Directory publishers find new pecking order amid financial and technological maelstrom

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Late in 2009, Dutch yellow pages publisher European Directories bit the bullet and hired Rothschild to advise it in a looming restructuring that will likely pit its sponsor, Macquarie Capital Alliance Group, against mezzanine lenders. In the UK, Yell Group dodged the very same bullet by reaching an agreement with its creditors to extend its debt maturities with a revised covenant package.

“The extension of our maturities got us over the refinancing hurdles and will allow us to repay debt over time in an orderly way,” John Davis, chief financial officer of Yell Group, told Debtwire.

A dividing line is emerging between the larger directory publishers and their smaller counterparts in Europe. “As far as Yell and Seat go, you have significantly larger businesses with low leverage, which gives them the opportunity to trade their way out of the problems,” said Robert Jaeger, director of high yield research at Societe Generale. “Truvo and European Directories, with smaller operations and higher leverage, do not have that luxury of time anymore.”

French yellow pages giant Pages Jaunes emerged as the only large player in Europe to end 2009 relatively unscathed. Peers such as Yell Group, Apax Partners and Cinven-owned Truvo, Dutch company European Directories and Italian company Seat Pagine Gialle are all experiencing difficulties. European Directories will likely set the battlefield for the first European debt restructuring of a directories business.

Between 2005 and 2007 loan and bond investors financed the leveraged acquisitions of European directories businesses, betting on a stable cash flow and resilience to downturns. European yellow pages publishers issued around EUR 14.3bn-equivalent of LBO debt during that period. A few years later, investors and sponsors are coping with underperforming businesses, forced refinancings and prospective restructurings.

The technological shift from print to online has established a new order in European directories by punishing the majority of publishers that have brick and mortar businesses or geographically disparate operations. In contrast, single-country monopolies and early adopters of the online medium are reaping the rewards.

The financial crisis exacerbated the problem, forcing overlevered publishers to either amend and extend their loans, or restructure them entirely. Workouts are a tough sell in the current environment as the traditional providers of liquidity in such situations – distressed investors – see little value in the directories publishers’ pricey senior loans and too much risk in their junior debt.

A challenging business model

The shift in technology in the last five years caught many yellow pages publishers unprepared. An increasing number of businesses moved from print to online advertising, but revenues and margins still suffered under growing competition from online advertisement sellers such as Google. Declining advertising revenues due to macroeconomic uncertainty intensified the paradigm shift in the yellow pages market.

“Back in 2007 investors considered directories to be recession-proof, more like utilities. But they did not factor in the magnitude of technological change,” an investor explained.

Truvo is forecasting a 29% drop in print revenues year on year in 2009, partially offset by a 12% increase in online sales. Similarly, Yell Group was forced to execute an amend-and-extend refinancing at the end of 2009 to address declining adjusted EBITDA. The company’s EBITDA is expected to flat-line until 2011, aided with sufficient headroom on its covenant package, said Yell investors.

Yell Group is now increasing its focus on web advertising. “We believe there is still value in print but we have also embraced internet and mobile devices,” Davis said. “Around 20% of our overall revenues come from online advertising and in the UK it is 30%.”

Pages Jaunes, which has a December year-end, also defended its margins. The French directories business forecasts a decline in revenues of less than 5% in FY09, in part due to success hedging the loss of print clients with growing revenues from its online platform.

“As already around 45% of total revenues are derived from online advertisement sales, they [Pages Jaunes] just need to match losses on the print side with an equal amount of growth on the online,” a portfolio manager noted. The company’s monopoly in France helped it establish a strong national redoubt against incursions by Google and the like.

Language barriers for foreign competitors and a monopoly in the Italian market also helped Seat Pagine Gialle cushion a sharp a decline in EBITDA. The publisher also benefited from the fragmented nature of Italian SMEs, requiring specialised and experienced sales forces working on the ground to meet their needs.

Last year, the company co-opted competitor Google Italy by using its strong client relationships to complement Google’s technical expertise. “As Google is unlikely to deploy sales manpower on the ground, Seat still has time to catch up,” an investor noted.

Directory publishers such as Seat Pagine Gialle are reclaiming ground by focusing on the partially untapped local online advertising market and forging alliances with large online advertisement sellers. “The market still doesn’t have a lot of confidence in some directories’ ability to successfully migrate to online advertising,” said Jaeger. But Seat Pagine Gialle’s online business has grown 20% in 2009, said a spokesperson for the company.

Kicking the can down the road

The most common strategy for both sponsors and lenders so far has been to postpone the problem by extending maturities or delaying restructurings. “I think they are buying time to adapt their business models. The next one to two years are going to be critical for these companies as they need to prove their ability to stabilise their businesses,” Jaeger said.

Seat Pagine Gialle and Yell Group found themselves facing looming maturities on their colossal debt piles last year. Both issuers recently began to address the maturity profiles with extension plans. Yell Group extended its debt maturities from 2011 to 2014 last year, rewarding its lenders with par debt repayment and higher margins. “Yell’s strategy will be from now on to focus on deleveraging using excess cash flow,” noted the portfolio manager.

Seat Pagine Gialle took a similar approach two weeks ago when it issued a EUR 550m bond to repay term loans. But the Italian behemoth must return to the market to refinance EUR 1bn of debt maturing between 2012 and 2013, according to investors.

“There is nothing wrong in refinancing loans with high yield bonds. However, directories need to pay a very high premium to get the deal done, which increases interest expense dramatically,” the portfolio manager commented. Seat Pagine Gialle’s bond pricing jumped by 2% to 11% and the issue was scaled down by EUR 100m after generating a lukewarm response from bond investors.

Macquarie’s European Directories to set the benchmark

Vulture funds circled directories groups in 2009 without actually circling in to feed, said a distressed debt investor. “The equity upside is uncertain for a loan-to-own operation, and in some cases the debt was still too expensive,” he said. European Directories loans trade at a discount of around 75% of principal, while Truvo’s debt is trading at around 65%.

The lack of M&A activity in directory names presents another hurdle for distressed investors, making valuations difficult. “There has been virtually no M&A or restructuring activity in this sector for about two years, everybody is waiting for a first event to happen to have a clearer idea,” a credit analyst explained.

As the typical vultures of the distressed debt markets are not taking the bait, the fate of struggling directories lies in the hands of existing lenders.

European Directories is poised to set the benchmark for restructurings to come. Senior and mezzanine lenders in the EUR 1.6bn debt package are expected to agree a standstill on an anticipated 4Q09 covenant breach, as reported by Debtwire. A battle between the shareholder and creditors could ensue, according to sources familiar with the situation.

Truvo is another workout candidate, but restrictive documentation and lender reluctance could hamper any pro-active restructuring. Apax Partners and Cinven-backed Truvo is saddled with EUR 1.4bn debt and is 12x levered. Despite the value breaking in the senior debt, the absence of maintenance covenants limits senior lenders’ ability to force the company to act.

As a result the company still has around EUR 45m in interest expenses on its EUR 540m senior bond notes per year. “Lenders should try to take control of the business, squeezing out both the sponsors and the bondholders. It makes no sense to pay interest on something which is so far out of the money,” the distressed investor said.

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