Description

Thesis

Buy first lien MTNLN 6 ¾ 01/31/23 (XS1756324411) bonds currently offered at 93.5 for a 16% YTW. Collect 6.5 points and a coupon as you wait for a near term refinancing.

Matalan is a value add retailer in the UK controlled and supported by the billionaire Hargreaves Family. Expectation is for either a straight refinancing or more complex refinancing with the Hargreaves Family supporting the transaction to reduce debt by pledging MTNLN used / Hargreaves owned real estate and other assets. First liens are fully covered in an unlikely bankruptcy filing, base case is the bonds will be refinanced by year end 2022.

Situation

Matalan is a value oriented retailer in the UK with 230 stores largely located in out of town retail locations. The Group is owned by the billionaire (net worth reported at $1.95 billion) Hargreaves Family who founded the business in 1985, took the company public in 2000 and then private in 2006. The business has done well and recently reported (on 1/17/22) Q3 numbers (three month period ending 11/27/21)) with revenues of £291.4 million (up 19% y/y) and Q3 EBITDA (pre-IFRS) of £ 36.2 million (up 25.7% y/y and up 7.4% yo/2y). The company is 3.2x levered through the first lien and 4.1x total leverage for 2022 (year ending 2/27/22).

 The second lien bonds come due 1/31/24 and are partly owned by the Hargreaves Family, who had also injected additional equity into the business. The Hargreaves Family has supported the company through the COVID crisis by converting £50 million of second lien notes they held into £50 million of unsecured PIK notes and conducting a sales leaseback of Matalan’s Head Office for £25 million. The risk here is the company is unable to conduct a refi of the 1/31/23 first lien notes, the timeline is late 2022. If the company is unable to conduct a straight refi of the bonds, the 1st lien bond will be fully covered in an unlikely bankruptcy scenario. On the macro side, inflation is a concern. The company updated the market on 2/21/22 with inflation expectations for the upcoming year. Energy and FX has been offset due to hedges/forward buying for the year with productivity benefits to offset other higher costs.   

 Financials

Matalan Q3 (q end Nov21)reported revenue of more than £291 million for the 13 weeks ended November 2021, a jump of 16% compared with the same period in the prior year, and reported revenue up 8% for the crucial five-week festive trading period, with sales surpassing £130 million for the period ended Jan. 2. The overall business is doing well, demand is strong and steps are moving forward to conduct a refinance in the near term. The company has relatively clear line of sight on FY22 numbers, and expectations are for FY23 top line recovery to ~£1.1bn, in line with FY20, IAS 17 EBITDA generation of £99m and implied margin of 8.8%, with FCF generation, after interest and capex, of £16m.

Risk

On 2/22/22, Matalan bonds dropped after founder John Hargreaves lost a long-running tax battle in the British courts. Hargreaves has been disputing his tax status with HM Revenue & Customs for almost 20 years, may have to pay as much as 135 million pounds ($183 million) with interest on capital gains tax related to his public offering of Matalan in May 2000. The tax verdict is being appealed. While a confidence loss for bond holders, the Hargreaves Family is still expected to support the first lien refinancing.

Catalyst

Refinance by late 2022