* Sterling exchange also alters covenants on dollar bonds
* Dollar bondholders offered no reward for changes
* Exchange expected to be successful, however
By Robert Smith
LONDON, Feb 13 (IFR) - Virgin Media is looking to exploit weak covenants in legacy bonds to carry out an exchange on sterling notes that will also impose covenant changes on dollar bondholders.
The Liberty Global-owned UK cable company launched the exchange offer last Wednesday, offering holders of its £628m 5.50% 2021 notes an exchange into new bonds maturing in 2025 with a 6% annual coupon.
This higher coupon is not the only incentive to roll into the new issue. The new bonds have a first call on January 15 2021 - matching the maturity of the old notes - and if they are not called at a 105 cash price, the coupon jumps dramatically to 11%.
In order to take part in the exchange, sterling bondholders will also have to consent to the removal of "all restrictive covenants" in the old bonds. This provides a stick, alongside the carrot, to encourage participation - a technique usually dubbed an "exit consent".
But language in the bond's documentation means that if at least 78.7% of these sterling bonds are tendered, these covenant changes will also be imposed on holders of Virgin Media's equivalent US$448m 5.25% 2021 notes.
Yet, the dollar bondholders will neither be able to participate in the new bond, have a say in the process,/ or have a reward for participating.
One high-yield fund manager said this was "above and beyond" aggressive tactics he had seen in previous liability management exercises.
"There's an inherent logical inconsistency in treating the dollar and sterling notes as just two different tranches of the same notes offering, and yet at the same time giving them unequal treatment in the exchange," he said.
"I find it unbelievable that one group of holders can impose their will on another, without equal compensation being passed on."
The bonds in question were issued in 2011 as investment-grade-rated notes, at a time when the company's equity was publicly listed.
Ratings agencies junked the debt when John Malone's Liberty Global took over Virgin Media in 2013, with bondholders suffering bad mark-to-market losses.
The notes had "suspended covenants" that came into play when Virgin Media's secured debt lost its investment-grade rating, however, meaning bondholders gained some additional protections, cushioning the blow.
But research firm Covenant Review said that the omission of "two key covenant protections" allow Liberty Global to leave dollar bondholders out in the cold in the liability management exercise.
These are the "payments for consents" covenants and voting provisions that require consent from each individual series of bonds.
"These covenant protections are standard in US high-yield deals, and their absence from the 2021s indenture permits the company to favour holders of the sterling 2021s over holders of the dollar 2021s," said Sabrina Fox, an analyst at Covenant Review, in a report published Friday.
Virgin Media has tempered its aggression to some degree, however, as it is not using language in the documentation that would allow it to strip the dollar bonds of covenants entirely.
Instead, it is putting the covenants in line with those on Virgin Media's bonds issued after the Liberty takeover, which notably employ a different calculation for the restricted payments basket.
The dollar bonds have actually strengthened since the exchange was announced, moving from a cash price bid of 106.625 prior to announcement to 107.50 on Monday, suggesting that covenant changes are not seen as damaging.
But, in contrast, the sterling notes have rocketed in value, jumping from 111.50 to 115 in the same time period, meaning dollar holders have missed out on gains seen in the sterling bonds.
"Weak covenants cost money - strong covenants protect your investment," said Fox at Covenant Review.
While the liability management exercise may have caused a stir, several market sources say they expect the exchange to be successful.
When Virgin Media announced the exchange, it said that holders representing £230m of the £628m issue had already agreed to the terms, meaning that it only needs another £265m to play ball for it to succeed.
Virgin Media has offered sterling bondholders generous terms in the exchange because the notes have a make-whole call, which make them more expensive to refinance ahead of their maturity.
And a banker away from the deal said that the large coupon step-up was designed to encourage short-duration investors that hold the debt to participate. Whether these funds' mandates will still block the new note due to its 2025 maturity remains to be seen, however.
"They are taking a bet that there isn't going to be that much cross-holding between the sterling and dollar tranches," said the fund manager.
"But they would have done their homework first and made sure there isn't much overlap." (Reporting by Robert Smith, editing by Helene Durand)