Six Flags and Incremental Recoveries to Junior Bondholders

Approximately a year ago, we analyzed the debt of Six Flags. Our recommendation was to buy the bank debt at 72. Currently that debt trades at 101. In round numbers, about a 40% IRR. On an absolute basis a strong number, relative to where we could have played in the capital structure: Not so much...

Currently, the senior opco notes at Six Flags trades at 113-115 and the holdco notes trade in the 31-33 context. Those are doubles and triples from when we wrote the post a year ago. Hindsight is 20/20 of course - I sacrificed upside potential, for downside protection. A better question to ask: Has Six Flags fundamentally changed so much in one year that the intrinsic value is really that much higher?

Some background: Six Flags has gone through a number of plan iterations. First the bank debt holders were going to get the majority of the equity. Then the opco holders were going to get the majority of the equity. And finally the hold-co debt, as the plan is currently filed, will get a majority of the equity. Initially they said they were going to force current management out, but when the plan emerged and it was revealed management was going to get 15% of NewCo (yes, you read that right), it was plain to see that incentives were aligned for the holdco plan to be taken up and adopted by management.

A Dow Jones Daily Bankruptcy Review article points out that Avenue Capital (the driving bondholder representing the opco notes) will lead a challenge of the Chapter 11 confirmation. They will argue that the plan that gives the majority of the equity to holdco noteholders will leave the new Six Flags with a burdensome load of debt and will challenge the feasibility of the plan. Therefore nothing is decided at this point, but we fashion a guess that the hold-co plan, which now pays out senior lenders in cash (vs. reinstating) will be approved.

Nonetheless, back to the original question: Has Six Flags fundamentally changed so much in one year that the intrinsic value is really that much higher?

For one, multiples have moved higher in the industry. At the time, Cedar Fair traded at 6.5x; Now with the proposed Apollo buyout, it trades for 7.5x. Using 7.5x versus the projected 2011 EBITDA of 260M (I initially forecast slightly higher), derives an EV of $1.95B more than enough to pay off both senior lenders and opco bond holders. So I was too low on my multiple.

Secondly, credit markets are WIDE open right now. On both the bank and bond side, most deals (except for the hold-co dividend deals which are reappearing) are well oversubscribed and dealers are flexing terms. While the hold co note holders didn't technically NEED to appease the bank debt holders by paying them in cash versus reinstating their low coupon paper, they did it to ensure their plan gets accepted by one of the larger creditors groups in the case. Six Flags did a term loan a month or so ago that was to finance the opco plan- that deal was oversubscribed. That being said it wasn't a stretch to assume you could layer on more senior secured debt (second lien) to get more cash in the door to help pay pre-petition claims. Would I have guessed this the case a year ago? Frankly, no.

Finally, and something that very few people are talking about right now, but from what I have heard, hedge funds are no longer in "deal with redemptions" mode. As returns continued to be impressive throughout 2009, more redemption requests were withdrawn, and funds that were sitting with idle cash on the side, ready to meet redemptions, needed to put that money to work to at least keep up with this rocketship of a market. That being said, funds are more able and willing to backstop rights offerings or provide fresh capital to reorganized debtors without having to deal with their LPs on their backs. A year ago, no one fund, or even groups of funds, would be able to step up to the plate and execute a $600 or $700M rights offering.

In my opinion, higher valuation, easier access to exit/debt capital, and more parties willing to fight over providing fresh capital to debtors via right-offerings has been the real driver of returns in distressed land over the past 12-18 months. Yes, some companies have seen dramatic improvements in operating performance, but to me the real driver to this rally (which has disproportionately helped junior creditors and equity holders) has been the multiple expansion (valuation in the bankruptcy court still relies on comp analysis) and the capital markets being awash with liquidity.

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Six Flags Bankruptcy

If you remember, a while back, we discussed the distressed debt opportunity that was Six Flag's bank debt. Well since then, and as expected, Six Flags filed for Chapter 11. Here is an update.

Just for a little bankruptcy lesson before we get started – when a company files, it has entered an “exclusivity period”, in which it has 180 days to put together a plan of reorganization, although the plan can be extended by the bankruptcy court almost indefinitely if they feel the debtor is acting in good faith. After such time, if the company does not come up with anything, or the plan is disputed by too many creditors and cannot be confirmed, competing plans may be submitted by creditors. Ad an additive point, this is part of the new bankruptcy law that was enacted in 2005/2006.

