Stressed High Yield: CEDC

Every few months, I post a recent idea from the Distressed Debt Investors Club (the "DDIC") to give potential members and guests a feel for some of the ideas being posted to the site. In recent months, ideas ranging from deep value equity to distressed debt ideas have populated the site. For those interested, you can find a list of all the ideas every posted to the site here (scroll navigation at the bottom of the page): List of DDIC Ideas

If my memory serves me right, this is the first idea posted to the blog from the DDIC since we established new compliance policies. We hired a compliance consultant to test our procedures and formulate a robust policy that will encourage idea sharing while at the same providing the correct disclosures and attestations for members. You can view those policies here: DDIC's Compliance Policy.

Every few days, I receive emails from potential members that inquire about the policies and procedures of the site. As stated previously, the DDIC is 100% anonymous. I will be the only one to know members identities and I will never share that information per our privacy policy. Members are free to contact each other via our online messaging system securely and anonymously.

If you, or better yet, your compliance department has questions, please let me know. I have written a number of letters attesting the above facts and can do so for potential members as well. We currently have 215 members versus our stated quota of 250 members and many many more guests (guests have a 50 day delay to the database and no read access to our forums). Theses members come from both the buy and sell side, across a variety of backgrounds. As time progresses, our database of ideas grows larger and I hope you'll consider joining in the near future. To apply as a member, you can go here: DDIC Member Application and Terms

With all that said, enjoy the write up from one of our members on stressed high yield name CEDC.

CEDC - Central European Distribution Corp


I recommend a long position in CEDC’s 9.125% Senior Secured Notes due 2016 at the current price of 60. On a risk adjusted basis, these bonds trade below fair value.

Challenging European spirits markets and several one-off events have challenged investor confidence in recent quarters. The Company’s shares as well as its public debt traded down following the FY2010 results and abridged discussion by management. Lackluster Q1 results followed by the aftermath of Russian licensing challenges and a shift in the excise tax burden announced in 2Q perpetuated the market’s concerns. In 3Q, CEDC’s modest progress in Poland was countered by excise tax in Russia and spirit cost challenges. Class action lawsuits now allege the management team and board misrepresented the severity operating and financial challenges during 2H10 and in the outlook for 2011. Today’s relevant comparables highlight the CEDC’s toxicity in the market.

However, the fundamental investment appeal of CEDC’s credit remains intact. The enterprise continues to demonstrate strong free cash flow potential with favorable positions in value-oriented market share. Given the strong liquidity position, the Company’s credit profile is robust. An eventually normalized Russian market, continued gains in Poland with Biala, and a focus on more profitable sales channels should further bolster CEDC’s creditworthiness as well as the bonds’ pricing following a strong 4Q11 / Q112. Under such a scenario, the bonds can be expected to trade a more appropriate yield of 10-12%, providing very aggressive return potential (40%+ IRR) upon a sale in a 4-6 month timeframe. Alternatively, the attached recovery analysis shows that an investment in today’s bonds would likely be covered, albeit with a thin equity cushion, in the event of a Chapter 11 reorg or out of court restructuring.

Investment Write Up

CEDC is one of the largest producers of Vodka in the world and the largest integrated spirit beverages business in Central and Eastern Europe when measured by volume. The Company produced and distributed 32.7 million nine-liter cases in 2010. Business activities include the production and sale of proprietary brands of spirits, and the exclusive importation of a variety of other branded spirits, wines, and beers in select locales. CEDC operates primarily in Poland, Russia, and Hungary. The Company maintains seven production facilities in Poland and Russia, and employs a workforce of 4,150 people as of year end 2010.

Poland (8.6 million nine-liter cases sold in 2010 / 21 million liters sold in 3Q11):

CEDC is one of the leading producers of vodka in Poland and maintains two production facilities there. The Company maintains top marketshare among traditional channels as well as discounters. Principal brands produced include Bols, Soplica, Absolwent, and Zubrowka. Absolwent and Zubrowka are leading mainstream brands locally, and Zubrowka is exported to many countries including the United States (via Remy Cointreau). The Company also exclusively imports 40 leading brands of spirits, 40 wine brands, and 5 brands of beer. Sales in Poland typically break down into vodka (70%), beer (7%), wine (12%), and other spirits (8%), other (3%). In terms of exports from Poland, the principal brand is Zubrowka into the United Kingdom, France, Japan, and the United States. Additional export possibilities include third party private label production where brands are sold by other labels in countries outside of Poland.

