, with European companies owing a total of 87.4 billion euros in high-yield bonds, according to Thomson Reuters data.
Exchanging bonds for debt of a lower value is a trend that emerged in the United States last year.
In 2008 the value of U.S. distressed bond exchanges totaled $30 billion, around double the total exchanged between 1984 and 2007, according to Edward Altman, a professor at New York University's Leonard N. Stern School of Business.
Investors expect the trend to ramp up on the European side of the Atlantic this year.
"It has been more of a U.S. approach, but we can expect to see more of it in Europe," said Quin Casey, a fund manager at Aviva Investors.
Bondholders may benefit from an exchange if they believe a business to be viable, and if the bonds recover. The alternative may be a company going into administration.
Once it might have been possible to get an offer from another private equity firm or from distressed debt investors, but rival buyout firms are in the same boat, and distressed debt investors have their own wounds to lick after the credit market collapse around the end of 2008.
As faint hopes emerge that the global credit crisis and economic slowdown could be nearing a bottom, more investors might be prepared to focus on distressed deals.
Some have already signaled a willingness, including BC Partners' Andrew Newington, who told the Reuters Private Equity and Hedge Fund Summit his firm planned several hundred million euros of distressed debt investments this year.
(Additional reporting by Natalie Harrison, editing by Will Waterman)