As I previously wrote, while the parties were far apart on terms initially I believed an amend-and-extend transaction was possible. On May 2nd, GEO (NYSE:GEO) released another cleansing material, highlighting that consensus was reached by parties on major terms. In the same press release, GEO mentioned that a new non-disclosure agreement will be signed to allow the negotiation to continue. I expect a definitive agreement to be signed in 1H2022. I will illustrate the proposed transaction first, then show a quick cash flow model, and finish with some comments from each of the security's perspective blow.
The status quo cap structure is shown below as a reminder. GEO has ~$1.5 billion secured debt, ~$1.0 billion unsecured bonds, plus ~$360 million other debt, gives a total of close to $3.0 billion of consolidated debt. The reason for this proposed amend-and-extend transaction is not because GEO lacks sufficient cash flow to service interest payments - it's the fact that it faces a $2.0 billion maturity wall between 2023 and 2024 and refinancing this debt stack is nearly impossible in this ESG-focused environment.
Let's first acknowledge that GEO has the support from the senior secured part of the capital structure, which is crucial for making a deal happen. Here are the proposed treatments for different parts of the debt stack:
Assuming a 70% term loan participation rate and 80% senior notes participation rate, below is my understanding of the pro forma capital structure. I used a probability weighted average for the two options to illustrate the final pro forma capital structure. I could be low on the amount of 2023 and 2024 notes choosing option B (i.e. no cash paydown) as the anchor participants seem to want to take more securities over cash.
Here are illustrative sources and uses of cash/non-cash to demonstrate the proposed transaction. Effectively the proposed transaction is using a combination of cash paydown, more certainty around deleveraging, higher coupons, and up-tiering for the unsecured bonds to incentive all parties to extend the maturity wall from 2023-2024 to 2026-2027.
I put together a quick cash flow model to analyze the impact of the contemplated transaction. Here are my assumptions:
My model shows $42.5 million increase in interest expense for 2.08% increase in weighted average cost of debt, which is roughly inline with GEO's comment about $18-$20 million increase for every 1% increase in cost of debt. Net-net, the deleveraging path is better than I modeled previously due to lower weighted average cost of debt and higher EBITDA.
As you can see, 1L leverage drops from 1.9x to 1.0 over this period as almost all excess cash will be applied to pay down the RCF and Term Loan balance. Total net debt should sit below 4.0x by FY2023 and drops to 3.3x by FY2025.
GEO popped +12% on the news and outperformed recently vs. the market, but except for the narrative changing from unpredictable election outcomes, I'm still negatively biased towards GEO's equity. The bankruptcy/severe dilution risk is almost off the table but going forward the creditors are keeping a very tight leash on where the excess cash flow can be applied. Specifically, GEO can only apply $5.0 million per year towards dividends/share repurchases, which mean there won't be any institutional-size buyer that's required to rerate a stock (of course we shouldn't ignore the power of the retail crowd).
I still prefer CoreCivic (CXW) over GEO if you want to invest long-only in the private detention center space. I still recommend long CXW/short GEO as a pair trade. GEO stock should underperform CoreCivic in the medium term for lack of share buyback capacity.
While there are minor disagreements on terms still, the 2023 and 2024 noteholders are in a relatively great position as they are given a few decent options: noteholders can either choose to take some chips off the table or stay invested in a more senior position. Extending credit in a second lien position at <3.0x leverage for close to 10% where the first lien debt is getting paid off aggressively is a pretty good proposition.
Additionally, since the transaction gives GEO some secured capacity to take care of the 2023 and 2024 stubs at maturity, it is not a bad idea to be a holdout in the 2023 notes. This is a sub-1 year bond at ~7.5% YTM. I would not recommend being a holdout in the 2024s however, as the risk/reward isn't as favourable (2.5 year term and ~8.5% YTM).
I was previously wrong about the 2026 senior notes. While I highlighted the risk that the ad hoc group "could potentially make a bilateral deal with GEO to only roll up their 2026s holdings and leave the smaller holders in a subordinated position", I viewed this as a tail risk thinking that GEO and the ad hoc groups would want a clean structure. However, it turned out that while the 2026 senior notes are not left out of this transaction entirely, only 50% of the existing 2026 notes are given the opportunity to uptier, and most importantly, this is "subject to all 2026 Anchor Participants uptiering into Exchange 2L Notes". This means retail noteholders will be partially stuck with some less liquid and subordinated bonds while the institutional holders can uptier their entire holdings.
Having sad all this, I don't know why the below highlighted language is in the proposal. Let me know in the comment section if you have some ideas.
This is of course very disappointing but there are a couple of silver linings. First, there is a springing maturity on the new term loan and credit facility tied to the 2026 notes which means GEO will be motivated to take the 2026 notes out 90 days prior to the scheduled maturity, making the "effective maturity" January 2026. I also believe GEO will take care of the stub 2026 notes well ahead of the springing maturity (maybe sometime in 2025). This reduces the term of the bond and increases the annualized return potential.
Second, GEO's 2L leverage ratio is essentially the same as CoreCivic total net leverage at ~2.7x. CoreCivic 8.5% 2026s is trading around 7.5% YTM. Let's assume GEO new 2L notes should trade at 8.0% YTM for a higher overall leverage (let's ignore the higher seniority and longer term for a second). Where the stub 2026 notes should trade post transaction depends on how much additional yield is required for the additional leverage. I think a 3.5-4% additional yield is fair, which puts the 2026 stub notes at 11.5-12% yield. This translates to a bond price of $81.5-83. This is not far off from where the 2026 notes is trading today ($83.5-84.5 range). In other words, I don't think the stub 2026 should drop much lower. Also keep in mind that GEO is a deleveraging story going forward, which should help support the bond price.
I'm encouraged to see that GEO is close to a definitive agreement with the creditor groups to push out the huge maturity wall. The contemplated transaction is affordable from an interest expense servicing perspective, and also forces GEO to de-lever in a meaningful over the next few years. Given the lack of shareholder return, I still prefer CoreCivic over GEO as an equity investment. Given the deleveraging plan, I'm comfortable holding GEO's bonds. Among the three series of senior notes, I equally like the 2023s and 2024s. The 2026s is not given the fair treatment in my opinion, but I believe this is fully priced in.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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'm long GEO 2023s and 2026s.