5 IN. DI LETTURA
* PIK falls on fear senior notes to be refinanced first
* Reports that VimpelCom will hold notes spook investors
* PIK recovers but investors warn of asymmetric returns
By Robert Smith
LONDON, Sept 20 (IFR) - Italian telecom company Wind's Payment-In-Kind bonds dropped sharply on Tuesday on concerns that the deeply subordinated notes would not be refinanced as quickly as some bondholders had expected.
Talk that Russian owner VimpelCom would launch a jumbo refinancing has been building for weeks, partly because market participants do not believe the company's structure will allow it pay the first cash coupon on PIK notes due in July 2014.
Those notes traded up on reports earlier this month that VimpelCom would refinance the PIKs with a USD4bn-equivalent loan facility.
"There was leakage from the loan side that this new facility was being put together, and the PIK traded up like a shot, as everyone just assumed the proceeds would be applied to the PIK," said a high-yield investor.
The bonds neared 106 by Tuesday morning, but plummeted almost five points later that day to 100.8 on speculation that the loans would repay the company's EUR2.7bn-equivalent 11.75% 2017 senior notes instead.
The PIK nose-dived as many bondholders rushed for the exit, and the buyside was rife with "conspiracy theories", according to the investor.
"There was immediate panic that something more sinister was up, but the price has recovered as people have realised that this is probably just step one of a straightforward refinancing exercise," said the investor.
The "more sinister" suggestions stem from reports that VimpelCom was looking to hold senior notes on its balance sheet, causing some investors to wonder if the company was looking to gain votes in a restructuring or push through a debt to equity swap in which VimpelCom would be equitised.
"On a smaller company this might be possible, but there's so much debt outstanding I don't think they could pull it off," said another investor.
"It's probably not a way for them to gain control, it's probably just an interest arbitrage game or it's tax efficient. This does not preclude them doing something untoward with the PIKs, but VimpelCom will want to look like a good corporate citizen to investors."
The price recovered to 103 by late afternoon, as investors' fears subsided, but VimpelCom would neither confirm nor deny the reports, stating that it does not comment on rumours.
Before the drop, Wind's bonds were approaching their call price of 106.125, suggesting that some investors were buying in anticipation of an imminent redemption. After recovering, they were trading close to their second call price of 103.063, which begins from July 15 2014, suggesting investors think the bonds will be taken out later.
Wind's EUR325m and USD625m 12.25% 2017 PIKs at the holdco level have so far allowed interest to accrue on the principal, but the notes become cash pay in January 2014, with the first cash coupon due on July 15 2014.
By that time, the PIKs will have accreted to around USD1bn and EUR450m in size, and will jointly require first cash interest payments of around EUR73m-equivalent.
Wind does not have capacity to upstream the cash to pay this coupon under its senior secured bond covenants or under its senior facility agreement, according to market sources, which gives it an incentive to refinance the PIK ahead of time.
The first investor said there is a good rationale for VimpelCom tackling the senior notes before the PIKs, however.
If VimpelCom repays the Wind PIK using cash instead of replacing it with a similar piece of capital, this would free the dividend stream from the Wind opco level up to the VimpelCom level, the investor said.
"Secondly, if VimpelCom is considering refinancing the PIKs with a debt instrument, it makes sense to first determine what they can afford in terms of the most junior part of the capital structure."
By refinancing the senior notes, VimpelCom would create a pricing benchmark for a more subordinated instrument, while helping it judge how much debt Wind can take at this level.
The bonds have traded up during the course of the week, bid as high as 104.25 on Friday morning, suggesting the market now thinks they are likely to be repaid.
Mitch Reznick, co-head of credit at Hermes Fund Managers, cautions that the PIK's return prospects are asymmetric, however.
"To get involved with the PIKs at these levels you have to be highly confident of the base case that the bonds will be called, because given the leverage of around 5.5x through the PIK versus an enterprise value of 4.5 to 5x, the downside could be meaningful" said Reznick.
"If you had a couple of turns of implied equity above you, it is a more comfortable investment." (Reporting by Robert Smith)