Structural Subordination -- Dude, What Happened to My Collateral?
Freescale Semiconductor was acquired by Blackstone Group, Carlyle Group, Permira Advisers LLC, and TPG Capital LLC in late 2006. A recent article by Henny Sender in the Wall Street Journal discussed how this consortium convinced its banks and other lenders to accept an especially lenient package of covenants and interest payment options. A review of Freescale's public filings since the deal closed reveals just how lenient the package is.
Believe it or not, due to the way the deal is structured, the trade creditors in 72% of Freescale's business are functionally senior to all of the $9.5 billion that was borrowed to finance the acquisition. The $9.5 billion is "structurally subordinated" to these trade creditors, because the borrower of these funds is the parent company and the trade creditors deal with subsidiaries that did not guarantee the parent's debt. Pretty neat trick.
Here is one of the Risk Factors in Freescale's Form S-4, filed on March 8, 2007 in connection with a bond exchange offer:
Apologies to Polonius, but what a great time it is a borrower to be.
Believe it or not, due to the way the deal is structured, the trade creditors in 72% of Freescale's business are functionally senior to all of the $9.5 billion that was borrowed to finance the acquisition. The $9.5 billion is "structurally subordinated" to these trade creditors, because the borrower of these funds is the parent company and the trade creditors deal with subsidiaries that did not guarantee the parent's debt. Pretty neat trick.
Here is one of the Risk Factors in Freescale's Form S-4, filed on March 8, 2007 in connection with a bond exchange offer:
Claims of holders of the Exchange Notes will be structurally subordinated to the claims of creditors of our subsidiaries that do not guarantee the Exchange Notes, including trade creditors. All obligations of these subsidiaries will have to be satisfied before any of the assets of such subsidiaries would be available for distribution, upon a liquidation or otherwise, to us or creditors of us, including the holders of the Exchange Notes.In a separate section of the S-4 we learn who these lucky trade creditors are and the magnitude of the structural subordination:
Our non-guarantor subsidiaries accounted for approximately $4,594 million, or 72% of our net sales, and approximately $635 million of our EBITDA for the year ended December 31, 2006.There's more. Not only is the unsecured high-yield debt in this boat, but the secured debt is too! Information about the secured debt is a little hard to find in the filing, which is an exchange offer for the unsecured notes. But here it is:
As of the issue date, none of our subsidiaries will guarantee the Exchange Notes or the new senior secured credit facilities.In other words, all $9.5 billion of the debt, secured and unsecured, sits at the parent company with 28% of the revenues. The other 72% of the revenues run through various subsidiaries, none of which has guaranteed even the senior debt. On top of that, the filing discloses that Freescale is allowed to incur an additional $1 billion of new debt, draw on a $750 million revolved and pay some of the bonds in PIK notes. With the bulk of its trade creditors protected and plenty of excess capital, it's hard to imaging how this boat could ever go down.
Apologies to Polonius, but what a great time it is a borrower to be.
