29/04/2024, 17:31 Victoria PLC — Calculating ratios and value leakage capacity under the bond covenants (9fin)

Victoria PLC 11:58 2nd September 2022

9fin-LevFin Secondary

Victoria PLC — Calculating ratios and value

leakage capacity under the bond covenants (9fin)
11:58 2nd September 2022 • 10 min read

By Caitlin Carey | caitlin@9fin.com

On Victoria PLC’s FY 22 earnings call in July, management was upbeat about the AIM-listed
flooring firm’s prospects, despite significant inflation in raw materials and energy prices. For
further detail, see Denitsa Stoyanova’s excellent write-up here.

As outlined in Denitsa’s piece, Victoria’s true leverage looks very different from the 2.7x
leverage figure reported in the consolidated financial statements. In this report, we consider
how leverage and EBITDA are calculated for purposes of the covenants for Victoria’s
outstanding high yield bonds.

In addition, given that Victoria’s management have indicated that they are actively
considering share buybacks and that they intend to fully redeem the £225m preferred equity
issued to Koch Equity Development (”KED”) with cash prior to their conversion to ordinary
shares, we also review Victoria’s capacity to send value out of the group to shareholders
under the bond covenants.

As outlined below, we estimate that Victoria’s net leverage for bond covenant purposes is
around 4.4x, and that Victoria may have RP capacity of around £108.4m available for share
buybacks and/or preferred equity redemptions.

Capital Structure
Victoria’s capital structure includes:

€750m of senior secured notes across two series (€500m of 3.625% senior secured notes
due 2026 and €250m of 3.75% senior secured notes due 2028) (the ”Notes”), issued
under the same indenture;
a £150m super senior RCF (the “RCF”) (undrawn at 2 April 2022); and

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£225m of preferred equity issued to KED for the purpose of expansion capex and
acquisitions (the “Preferred Equity”) (£75m in November 2020 and a further £150m in
January 2022).

Victoria’s FY 22 balance sheet also included £32.2m of debt outstanding under various local
working capital facilities and £105.6m of lease liabilities (comprising £0.8m under finance
leases and £104.8m under right-of-use leases per IFRS 16).

Calculating leverage and EBITDA under the bond covenants

According to the FY 22 Annual Report, Victoria’s net leverage was 2.66x for purposes of its
bank covenant (we assume this is in reference to the RCF springing leverage covenant).
We’ve pasted the reconciliation from Victoria’s annual report below.

Note that this calculation has been made on a pre-IFRS 16 basis and does not include the
Preferred Equity within the scope of adjusted net debt.

However, for purposes of the bond covenants, our reading is that net leverage is calculated
on a post-IFRS 16 basis and that the Preferred Equity counts as “Debt”. On this basis, net
leverage would be much higher than 2.66x — we estimate bond covenant net leverage as
approximately 4.4x.

IFRS 16 lease treatment

“IFRS” for covenant purposes refers to IFRS as “in effect on the Original Issue Date” (July 26,
2019), except with respect to the Reports covenant, which uses IFRS “as in effect from time
to time”. Victoria can elect to “freeze” IFRS as of another date that is after March 5, 2021.

Since Victoria implemented IFRS 16 “with effect from March 31, 2019”, this means that by
default, IFRS 16 treatment would apply for the bond covenants’ financial definitions.

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Moreover, we did not see any drafting in the “Debt”, “Consolidated EBITDA” or other related
definitions that would result in EBITDA or leverage being calculated on a pre-IFRS 16 basis for
covenant purposes.

Note that this is different from the IFRS 16 treatment with respect to Victoria’s previous
(refinanced) bonds issued in 2019 and tapped in 2020. The “IFRS” covenant definition for
those bonds stated that “the impact of IFRS 16 Leases… shall be disregarded” for covenant
calculations.

Preferred Equity treatment

Our reading is that the Preferred Equity is “Redeemable Capital Stock” for covenant purposes,
which falls within the definition of “Debt” under the bond covenants.

“Redeemable Capital Stock” generally includes any capital stock that could be subject to
mandatory redemption, redemption at the holder’s option, or conversion/exchange into debt
prior to the Notes’ maturity. However, the definition provides an exception if the redemption
rights are limited to “asset sale” or “change of control” provisions no more favourable than
the corresponding provisions under the Notes and the capital stock specifically requires the
Issuer to first comply with the corresponding Notes’ provisions.

Under clause 7 of the articles of association, Victoria would be required to redeem the
Preferred Equity prior to the Notes’ stated maturity in certain circumstances (if a “Mandatory
Redemption Event” occurs).

The “Mandatory Redemption Events” are broader than those mentioned in the definition of
“Redeemable Capital Stock”, as they include certain insolvency events and any acceleration
of the “Senior Debt” (i.e. Notes and/or RCF).

Moreover, the circumstances for mandatory redemption on a “Change in Control” do not line
up with the Notes’ change of control or asset sale provisions and in some circumstances
would be more favourable to the Preferred Equity holders. We also didn’t see anything in the
mandatory redemption provisions that would require Victoria to first comply the Notes’ Asset
Sales and Change of Control covenants.

So even though management views the circumstances for mandatory cash redemption of the
Preferred Equity as “highly unlikely”, we think that these provisions are broad enough to make
the Preferred Equity count as “Redeemable Capital Stock” (and therefore “Debt”) for covenant
purposes.

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As we describe in further detail below, our analysis that the Preferred Equity would be
considered “Redeemable Capital Stock” not only has implications for Victoria’s leverage
calculations for purposes of the bond covenants, but also affects the amount of Restricted
Payments capacity under the bond covenants that can be used to redeem the Preferred
Equity.

