Oi Debt Restructuring: A 4 Player Chess Game (OTCMKTS: OIBZQ)

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Background

In the next weeks, Oi SA (OIBR) management will be very busy defending the company against the potential consequences of noncompliance with certain restrictive clauses and the possible repercussions of a court case launched in Europe by Aurelius Capital.

On April 15, Oi will hold a meeting with 9th and 5th issue debentureholders to discuss the company’s failure to meet its debt to EBITDA ratio at the end of the first quarter of 2016.

There are no management proposal for the meeting, which means that, most likely, the company will not ask for a waiver.

We believe this is an indication that Oi has not reached any agreement with the holders of these two debentures, and that the company will be forced to redeem the few remaining debentures outstanding. We do not believe this will lead to a cross default.

Oi redeemed approximately R$218 million ($61 million) of debentures in 2015, mainly from the 5th and 9th issuances (Source: Company Annual Report, p. 73). In mid-February, it also redeemed approximately 21 million reais ($6 million) of these 2 debentures. The relatively low stock is highlighted in This folder (HT Xedron):

Outstanding Debentures of OI Brazil

We estimate that it will cost the company approximately 24 million reais ($7 million) to redeem the remaining debentures.

Oi also risks breaching other financial covenants. However, as the company confirmed to us, “information about other lines of credit with financial covenants is not public. These contracts have confidentiality clauses, so we cannot disclose details about them.”

On April 18, Oi will have to appear in court in Amsterdam (Netherlands) to oppose Capricorn Capital’s lawsuit.

Capricorn Capital is a fund managed by Aurelius Capital which claims to own more than 100 million euros in Oh debt issued by PTIF – the Portugal Telecom International Finance legacy.

Aurèle tries to ban Oi Brasil Holdings Coöperatief to transfer funds or make inter-company loans to the parent company or one of its subsidiaries in order to use existing funds to repay PTIF debt, including bonds due for repayment in June 2016 .

Here are some interesting highlights from court documents (courtesy of Reorg Research):

OI Brazil Legal documents PTIF 01

OI Brazil Legal documents PTIF 02

OI Brazil PTIF court documents 03

Failure to appear in court Oi’s side can be seen as a defect and lead the court to grant Capricorn’s claims, according to Dutch law:

2.4 The initial complaint

Finally, a writ that clearly sets out and specifies the relief sought may allow the court to grant a default judgment if the defendant does not appear in the proceeding.

It is unclear, however, whether this would trigger a cross default for the entire Oi’s Debt – more on that later.

Reorg Research, a provider of analysis on distressed debt and leveraged financial markets, reports: “Houlihan Lokey and Alvarez & Marsal launch Oi bondholders in an attempt to form groups of creditors awaiting a restructuring process”.

This adds to a previous report by Reuters that “a group of unidentified people bondholders Oi SA hired Moelis & Co”.

What’s going on behind the curtain? Why are so many different advisors needed if their role is simply to negotiate a better deal with the company once a restructuring is announced?

The answer lies in the complexity of Oi’s debt and the fact that different debt instruments may have different trading needs.

A 4-player game of chess – each debtor also fighting against each other

Oi’s debt structure is extremely complex. Part of its bonds were issued by Portugal Telecom International Finance and inherited by the company, part by Oi itself, and part of Oi’s debt is guaranteed by Telemar. The company’s debt is issued in three different currencies (euro, US dollar and Brazilian real), and there are domestic and foreign institutional and retail investors as bondholders.

Even the three major ratings agencies have basically admitted that it’s hard to say if there is “better debt” out there right now. With respect to tickets guaranteed by Telemar, which has priority over approximately two-thirds of the cash flow and Brazilian operating assets of Oi, Fitch recently commented that it “has low visibility as to whether these notes would be entitled to seniority under the Brazilian legal system during a possible reorganization or restructuring of the debt of Oh”.

Some bonds, such as those issued by the PTIF, have collective action clauses [CACs] that, in the event that a super-majority of bondholders accepts a debt restructuring that is legally binding on all bondholders, may force even those who vote against the restructuring to agree. Other bonds do not include these clauses and may allow for a hold-out strategy.

With the company being very quiet about its future intentions, it is completely understandable that each creditor would try to get outside counsel to better understand the strengths of their own position and come to the negotiating table in the best possible position.

Excluding bank debt, we essentially see four different categories of debt holders, each with different strategies and objectives:

  • Debentureholders
  • Telemar Bonds
  • PTIF bondholders
  • Oi Bonds

Debentureholders

As we have already noticed, the holders of the 9th and 5th issues of Oi’s debentures cleverly used the bargaining power conferred by the presence of EBITDA covenants that the company was not meeting, in order to force Oi to redeem that specific debt both in the past and most likely in the very short future.

On the other hand, the holders of the 8th and 10th issues are in a weak position because their covenants were lifted for December 15, 2015 and the next measurement will take place in December 2016 (link to the minutes of bond meetings: 8th and 10th).

We anticipate that holders of the remaining debentures will have to play a relatively tough game, as they do not appear to have much bargaining power with Oi in the short term – unless, of course, Oi decides to continue to redeem its own local debentures, giving this category a “preference” since it is a domestic debt instrument.

Telemar, PTIF and Oi Bonds

According to Reuters, the Telemar bondholders hired Moelis as a financial adviser. We anticipate that Houlihan Lokey and Alvarez & Marsal will likely adopt either PTIF or bondholders of Oi, and are trying to build a stronger case for their client.

As we noted when analyzing the Capricorn lawsuit, a shrewd legal action can have significant consequences on a single bond issue.

The rating agency’s comment confirms that it is anything but clear which debtor may be in a stronger position to get a bigger slice of the pie.

However, we expect all of these consultants to be on the same side of the table when it comes to negotiating with Oi once a proposal is formally made to creditors.

What happens if a player actually tries to “win the game”?

According to ISDAPTIF has approximately $1 billion in outstanding notional amounts net of credit default swaps [CDS].

OI Brazil CDS credit default swaps

Reorganization search reports that “other investors believe that Aurelius may also have a CDS position and may seek to force a default at Oi by preventing the company from shifting cash from one part of its corporate structure to another as the company’s maturity schedule accelerates later this year.”

Although we have no idea if this could be the case, we do not rule out the possibility that, in such a complex debt structure, certain actors could benefit from a financial advantage if the company is forced into bankruptcy. – which is not a result that can be completely ruled out at this time.

This is why even a single action must be carefully evaluated for its potential cross-default consequences.

Our take: Grab some popcorn and watch from the sideline

Given the complexity of Oi’s debt structure, the many unknowns that exist, and the fact that even qualified investors might find it difficult to identify the best debt instruments to invest in, we suggest looking aside until the situation becomes a little easier to decipher.

We always thought an alien white knight might have been the best fit for both Oi and TIM Brazil, as Telecom Italia (TI) now seems inclined to sell its Brazilian assets. We still believe that a combination of the two companies would be beneficial for the whole market, and not just for these two players.

However, taking into account the fact that Oi’s debt situation could plummet at any time, we’re not sure a white knight could materialize any time soon – another good reason to monitor the situation without taking a position, as investment opportunities more cautious ones may materialize as the story unfolds.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these actions.

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