Smurfit-Stone Container Corp., the packaging giant based in Chicago, has been getting crushed by the dire economy. Faced with mounting losses and a $5.6 billion legacy of debt from a string of deals, including the founding 1998 merger of Jefferson Smurfit Corp. and Stone Container Corp., the company filed for Chapter 11 bankruptcy protection in January. But Smurfit-Stone, the second-largest maker of corrugated packaging by revenue in North America, has a good shot at survival. It recently succeeded in raising $750 million in debtor-in-possession financing, a loan that will be used to keep operations going while the company reorganizes.
The Smurfit deal is part of a growing wave of such transactions. Global DIP financing reached $12 billion as of April 15, close to the record $13.5 billion raised during all of 2008, according to research firm Dealogic.
The demand side of the equation is obvious. Business bankruptcy filings increased by 87.5 percent in 2008, to 43,500, up from 23,200 in 2007, according to Marisa DiNatalie, a senior economist at Moody’s Economy.com.
But just as important, a new wave of institutional investors is starting to surge into the DIP market. That could boost volume to as much as $100 billion this year, says Mark Cohen, global head of restructuring at Deutsche Bank, which co-led the Smurfit deal with JPMorgan Chase & Co.
The market is drawing hedge funds, distressed-debt investors and loan funds that were once active in the now-moribund markets for collateralized debt obligations and collateralized loan obligations. These investors are attracted by the short 12-to-18-month duration of most DIP loans as well as by their high yields, Cohen notes.
Smurfit is paying about 650 basis points above LIBOR, which is below the recent average of 717 basis points, according to Dealogic. In addition, DIP loans offer some of the best security in the high-yield end of the market today; such debt typically ranks above a company’s other outstanding debt and equity. The Smurfit loan consists of $350 million in new funding and a $400 million refinancing of accounts-receivable securitizations in the U.S. and Canada. The new money is coming from existing investors as well as ten institutions with no previous exposure to Smurfit, including hedge funds, distressed investors and large investment funds, according to Deutsche Bank. About 25 subordinated investors also participated in the deal. “The bankers knew who to go to first,” says a manager with one loan fund that participated in the deal. “It was the right recipe for us.” The structure provided a total return of 15 percent, including an up-front fee that Smurfit had to pay.
Even with the fresh funds, Smurfit still faces huge challenges. It lost $2.99 billion on $7.04 billion in sales during 2008. Its stock has been delisted from Nasdaq Stock Market and was trading over the counter at 8 cents on April 27, down from a 52-week high of $7.10 on September 9, 2008. Nonetheless, the company stands to benefit as the global economy recovers, assuming the courts will cut its $5.6 billion in debt after one year, when the DIP matures. It can be extended, but only if Smurfit pays a premium. With a market share of 18 percent in North America, Smurfit has the scale and scope to profit in a commodities business. “We believe that the DIP facility will provide the company with ample liquidity to operate throughout the restructuring process,” Patrick Moore, chairman and chief executive of Smurfit, said in a statement.
The increasing role played by hedge funds, distressed-debt investors, loan funds and other institutions in the Smurfit-Stone deal reflects a striking shift from years past, when banks tended to dominate DIP financing. But facing their own capital constraints, most lenders have little choice but to bring in outside investors.
Aladdin Capital Holdings of Stamford, Connecticut, NewOak Capital of New York and Oaktree Capital Management of Los Angeles, recently entered the market with DIP funds that seek to raise $500 million each. Tapping third-party money is good for the economy, says Cohen. “If the improving investor climate continues, companies may again have the ability to secure exit financing,” he says.