Our estimates of covenant EBITDA and Consolidated Net Leverage

We estimate covenant Consolidated EBITDA of £175.4m for the fiscal year ended 2 April
2022, based on Underlying EBITDA of £162.8m (post-IFRS 16 lease costs of £19.3m) and
adding the “Proforma adjustment for acquisitions” of £12.6m shown above.

We have included this pro forma adjustment because covenant EBITDA is permitted to
include “anticipated cost savings or synergies” relating to any transaction being given pro
forma effect, without any cap or time limit, as well as cost savings projected to result from
actions taken / to be taken within 24 months after any operational change.

We estimate covenant Consolidated Net Leverage of approximately 4.4x as of 2 April 2022.

We have calculated this by adding the IFRS 16 lease liabilities of £104.8m and the balance
sheet amount of the Preferred Equity of £254.2m to the above “Revised net debt” figure of
£415.8m and dividing this by our £175.4m estimated Consolidated EBITDA figure.

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The above are only rough estimates, as we don’t have enough information to calculate the
various adjustments under the covenant definitions with precision. We also note that the
Preferred Equity would be valued at its “maximum fixed repurchase price”, which requires
calculating the redemption price (including the make-whole premium).

Value leakage capacity under the bond covenants

Capacity for share buybacks / redemptions of Preferred Equity

Any buybacks of Victoria’s ordinary shares or redemptions of the Preferred Equity would be
Restricted Payments (RPs) requiring capacity under the Restricted Payments covenant.

The most relevant baskets for general Restricted Payments, including buybacks of ordinary
shares or redemptions of the Preferred Equity, are:

CNI Builder: 50% of Consolidated Net Income (cumulative from the fiscal half
commencing immediately prior to 26 July 2019) plus certain other customary builder
components, subject to no default and meeting the 2x FCCR test
Leverage-based RPs: Uncapped, provided pro forma Consolidated Net Leverage Ratio <
2.5x (not available at current net leverage of c.4.4x)
General RP basket: £50m / 45% Consolidated EBITDA (approx. £78.9m)

Although reported net income in recent years has been negative on a cumulative basis, there
are various addbacks and adjustments permitted when calculating CNI for covenant
purposes. In particular, “any pre-tax special, extraordinary, one-off, irregular, exceptional,
unusual or non-recurring gain, loss, expense or charge” is excluded (i.e. added back).

While actual CNI amounts would need to be confirmed by Victoria, for illustrative purposes
we have done a calculation adding back the “Non-underlying items” disclosed in Victoria’s
annual reports as a proxy for the types of items that might be added back to CNI. This gives
us an estimate of approximately £64.2m of capacity under the 50% CNI limb (see table
below), assuming the no default / 2x FCCR conditions are satisfied.

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For completeness, we note that if the Preferred Equity did not count as “Redeemable Capital
Stock” for covenant purposes, then it would have built RP capacity under the CNI Builder
basket. This is because the CNI Builder basket builds from the amount of net cash proceeds
or fair market value of assets received after 26 July 2019 from issuances of Qualified Capital
Stock (= any capital stock other than Redeemable Capital Stock).

In total, then, we’d estimate up to £143.1m of capacity for general RPs across the CNI builder
(£64.2m) and the general RP basket (£78.9m), without taking into account previous
utilisations of these baskets.

Some RP capacity appears to have been previously utilised. Following KED’s initial Preferred
Equity investment in November 2020, the Issuer applied £30m of the proceeds towards share
buybacks, which would have used RP capacity. If the Preferred Equity were not “Redeemable
Capital Stock”, Victoria could have used a separate RP basket for share repurchases from
proceeds of a “substantially concurrent” issuance of Qualified Capital Stock.

In addition, the FY 22 annual report discloses buybacks of ordinary shares for £0.6m during
that fiscal year, and Victoria has issued regulatory announcements of share buybacks since
fiscal year-end totalling more than £4.1m.

Assuming that these buybacks have used capacity under the CNI and/or general RP baskets,
we’d estimate that the c.£143.1m RP capacity above would have been reduced to c.£108.4m
under those baskets.

Other notable RP and PI capacity

In addition to the above baskets that can be used for share buybacks, Preferred Equity
redemptions and any other RPs, Victoria has other RP and Permitted Investment (PI) baskets
that could be used to leak value out of the group, including:

Restricted Payments

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Common equity dividends: 7% of Market Capitalization per fiscal year, provided

Consolidated Net Leverage Ratio < 3x (not available at current net leverage of c.4.4x)
Redeemable Capital Stock dividends: Permitted so long as the Redeemable Capital Stock
was issued in accordance with the Debt covenant (we assume that the issuance of the
Preferred Equity was permitted under the 2x FCCR Ratio Debt test or another Debt basket)
Management Equity Repurchases: £7m per twelve-month period, with unlimited carry
forward

Permitted Investments

General Basket: £45m / 40% Consolidated EBITDA

PIs in Unrestricted Subs / Qualified JVs: £35m / 31% Consolidated EBITDA
PIs in a Permitted Business: £35m / 31% Consolidated EBITDA

As described further in our “J-Screwed” 9fin Educational report, Permitted Investments

capacity could potentially be used in the context of a “two-step” transaction to spin assets off
to the shareholders, using one or more of the above baskets to transfer assets to an
Unrestricted Subsidiary and using a Restricted Payments carveout to distribute the shares of
the Unrestricted Subsidiary to shareholders.

Adding up capacity under the above PI baskets, these baskets could give Victoria up to
£178.9m of capacity for investments in Unrestricted Subsidiaries (assuming no capacity
under these baskets has been previously utilised).

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