Lear will likely file for bankruptcy

June 2009

This was one of my best calls in distressed securities and it was actually a short. In early June, Lear stock traded at $2.50 even though there were signs that the company may file for bankruptcy. This was due to the hope that the US government’s cash for clunkers program would save the auto industry. However, not all auto companies will survive. GM and Chrysler filed for bankruptcy just a few weeks ago. We were able to short the stock for one of the biggest winners of the year.

This is why I think Lear will likely file for bankruptcy. There could be a small chance of a highly dilutive exchange offer.

Capital Structure

$486m revolver expires 3/2010

$822m revolver expires 1/2012

$1.0B term loan due 4/2012

$400m 5.75% unsecured bonds due 2014

$300m 8.5% unsecured bonds due 2013

$590m 8.75% unsecured bonds due 2014

$1.2B in cash (needs at least $500m to run the business, burned $200m last quarter)

  • Lear is currently in violation of covenants on two revolvers and a term loan but lenders agreed to give the company until June 30th to come up with a plan.
  • The problem is that hedge funds control the $486m revolver that expires 3/2010. If the banks that own the $822m revolver due 2012 decide to relax the covenants, then Lear will use its cash to pay off the hedge funds next year. The banks do not want this so any out of court restructuring would have to involve the hedge fund group. Early indications are that the hedge fund group is not interested in negotiating.
  • There is bad blood between the banks group that owns the revolver due 2012 and the hedge fund group that owns the revolver due 2010. In 2Q 2008, the bank group decided to extend the revolver to 2012 but the hedge fund group refuse to go beyond 2010. The banks came away with a bad taste after the deal and will not want to allow their money to be used to pay off the hedge fund group.
  • Another problem is that the 5.75% bonds have a limitations of liens covenant that prevents the company from offering more collateral to secured lenders. Lear would have to get these holders to release the liens before it can negotiate with the banks to offer them more collateral.
  • Carl Icahn owns a chunk of the term loans due 4/2012 and may plan to combine that stake with an offer to provide DIP financing in bankruptcy for a controlling position.
  • Management does not hold much equity so their main incentive is to strike a deal that will allow them to keep their jobs, which according to Goldman has been happening across bankrupt companies.
  • Both Goldman and JPM credit guys think it will be too difficult to get everyone to compromise in such as short period of time.
  • There is a slight chance that Lear may try an exchange offer to get bondholders to swap their debt to equity but given the $1.3B face of unsecured debt and only $162m in market cap, the exchange will be highly dilutive to the stock. Banks will also have to agree to this deal.
  • Lear has already missed a $38m coupon payment on June 1 so the banks may not want to agree to any deal that
    allows unsecured bond holders to continue to get paid large coupons.

Conclusion

On July 6, 2009, Lear officially filed for a pre-packaged bankruptcy that valued the stock at zero. The unsecured bonds traded at 25 and went straight up form there and ultimately got a recovery in the 70s when the company emerged in march 2010.. The secured loans traded up from 70s and ultimately recovered 100.

 

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