Russia (21.3 million nine-liter cases sold in 2010 / 38 million liters sold in 3Q11):

The Company is the leading integrated spirits company in Russia and maintains 12.4% market share in vodka production. CEDC produces Green Mark, the best-selling vodka in Russia, as well as Parliament and Zhuravli, the two leading sub-premium vodkas in Russia. Other products produced in Russia include Yamskaya, the best-selling economy vodka in Russia, and premixed alcoholic beverages. Primary distribution is through large retail chains and hypermarkets, and CEDC’s relationships with these companies continue to allow penetration in both urban and rural parts of Russia. Operations in Russia also include the Whitehall Group, a recently acquired company that holds the exclusive rights to import premium wines and spirits into Russia and includes several key distribution centers and its own retail network. This acquisition made CEDC one of the leading importers of wine and spirits in Russia. Full financial results including Whitehall are included in 2011 figures in public filings and herein. Sales in Russia break down into vodka (85%) and wine and others including long drinks (15%). In 2010, the Company launched a small operation in the Ukraine to sell its branded vodkas including Green Mark. Market share initiated around 4% at the end of 4Q10, and has grown to 6.7% as of 3Q11.

Hungary (2.8 million nine-liter cases sold in 2010):

CEDC’s business operation in Hungary principally includes the sale of Royal Vodka. This trademark was acquired by the Company in 2006, and the vodka is currently produced in Poland and sold in Hungary where it is the leading seller with 33% market share. Similar to activities in other countries, CEDC maintains importation rights to several other spirit brands as well.

The Company uses Polish zloty, Russian ruble and Hungarian forint as functional currencies in daily operations, but financials are reported in USD. As such, CEDC is exposed to translation movements both on its balance sheet and operating financials. Additionally, CEDC’s Convertible Notes due 2013 and Senior Secured Notes 2016 are denominated in U.S. dollars and euros, and these proceeds have been lent to operations with different functional currencies. The Company has entered into only very limited foreign exchange risk hedging in the past. Financial results and projections in this report for 2011 going forward reflect the full integration of the Whitehall acquisition.

