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Last year, Sandelman Partners forced troubled conglomerate Spectrum Brands to sue for peace – and issue expensive debt – by threatening to topple the company’s teetering capital structure with a default notice. The hedge fund is looking for a similar payday from a comparable offensive launched last week against Georgia Gulf, but the construction products and chemicals supplier may not go as quietly as Spectrum.
A group of investors led by Sandelman that holds much of Georgia Gulf’s USD 100m 7.125% unsecured note due 2013 sent management an email about the alleged default on 8 May. The company failed to engage the bond holders meaningfully, according to a letter from Sandelman fund manager Peter Bio, prompting the service of a default notice on 6 June. The group alleges that the company issued more senior debt than allowed under their indenture – the same argument used so successfully against Spectrum.
Management of the company promptly counterattacked with a request in Delaware Chancery Court yesterday (9 June) for injunctive relief and declaratory judgement against the notice via legal counsel Jones Day. Officials at both Georgia Gulf and Jones Day declined to comment. Sandelman and its legal counsel, Bracewell & Giuliani, also declined to comment.
The default notice “was issued in bad faith …,” the filing states. “If left unchecked, these self interested, coercive efforts and the publicity generated thereby will cause irreparable harm to Georgia Gulf through triggering a liquidity squeeze and impairment of … relations with suppliers, customers and lenders.” Tightening credit conditions and the economic slowdown could accelerate that process, the filing also states.
Credit crunch aside, the default notice comes at an inopportune time for Georgia Gulf, which counts Highland Capital and Harbinger Capital among its large shareholders. The company is already battling tightening maintenance covenants built into the USD 800m term loan it borrowed in 2006 to acquire PVC pipe maker Royal Group. As a result, management is in the midst of “exploring alternative financing structures” with Bank of America, according to court documents. Harbinger is also rumoured to own Georgia Gulf’s loans.
Management drew criticism from analysts for buying Royal with debt and exposing the company to residential construction right before the real estate and credit bubbles burst, as previously reported. The acquisition boosted leverage to 4x in 4Q06 from 0.75x in 3Q06, according to SEC filings.
BofA is soliciting interest from selected funds invested in the Georgia Gulf capital structure for a 10% senior secured note that would take out the company’s covenant-laden credit facility, said one buysider claiming knowledge of the situation.
A default on the 7.125% notes could put a wrench into those plans, and further complicate any amendment talks with lenders should the company breach a leverage covenant in 2Q08, as expected, said multiple buyside and sellside sources.
Holders of the USD 423m balance on the 2006 term loan, revolver lenders, holders of USD 350m in 8.5% senior subordinated note, and USD 497m in 9.5% senior unsecured note holders could accelerate should the company be found to have defaulted. That would leave Georgia Gulf until 7 July to cure the violation or face cross defaults throughout its yield curve, according to the company’s complaint.
The 7.125% bond indenture – now the eye of the alleged default storm - stipulates that Georgia Gulf was allowed to incur incremental senior debt as long as it maintained a consolidated coverage ratio of 2:1. Should the ratio dip below that threshold, incurrence would be capped at USD 525m of secured debt less asset sales plus an additional USD 75m allowance.
Sandelman claims that Georgia Gulf slipped below the 2x coverage ratio last year and that incurrence now outstrips the USD 525m basket and USD 75m allowance, according to court and SEC documents. The hedge fund calculates the breach based on a reduction of; USD 361m from the repayment of term debt with asset sale proceeds last year, USD 200m from the term debt outstanding in December 2003 when the 7.125%s were issued and an assumed USD 65m of revolver draw to fund bond coupon payments this year.
Georgia Gulf is arguing that since it paid off the balance of the 2003 term loan in 2004 and 2005 with operating cash flow, that sum is no longer applicable to the incurrence basket, according to its court filing.
Multiple buyside and sellside sources said they are dismissive of the claim, and doubt the Chancery Judge would give credence to the hedge fund’s argument with so much at stake for Georgia Gulf, a large public company.
That might sound painfully familiar to holders of Spectrum, who also second guessed Sandelman’s legal argument. Many of them watched the company bluster about fighting Sandelman off only to back away from a court battle and swap the bond the hedge fund owned into a more attractive instrument at the expense of investors in other unsecured debt.
Sandelman has demanded Georgia Gulf prepay the 7.125%, which would force the company to raise new debt that would cost millions of dollars more in interest than currently paid on the bonds, according to the company’s court filing. The hedge fund also requested a fee of millions of dollars to compensate it for waiting to be paid out, according to the document.
Georgia Gulf’s USD 497m 9.5% senior unsecured notes due 2014, which do not benefit from the same incurrence basket built into the 7.125% indenture, slipped one point to 82 on news of the default notice. Common shares in the company fell 8% to USD 4.61 since the notice was served. The 7.125% last traded at 80.7 on 21 May, up from 76.5 on 12 May.
While Sandelman’s case against Georgia Gulf bears strong similarities to its dispute with Spectrum, the chemical company’s treatment of its incurred debt differs in one significant way. Georgia Gulf alleges that it used internally generated cash to pay back the full amount of its term debt outstanding when the 7.125%s were issued, thereby removing it from the incurrence basket calculation. Spectrum, on the other hand, refinanced its loans with new senior debt, never actually expunging the debt.
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