Fagron Unveils A Recapitalization Plan - Implications For Shareholders And Bondholders

| About: Fagron SA (ARSUF)

Summary

Fagron has reached an agreement with private equity partners, and this will save the company.

$250M will be pumped into the company in two different equity-based tranches.

The dilution will remain 'limited' and the Net debt/EBITDA ratio will fall below 3 again, in line with the covenant maximum of 3.25.

Good news for the bondholders, as the capital increase is fully underwritten!

Introduction

In January, I wrote an article about Fagron (OTC:ARSUF), wherein I made my case for buying the company's bonds that were trading at just 86 cents on the dollar on the back of Fagron breaking its bank covenants. I explained why I thought the company would be successfully recapitalized, and the bondholders would be fine.

Fagron is a Belgian company and you should trade in the company's shares through Euronext Brussels, where the average daily volume is in excess of half a million shares. The bonds I will discuss in this article are also trading on Euronext Brussels.

Details of the recapitalization plan have emerged, and all pieces of the puzzle are falling into place

Approximately one month after my original article, Fagron released its full-year financial results, and the net debt was a bit higher than I expected, so the company most definitely had to do something. Back then the company was already discussing a $250M equity infusion, but no details had been provided just yet, but that has changed now!

Click to enlarge

Source: annual report

The company has completed discussions with 'a cornerstone investor and five individual investors' whereby an agreement has been reached to recapitalize the company. In a first phase, several private equity parties will invest up to 131M EUR ($145M+) in an off-market placement. And guess who's part of the group of private equity investors? Yes indeed, Marc Coucke, the vice-president of Perrigo (NYSE:PRGO) is the driving force behind the first private placement. This is what I wrote in January:

'But Coucke might have new plans for Fagron. Guess who entered the scene again when Fagron's share price was crashing in August? Indeed, Mr. Coucke himself, taking advantage of the volatility to build a 5%+ stake in a matter of days (at a share price that was 150% higher than the current share price). Coucke already invested quite a few millions to earn a 5.32% stake in Fagron, and I'd dare to bet he would have no problem backstopping a rights issue to increase his position up to 20%. By buying a stake on the open market, he basically confirms he still likes the company, and there's no doubt he still has the financial capability to cough up more cash.'

And:

'A 1:1 rights issue is very aggressive and might need to be underwritten to avoid any embarrassment. But that also shouldn't be a problem for Fagron, as it will very likely be able to count on one specific guy, the founder of the company (who no longer plays an active role).'

So besides the $146M private placement, there will also be a rights issue to complete the additional $94M. This rights issue will indeed be backstopped by members of the consortium that are prepared to cough up $146M in the first tranche!

Click to enlarge

Source: annual report

Of course there are some requirements, but it looks like these requirements are pretty straightforward and 'doable'. First of all, the current shareholders will have to vote to approve this deal, as the dilution will be quite high. I don't consider this to be a problem as the Fagron shareholders are more or less with their backs against the wall; there is no other solution.

A second requirement by the private equity parties is the price of the placement. Instead of pushing the company with its back against the wall, the private investors have agreed to purchase the new shares at the average price during the 30 days before the shareholder vote, with a maximum price of 5.50 EUR/share ($6.15). This meeting is scheduled for April 16, so it's not really a surprise to see the share price being pushed up towards the upper level and Fagron just closed at 5.49 EUR today (indeed, one cent below the maximum price).

What does this mean for the shareholders? And the bondholders?

Why is this maximum price important? Because the rights issue will be priced at 90% of the private placement.

So let's now assume a private placement price of 5.20 EUR, then Fagron would have to issue 25.2M new shares to the private equity partners, increasing the share count to 57M shares. This has two consequences.

First of all, the second tranche of the capital increase (the rights offering) will then be priced at 4.68 EUR ($5.27). This means that in order to raise an additional 89M EUR ($100M+), Fagron would have to issue an additional 19M shares. That's actually quite positive for the existing shareholders, as the total amount of outstanding shares would remain 'limited' to 76M shares. Even though that's a 150% increase, I indeed still call that 'limited' as I was expecting the share count to increase to 95M shares in my previous article!

This underwritten capital raise also is an excellent deal for the bondholders. This deal will reduce the net debt to less than 300M EUR ($336M), assuming Fagron will remain free cash flow positive this year. The bondholders definitely liked this announcement as the price of the bonds immediately shot up towards the 100% level before drifting down a little bit towards the 97% it's currently trading at.

Source: Euronext

Investment thesis

This was probably due to the fact the bondholders are still waiting to see the shareholders approving the deal, and Fagron effectively closing this $250M financing. That being said, after seeing the people involved with the deal and the fully-underwritten rights issue, I'm increasingly confident the bondholders will be repaid 100% of the par value in July 2017.

I still own all my bonds and intend to hold them until the maturity date in July 2017. The YTM still is approximately 5.8% which is pretty good in a NIRP/ZIRP-environment. The reduced dilution factor means that instead of a 1:1 rights issue, I will now very likely be allowed to purchase 'just' 1 new Fagron share per 3 shares I already own, so I might invest the cash I had allocated for the capital raise in the bonds as well.

Disclosure: I am/we are long ARSUF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own common shares of Arseus, as well as a substantial position in the 2017 bond, which I intend to hold until the maturity date.