Valuation Waterfall


Recent Company News
Covenant Violation of Bank Facility – The Company violated its bank covenants as of 12/31/2010 and successfully negotiated relief.
  • During 2010, CEDC’s bank credit facility covenants included net leverage and consolidated coverage, tested at the end of every quarter. At 12/31, the Company’s reported net leverage 6.4x (using covenant EBITDA calculation which includes some cash adjustments not described in public filings) due to the decline in EBITDA suffered in FY10, which violated the 5.0x covenant. CEDC also reported an actual coverage ratio of 1.7x, violating a 2.0x covenant. Credit facility lenders waived any breach of the two covenants at the end of FY10 and amended the two covenants to 8.35x and 1.28x for the end of FY10 as well as for the end of 1Q11. In connection with this waiver/amendment, the Company paid a one-time waiver fee of PLN 3.3 million (approximately US$1.15 million) as well as agreed to a reduction of the overdraft facility to PLN 120 million (approximately US$41.6 million) and an increase to the margins on term loan and overdraft facilities to 4.25% and 3.25%, respectively.
  • In April 2011, management reached agreement with select lenders to amend the Bank Facility to eliminate the aforementioned covenants out right. This refinancing successfully avoided an event of default until the Bank Facility as well as cross default provisions for the Company’s other debt which included acceleration implications. Analysis shows that the Company would clearly have violated these covenants at 6/30. Based on the limited information in the Company filings, these credit facilities only extend until 4Q2012.
Completion of Whitehall / Kauffman Acquisition
  • The Company completed the full purchase of the Whitehall Group on February 7, 2011 for $68.5 million in cash and issued common stock worth $23.0 million at the date of close. Additionally, the Company also gained the global intellectual property rights for the Kauffman vodka brand. CEDC owned a minority position in Whitehall prior to this purchase, and that ownership was treated as an equity interest in the Company’s financials. Notably, following the sale, CEDC remained liable for a cash payment to the seller in the amount of the difference between $23 million value of the equity compensation at the sale date and the present value at a specific trigger date. This was settled in March 2011 through a payment of $0.7 million as and stock to the seller.
  • The Whitehall Group is one of the leading importers and distributors of premium wines and spirits in Russia. Kauffman vodka is one of the leading super-premium vodkas in Russia with a strong presence in top end restaurants and hotels and key accounts. The brand is also exported to high-end customers in over 25 countries.
Production Disruption and Licensing Problems in Russia
  • In 11/10, the Company disputed with Russian authorities on the use of old excise stamps to distribute stocked product and the timing of acquisitions of new stamps.
  • This misunderstanding halted production at key factories for two weeks during peak production season (Oct and Nov). The loss of capacity resulted in increased cost of enhanced throughput at other plants and additional transportation expenditures to distribute product.
  • Estimates suggest that this incident cost the Company about $30-35 million through 3Q 2010. The incident also exposed management weakness at the local level.
  • The Company successfully renewed its wholesaler business licenses in Russia, but certain of the Company’s wholesale customers failed to do so. This perpetuated the destocking trend seen earlier in the year, and ultimately cost the Company around $10 million of operating profit in Q2 alone. The complete of the relicensing process is expected to be completed soon as only 25 out of 140 are left to renew their licenses as of 8/4 and the Company is working to sign contacts with new, licensed wholesalers.
Regulatory Shift – Russian Excise Tax
  • During the Company’s 2Q11 earnings call, management announced a change to excise tax regulation in Russia. Effective August 1 (practically September 1 given the Company’s spirit stock), the remaining portion of excise tax that had been paid by spirit producers in the past is now shifted to vodka producers. The cited aim is to provide transparency into the collection of those funds. Notably, even at current higher rates, excise taxes in Russia are only 65% of the rate in Poland.
  • Unfortunately, this increases the Company’s cost of spirit by 35% - which equates to an increase of $11 milion cost of sales for the 4Q11 period.
  • Looking ahead, this increase could be mitigated by a plentiful grain harvest which is expected for 3Q and 4Q in Eastern Europe.
Outside Shareholder Announces Large Equity Stake
  • On 8/29/11, Mark Kaufman reported a 9.6% stake in CEDC. Mr. Kaufman was the chief executive of the Whitehall Group.
  • Kaufman has requested a meeting with the CEDC board to “contribute ideas” and “facilitate additional investment”.
Board of Directors Adopts Stockholder Rights Plan / Poison Pill
  • On 9/6/11, CEDC announced the adoption of a stockholder rights plan / poison pill, likely in response to Mr. Kaufman’s announcement. This is designed to deter hostile takeover efforts as the potential buyer would likely have to negotiate with the board to acquire / control the Company.
  • Functionally, one preferred stock purchase right will be distributed as a dividend on each common share held as of 9/19/11.
Class Action Lawsuits filed regarding 2H10 events
  • During the week of 10/24/11, several class action lawsuits were filed citing CEDC management and board members as defendants.
  • Allegations state that defendants misrepresented and/or failed to disclose the following: (i) that CEDC had double digit declines in its vodka portfolio and its loss of market share in Poland was growing steeper as discounters were taking shares; (ii) that the seriousness in the market share declines required that CEDC take an impairment charge which CEDC did not record on a timely basis; (iii) that the launch of Central European Distribution’s new vodka product, Zubrowka Biala, with significant market spending in the form of rebates, was having a materially adverse effect on gross margin and impacted the channel mix in the market; and (iv) that, based on the foregoing, defendants lacked a reasonable basis for their positive statements about the company, its prospects and growth. It is further alleged that defendants’ false statements caused CEDC’s stock to trade at artificially inflated prices during a period between August 2010 and February 2011.
Industry and Market Overview
Poland – The total sales value of alcoholic beverages in Poland is estimated at $7 to $9 billion in 2010, a 1.9% decrease from 2009 principally due to the global economic recession. Through 3Q11, the Polish vodka market is down 5-6% in volume and spirit prices are up 3-5%. The country is the fourth largest market for the consumption of vodka and in the top 25 markets for total alcohol consumption. CEDC produces vodkas in all four segments (top premium, premium, mainstream, and economy). Poland is the fourth largest beer market in Europe. Sales of beer remained stable in volume in 2010 but still account for 50% of the total sales value of alcoholic beverages in Poland.