The proposed “Support Plan”, yet to be confirmed, contemplates the existing secured bank lenders receive consideration upon confirmation of the plan composed of $600 million in new term loans with a L+700 margin, and the balance paid in equity which would represent 92% of the total equity in the reorganized firm. The Opco Notes (SFO) would receive 7% equity, the remaining Holdco Notes (SFI) would receive 1%.

This is a stark contrast from the proposed out of court restructuring that was abruptly abandoned after a holdout caused a lack of voting support to effect an out of court debt for equity exchange. Under this previously proposed exchange, the secured bank debt and the Opco Notes would have been unimpaired, and continue receiving interest payments as if nothing had changed. The Holdco notes would receive 85% of the equity, the Preferreds would receive 10%, and the remaining 5% would have gone to the existing shareholders.

For a judge to confirm this plan, Six Flags is going to have to prove that after paying bankruptcy fees and taking care of the secured bank debt, there will be a *very* marginal amount of value left to distribute to the junior creditors. I find it hard to believe that not more than 2 months ago Six could afford to reinstate the bank debt and the Opco Notes, implying they probably think the company is worth around $1.5 Billion (close to the book value of PPE, and 5.5x 2008 EBITDA), but now, they claim to have only enough residual value left to pay 1% to the Opco Notes?

Even taking into account bankruptcy costs which will dilute recovery from what it would have been out of court (I am assuming $150 million value, or 10% Enterprise Value), Six would still have $1.35 Billion left, which is enough to cover the approximate $1.1 Billion secure bank debt, with $250 Million left to distribute among the Opco and or Holdco Notes.

Six Flags stated in it’s 8-K that it had the unanimous support of the secured lender Steering Committee, however this may be misleading to some because although this is true, the steering committee represents only 50% of the secured bank lenders. For this plan to even have a shot in hell, 50% in number as well as 66% in dollar amount is needed, and this is not even taking into account the objections that will surely come from the unsecureds who will basically be hung out to dry. Avenue Capital, as a matter of fact, holds Six Flags secured bank debt, and it has openly stated it does not plan to consent to the plan (they were not represented on the Steering Committee). Avenue deemed the proposed Support Plan a “sweetheart deal” for secured lenders, leaving little for the unsecureds. While I’m sure Avenue had it’s philanthropist duties in mind when it released this statement, some of us would probably be inclined to think they hold a portion of the unsecureds.

As of close today, the Term Loan was quoted in the 95-96 context, the Opco Notes where around 61-62, and the unsecuredes were all around 10-11. Before the filing, the Term Loan was quoted around 76-78, the unsecuredes 18-20, and the Opco Notes 69-70. Obviously the market has responded favorably for the Term Lenders at the prospect of owning the company if this plan is somehow confirmed, and as should be expected, the unsecuredes fell on the news. If one were to believe, as I do, that this plan has a very slim chance of going anywhere, it may be interesting to consider playing some capital structure arbitrage and longing the unsecuredes while buying LCDS on the Term Debt. The idea is that the deal will be recut to give the unsecuredes more recovery (there can only be upside from 1% if it’s recut), which will likely take away from some of the secured bank debt’s “sweetheart” package.

Now, what is interesting to me is how well the opco bonds have hung in. I am very excited about this case for the simple reason that this will be a real fight. Bondholders and bank debt holders both have reasonable arguments - it now depends on how well they present their case.

Nonetheless, as we mentioned in our original recommendation, the bank debt in the low 70's was a "no brainer." This is a perfect situation for a bank lender in that: more than likely we are getting par back and there is a chance, albeit small, that we might get equity, which could push our recovery well over 100% of par.

This will be an interesting distressed debt case study to follow. We will update you with any big information that comes out of the docket.

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Distressed Debt Analysis - Six Flags

Six Flags (SIX) is a regional operator of theme parks across North America.  Their corporate Investor Relations website can be located here: Six Flag's IR Site

For reference, here are the current trading levels of the company's equity and debt instruments:

• Six Flag's Term Loan: 70-72
• Six Flag's 12.5% Subsidiary Notes: 54.5-56.5
• Six Flag's 8.875% Notes: 13-15
• Six Flag's 9.75% Notes: 10.5-12.5
• Six Flag's 9.625% Notes: 10.5-12.5
• Six Flag's 4.5% Convertible Notes: 7
• Six 7.25% Preferreds due 2009: $0.66
• Six's Common Equity: $0.21

And here is a simplified capital structure (with outstanding associated debt amounts listed):

The Washington Post wrote an interesting article on Six Flags and its current situation.   As the article pointed out, the company faces a liquidity shortfall with their preferreds (PIERs) coming due in August.  

