Description

***Note - this is labeled under the DBD ticker because there is no WIN GY holdout shareholder ticker, but this writeup is for the WIN holdout shares. Also, the market cap details I gave above relate to the WIN holdout shares, not the DBD parent company***

Summary: Wincor Nixdorf redeemable minority shares currently trade around a 5% yield and just under par value despite significant going concern risk for the parent company, Diebold (DBD). This is even more surprising when considering where DBD's senior debt instruments currently trade (85c for loans, 55c for senior notes) and suggests German retail investors (who owned these holdout shares basically for yield) are asleep at the wheel. While it may still be that DBD muddles through the next 3-6mos without a solvency issue/liquidity crisis, the fact that you get paid 20:1 on this trade if a B/K happens is to me a severe mispricing and I think there is still a reasonable non-zero chance you see a snap bankruptcy because a) the issues facing the ATM business are clearly structural and b) there is no reason for senior bank lenders to allow subordinated shareholders to make off with par value (drained from their collateral package) without new capital coming in to the entity (something that seems difficult with DBD stock breaking new lows every day).

While borrow is not plentiful, at least $5mm is available at 2.5-3% as of today so it is reasonably actionable for smaller funds.

This one is more of a very attractive asymmetrical trade, than a typical value investment. Diebold (DBD) bought out Wincor Nixdorf (WIN GR) in 2016, creating Diebold Nixdorf. This is one of the largest ATM manufacturers globally, and competes with NCR in the US and Europe. You can imagine how the hardware portion of this business has been doing (that is, terribly), which creates the opportunity today. At the time, there were a number of holdout shareholders (about 25% of the Wincor s/holder base) who did not accept the DBD takeover consideration. DBD came to an agreement (in early 2017), ratified by German courts (the ‘DPLTA’), which stipulated the following compensation for holdouts:

-          55.02 EUR per WIN share;

-          2.82 EUR per share dividend (paid annually in arrears);

-          Shares are puttable at any time, for cash (the process should be speedy, you simply instruct your custodian to put the shares to DBD’s bank transfer agent, Deutsche Bank, in Germany);

-          While the put option was meant to only last for 2months after the settlement, it is still live due to ongoing shareholder disputes re the fairness of the amount offered

Essentially then this became a preferred security (fixed coupon, redeemable for cash, no upside to DBD business performance and only credit risk on the downside). The current price of the WIN holdout shares are 53.5 (ie, below the put price, implying a 5.3% yield) – thus, WIN shareholders are free and clear to put their shares at any time. The holdout WIN shares are treated as ‘redeemable minority interests’ in DBD’s balance sheet, ie, not as debt (though they clearly have debt-like characteristics). This is important because if DBD were to file, WIN holdouts would be bottom of the totem pole (essentially an equity-like recovery position).

The issue is DBD’s liquidity position has become extremely precarious as they levered up substantially to do the acquisition. Meanwhile, hardware sales were -16% YoY  in the most recent quarter and the ATM spending environment is very bad. If all WIN s/holders put their shares it will amount to a $440mm ‘run on the bank’ which could drain the company of liquidity and, I think, potentially precipitate a snap bankruptcy filing.

Here is the math on the WIN minorities cash-out consequences:

DBD disclosed in their recent 10-Q that an additional $160mm of minorities tendered in early August, ie ~40% of all remaining holdout shareholders in response to DBD’s disastrous 2Q report (where they cut EBITDA 25% for the FY, posted the terrible hardware rev numbers, spoke about another $150mm of cash out restructuring costs needed, and suggested they would violate covenants),

I highly expect most all WIN minorities to tender for cash in the next few months as DBD’s liquidity position is extremely tight and they admitted they will bust covenants when they next get tested in September.

Here is what the simplified liquidity position looks like. Note that the majority (75%) of gross debt is held by banks (a revolver + term loan, all governed by the same set of covenants). The bank debt is now trading mid-80s, while the senior notes (due 2024) are now at 55c…as you can see a huge discrepancy versus where the holdout shares are pricing (the senior bonds imply 24% yield at 55c with some collateral versus the WIN holdouts at 5% with zero collateral and a lower priority claim):

For now, it appears they have plenty of liquidity - $694mm (excluding uncommitted funds) versus total potential holdout puttable amount of $440mm. But there are a few things to keep in mind:

-          Almost all the cash is held offshore;

-          If they ran down all the revolver, and then their cash balance, by the puttable amount, cash would fall to ~$230mm, which would be ~5% of group revs, versus historical minimum of 8-9% of revs;

-          The revolver covenants will clearly bust in 1.5mos and they are mid-negotiation to waive/loosen the covenants so it may not be entirely practicable to fully draw the revolver;

-          None of the company executives own any/meaningful amounts of DBD stock (ie minimal incentive to keep it solvent).

In other words I see two main possible outcomes:

-          DBD gets a waiver/extension on the covenants and raises new equity (or new $$ from asset sales): this is the base case scenario. The business has deteriorated very quickly but banks are likely stuck; it is in practice difficult to tip a company into B/K between periods (when covenants haven’t been breached yet, as the case here), and you could still make an argument that DBD is better off alive than dead. At the same time it would require a lot of new capital to come into the company and decimate current shareholders (hence the DBD stock price reaction of late). The company will still need an incremental $150mm to fund a restructuring program, let alone begin to delever. If this happens the holdout shares should trade around 55, ie, par value, as the credit risk to DBD is still significant and I don’t think the bonds would price in much improvement. In this scenario you lose ~1.5-2 EUR/share and pay borrow cost in the meantime, ie I think max 10% loss, maybe more like 5%;

-          DBD snap files: ie the banks take the view that, pro-forma for the WIN holdouts and more restructuring costs, even with a recovery in the business, the debt is likely not covered (the junior bonds trade at 55c), meaning they are much better off restructuring now and owning the new entity at ~4x EV/EBITDA (creation value based on the bank loans at par) than watch the entity burn through another $550mm (holdouts cash out; restructuring costs) against their collateral position. In this scenario the WIN holdouts are worth zero (below the senior bonds which trade at 55c, and are likely to get 30-40c in a restructuring I think)

There is ~$5mm+ of borrow available at 2.5% or so. I think the max downside is ~5-10% (closer to 5%) while even if small, I really think this could go, and if it does the holdout shares are worth 0. So it is very interesting…

Catalyst

- snap filing/banks refuse to countenance covenant waiver

- business conditions deteriorate further

- no one willing to put in new money/not enough to make a difference

- asset sales/new equity raise (would be positives clearly and bad for the trade)

- quarterly earnings