Russia - Russia is the largest vodka market in the world with production of approximately 1.05 billion liters in 2010. Vodka represents 95% of all spirit consumption in the country. The market is fragmented with the top five producers containing up to 50% market share. While traditionally there has been a large black market for vodka in Russia, the government recently introduced minimum pricing in 2010 which moved some consumers back into the official market. The long term effects of this change are yet to be determined. Wine and long drinks represent a very small portion of the market, but each has strong growth potential ahead. Overall, regulation of alcohol in Russia is a highly debated and politicized topic today, and both 2011 and 2012 are election years.

Hungary – The spirits market in Hungary is concentrated in brown liquors and bitters. Overall spirit trends in Hungary are decreasing and shifting to import brands from local producers which have traditionally produced lower quality spirits. The a large increase in the amount of imported spirits due to elimination of local duties and increased purchase power by the Hungarian population since the country joined the EU.

Industry and Market Overview

Russia / Whitehall
  • 2010 – 16.9% top line increase reflecting Russian Alcohol Group(RAG) acquisition benefit for the full year, countered by effects of production disruption in Q4 and a heat wave in Q3. Decline in overall market share to 15.3% estimated from 18% in 2009.
  • 2011 Forecast – Topline growth of between 6 and 8%(60%/40% split between existing and new brand growth) as Whitehall completes integration; Restyling of Green Mark and introduction of a new economy brand (Sotka) and a sub premium brand. Diminishing effect of licensing issues into 4Q and an overall a stabilizing market in line with Russian economic recovery (including price increases, as successfully implemented in 1Q11) and a diminishing black market due to minimum pricing. Gross margins will be challenged by the 35% increase in cost of spirit due to excise tax shift initiated in 8/11. Strong export growth into Ukraine and overall improvement in value over volume.
  • 2010 – 14.8% decline reflecting overall market decline, mourning period for the President, increased competition, aggressive marketing spend, and increased raw materials cost. Decline of 3% in marketshare to 22% in 2010. Recovery expected ahead due to enlarged sales force and decline of marketing expenses.
  • 2011 Forecast – Increases in revenue nearing 10% following aggressive marketing yields (Biala) results and larger salesforce, but in a declining overall market; flavor extensions introduced to Zubrowka and Jezowka family in 4Q and others and restyling of Soplica in July; erosion of competitor’s market share; CEDC’s own marketshare remains in the low to mid 20%’s (25% by 4Q) while value to volume continues to improve by the end of the year and exports gain on imports· 2010 – 16.6% decrease reflecting increases in local excise taxes as well as adverse exchange rate changes
  • 2011 – Top line growth of 10% reflecting normalization of pricing and adjustment of costs towards profitability
Key Investment Considerations
  • Integration of Kauffman / Whitehall cash flow - Recent concern over the Company’s inflated leverage may be overblown. In addition to anticipated demand recovery for 4Q11, the Company can expect to realize the financial upside of the Whitehall acquisition and normalized pricing as marketing yields are recognized. Whitehall was financed with cash and stock, and should contribute $30 to $40 million of EBITDA going forward as operations normalize in Russia in 2012.
  • Continued Strong Liquidity Profile / Free Cash Flow Generation – The Company maintains over $110 million of cash on the balance sheet and significant capacity (close to $50 million) under its credit facilities. Looking ahead, the Company should be able to produce an average of $50 to $60 million of free cash flow in each of the next years (25 to 30% EBITDA conversion rate). Accordingly, management is equipped to handle any additional market hiccups and is positioned to de-lever the balance sheet in coming years.
  • Realization of benefit of marketing spend in Poland and Russia – As reflected in historical marketing expenditures, the Company has focused on the promotion of some of its new and up and coming brands over the past 12-18 months. This was done in response to consistent and accelerating losses of market share in 2010, primarily in Poland. One example is Zubrowka Biala (White) launched in Poland in November 2010 where sales volumes came in far above expectations. Here, promotional pricing squeezed margins in Q4, but new customers should add to cash flow levels as promotions burn off and pricing normalizes in 2012.