As those who have participated in the high yield debt markets are aware, Six Flags has been a serial refinancer of debt over the past five plus years.  Unfortunately for Six Flag's investors and management, that option is effectively closed to them right now given the state of the credit market as well as their balance sheet and the restrictions imposed on it via the various debt indentures and credit agreements.  

Management commented on their 4th quarter 2008 conference call (transcript here) and as many press reports have announced, the company has been negotiations with its bondholders. And one bondholder (2010 bonds) looks to be holding out.  

As we have talked about in this post, Distressed Debt Terminology, Six Flags has an opco / holdco structure.  As a bondholder or bank debt holder, you want to be as close to the assets as possible.  So in a simplified waterfall structure using the above chart as a reference, the obligations of Six Flags Theme Park would be paid off first, then Six Flags Operations, and then Six Flags Inc.  This concept is called structural subordination and will be talked about constantly on this blog.  As you can see in the trading levels above, the market has reflected that subordination fairly dramatically.

Operationally, Six Flags has done fairly well.  EBITDA in 2008 was approximately $275M dollars and visitor count was better than expected.  The company drew down on its revolver in the 4th quarter and ended the year with $210M of cash.  Interest expense was $178M last year and capex was approximately $99M meaning the company was essentially break even on a free acsh flow basis.  Unfortunately for shareholders and management, the combination of a capital intensive business, with an overlevered balance sheet, in a weak economy always spells trouble.  An interesting statistic:  Including FY2001, Six Flag's has spent ~ $1.050B on capex in the last 8 years. At the end of 2001, its market cap was $1.4B and today it is $20M.  That is a substantial amount of shareholder value destruction. 

Nonetheless, that is the past and we are more concerned about the future and how to profit from this opportunity.  As Warren Buffett says, the first rule of investing is to not lose money.  In other words, you need to make sure not only do you have have a return on capital employed but also a return OF capital employed.  

I am going to go with the assumption that there is some kind of in court or out of court debt restructuring.  Press reports have stated something to the effect that 85% of the new equity will go to the holdco bonds, 10% to the preferreds and 5% to the common equity.  Now this could indeed be the case.  There currently is only one true comp: Cedar Fair (FUN), which trades for ~6.5x 2008 EBITDA and 6.3x expected 2009 EBITDA.  EBITDA for Cedar Fair in 2009 is expected to be flat year over year.

Assuming a 6.0x multiple for Six Flag's recent $275M, that would translate into a value of $1.650B, which would be enough value for the existing bank lenders and the 12.25% OpCo bonds to get their principal back.  Given that the OpCo is trading at 52 cents on the dollar, that is a very nice return from these levels.  

Unfortunately, I am going to be much more conservative that that.  We do not want to lose money.  Given how much bank debt leverage there is, a slight change in our multiple and EBITDA assumption can wipe out the 12.25% OpCo notes recoveries:

The average of that entire chart is a 50 cent recovery on the bonds.  The average if you exclude the 4.5x multiple is a 67 cent recovery and if you just include the columns in the right (5.5x-6.0x), you come up with an 82 cent recovery.  Therefore, if you are a real believe in the Six Flag's business model (unfortunately I just cannot predict the EBITDA of this company even a few years out given the volatility of EBITDA over the past 10 years) and you think a company with this kind of capital needs is worth more than 6.0x, you would be buyers of the opco bonds at these levels.  

For me though, the bank debt looks much more attractive at 72.  For a few reasons:

1. As noted in the chart above, only 4 scenarios produce a recovery less than par for the bank debt
2. If a meaningful portion of subordinated debt is converted to equity, the company should generate modest free cash flow
3. If bondholders cannot agree on a consensual solution, there is a small chance you could also receive equity in a restructuring which would could be very valuable if enough debt was extinguished
4. The bankruptcy process is a near term catalyst that could drive bank debt prices higher as lenders would be offered a higher rate to "play ball" in the restructuring process

In summation, the bank debt offers investors a substantial margin of safety with decent option value.  The bonds on the other hand, offer very juicy returns in some scenarios but little margin of safety.  We will continue to dig into the business model of Six Flags to see if we can find any diamonds in the rough to change our opinion on the opco bnds.  The equity, preferred, and holdco bonds in my opinion, at this moment in time, are speculations with fire and should thus be avoided if you are a conservative value investor.  Things may change in the interim, new facts and figures will emerge, and if they do, we will update our analysis with our most recent opinions.

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