  • Relicensing in Russia / Destocking reversal – The Company has successfully negotiated new licenses for its operations in Russia, but a few wholesalers are still in the process. The practical implication here is a reduction in inventory levels of wholesalers as they successfully renew their licenses. New wholesalers are brought on board to replace those who fail to renew. Previously, stock had been increased to protect against another production outage for regulatory reasons. Since wholesalers are contractually bound to 4 to 5 weeks of inventory, destocking will reverse naturally. Based on Q3 results, a significant portion of this destocking is still to be realized by the Company in 4Q via both new and old wholesalers.
Investment Concerns
  • Impairment charges in Poland (2010) and Russia (2011) – In 2010, CEDC recognized impairment charges of $131.8 million related to the Absolwent brand in Poland, and an impairment charge in 2009 of $20.3 million related to the Bols brand in Poland. While these charges are non-cash, questions arose regarding the Russian and Hungarian brand valuations and the potential business impact of further similar charges ahead. In 3Q, CEDC incurred goodwill impairment of $547 million ($88 for Poland / $459 for Russia) and brand impairment of $128 million for Polish brands due to cannibalization by Biala.
  • Negotiations with Bank Lenders / Refinancing of Convertible Notes – The Company successfully negotiated with Bank lenders for covenant relief through 4Q12, and the convertible notes are due to mature in 2013. In light of recent financial hiccups, there is a risk that the market may not be receptive to another covenant light facility or a refinance of the Company’s convertible notes at a reasonable cost to borrow. An inability to negotiate could lead to an in or out of court restructuring that would be costly for the CEDC equity holders.
  • Risk of another mismanaged product launch / Poor management decision making. The launch of Zubrowka Biala in Poland led to a sale of three times expected volume in 4Q 2010. Excessive rebates had a negative impact on gross margins and the overall profitability for the Company during that period. These promotions expired in January 2011, but management’s mistakes highlight an apparent inability to control new product launches completely. As such, further gains in market share from marketing pushes could again come at the expense of margins.
  • Higher Spirit Costs / Excise tax shift – A large percentage (40-45%) of the Company’s COGS is raw spirit, the cost of which already increased in 2010 and early 2011 as a result of a poor grain harvest in Eastern Europe. The Company purchases grain at spot prices or on short term contracts. The market, however, believes that the 2011 harvest in the autumn will be much more successful. Management reaffirmed its positive outlook for the late 2011 crop during the 2Q earning call, but management announced a change to excise tax regulation in Russia that suggests a 35% increase in the Company’s cost of spirit, which equates to as much as a $33 million increase in the Company’s cost structure annually.
  • Principal Assets located in Europe / Complications in Chapter 11 or other Restructuring.

Summary Terms


D 11/19/2011  

Hi, may I know if these notes are listed or do they have to be bought OTC? If they are listed, which exchange is it on? I can't seem to find it on the list of bonds on the NYSE website.

Thanks in advance!


Anonymous,  11/25/2011  


The new compliance policy looks pretty good, but I think that you might want to consider changing the last sentence under #12 from

"We will investigate the complaint and if we discover that the Member or Guest is in violation, the Member or Guest will be terminated."

to something like

"We will investigate the complaint and if we discover that the Member or Guest is in violation, the Member's or Guest's membership will be terminated."

(Just saying that there's no need to hire a hit squad or ninjas or anything.)

Anonymous,  11/29/2011  

No acquirer in their right mind would want to repay the debt. Question is, is there a way to force a huge haircut on the bondholders while keeping your sit at the carving table. I think there is more than one. A theoretical exercise of assessing a risk adjusted fair value is useless, in my opinion, as no one seems to understand the risks.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.