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Technical debt question - help needed please


MrB
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Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

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Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

 

It is basically just a scare tactic from management. Saw the same thing last year from Consolidated Tomoka's disingenuous fear mongering campaign. Management tries to use this as a poison pill of sorts. Additionally in many instances, change of control can trigger onerous golden parachutes. That said, if activists are involved, chances are they feel a shake up is necessary. So I guess in the absolute worst case that it triggers a default, what is the problem? That a company that is probably already over leveraged is forced to sell off some assets and pay it down. Don't be fooled by these clowns.

 

The lawyer in me would also point out the word "could" in your bold highlighted paragraph. A change in control "could" cause one. But it also "could' not. All this stuff is usually negotiable.

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Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

 

It is basically just a scare tactic from management. Saw the same thing last year from Consolidated Tomoka's disingenuous fear mongering campaign. Management tries to use this as a poison pill of sorts. Additionally in many instances, change of control can trigger onerous golden parachutes. That said, if activists are involved, chances are they feel a shake up is necessary. So I guess in the absolute worst case that it triggers a default, what is the problem? That a company that is probably already over leveraged is forced to sell off some assets and pay it down. Don't be fooled by these clowns.

 

The lawyer in me would also point out the word "could" in your bold highlighted paragraph. A change in control "could" cause one. But it also "could' not. All this stuff is usually negotiable.

Ok that is helpful thanks Gregmal.

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Guest Schwab711

Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

 

It's just a covenant that effectively gives the lender the option to call their loans. I'm not familiar with RCII but it looks like this covenant was put in by the lenders to prevent the large owner (a PE firm) from taking a majority stake. I imagine the lenders were probably concerned that cash flow would be distributed to equity holders to the point that they might not be able to fully recover their principal if the company faced a temporary or sustained decline following these distributions. In this case, I would guess it's probably included because of the reputation of PE firms aggressively distributing to equity holders at the expense of creditors (again, I really don't know RCII's situation but that would be my guess).

 

Management already has a 'veto vote' for takeovers in the sense that board gets to choose whether or not to entertain offers (with some limitations). This has nothing to do with management fear mongering or poison pills. This is just a lending covenant. All else equal, the covenant does not benefit management in any way.

 

To give some perspective, change-of-control covenants were fairly common at the bank I worked at for SMID businesses. In my limited experience, they were almost always waived as long as the bank's expected recovery rate was unaffected or 'LGD remained unencumbered' (sometimes covenants related to equity holder distributions were added as a condition of the waiver (if they weren't already present) - depends on the purpose of including the covenant).

 

The point of this type of covenant (from the bank's POV) is the bank lent to RCII and their current management. The bank may or may not want to lend to whoever the new ownership group ends up being. The primary purpose is to prevent the obligation from being automatically transferred to unknown owners/counterparties (and potentially, unknown stewards/managers).

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Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

 

It's just a covenant that effectively gives the lender the option to call their loans. I'm not familiar with RCII but it looks like this covenant was put in by the lenders to prevent the large owner (a PE firm) from taking a majority stake. I imagine the lenders were probably concerned that cash flow would be distributed to equity holders to the point that they might not be able to fully recover their principal if the company faced a temporary or sustained decline following these distributions. In this case, I would guess it's probably included because of the reputation of PE firms aggressively distributing to equity holders at the expense of creditors (again, I really don't know RCII's situation but that would be my guess).

 

Management already has a 'veto vote' for takeovers in the sense that board gets to choose whether or not to entertain offers (with some limitations). This has nothing to do with management fear mongering or poison pills. This is just a lending covenant. All else equal, the covenant does not benefit management in any way.

 

To give some perspective, change-of-control covenants were fairly common at the bank I worked at for SMID businesses. In my limited experience, they were almost always waived as long as the bank's expected recovery rate was unaffected or 'LGD remained unencumbered' (sometimes covenants related to equity holder distributions were added as a condition of the waiver (if they weren't already present) - depends on the purpose of including the covenant).

 

The point of this type of covenant (from the bank's POV) is the bank lent to RCII and their current management. The bank may or may not want to lend to whoever the new ownership group ends up being. The primary purpose is to prevent the obligation from being automatically transferred to unknown owners/counterparties (and potentially, unknown stewards/managers).

 

You are correct in terms of the reasoning behind it and the perspective of the underwriters. This is absolutely accurate. I was more so referring to Mr.B's presentation of this covenant within the context of a proxy fight for board seats. Most often change of control is thought of in the perspective of a takeover or go private deal(PE type stuff as you mentioned). However it can also simply be a hedge fund taking 5/9 board seats at an Annual Meeting. The fear mongering comes into play when during a proxy fight you have company executives telling shareholders "if the dissidents take 5 seats we could be in default and have to liquidate/etc". I've seen that before and it's basically dishonest bullshit.

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Guest Schwab711

Rent-a-Center is under pressure from activists and it recently seemed to have negotiated with it's banker (JP Morgan) that a change of control and certain changes in the composition of its board will qualify as an event of default. It is explained as follows in its 2016 annual report under risk factors. 

 

A change of control could accelerate our obligation to pay our outstanding indebtedness, and we may not have sufficient liquid assets at that time to repay these amounts.

Under our senior credit facilities, an event of default would result if a third party became the beneficial owner of 35.0% or more of our voting stock or upon certain changes in the constitution of Rent-A-Center’s Board of Directors. As of December 31, 2016, $191.8 million was outstanding under our senior credit facilities.

 

I don't think I've ever seen this and not sure how it will hold up in court and/or how it will play out in practice. Anyone with experience in this field care to weigh in please?

 

Link to AR & proxy http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY4MDMwfENoaWxkSUQ9Mzc1OTk4fFR5cGU9MQ==&t=1

 

It's just a covenant that effectively gives the lender the option to call their loans. I'm not familiar with RCII but it looks like this covenant was put in by the lenders to prevent the large owner (a PE firm) from taking a majority stake. I imagine the lenders were probably concerned that cash flow would be distributed to equity holders to the point that they might not be able to fully recover their principal if the company faced a temporary or sustained decline following these distributions. In this case, I would guess it's probably included because of the reputation of PE firms aggressively distributing to equity holders at the expense of creditors (again, I really don't know RCII's situation but that would be my guess).

 

Management already has a 'veto vote' for takeovers in the sense that board gets to choose whether or not to entertain offers (with some limitations). This has nothing to do with management fear mongering or poison pills. This is just a lending covenant. All else equal, the covenant does not benefit management in any way.

 

To give some perspective, change-of-control covenants were fairly common at the bank I worked at for SMID businesses. In my limited experience, they were almost always waived as long as the bank's expected recovery rate was unaffected or 'LGD remained unencumbered' (sometimes covenants related to equity holder distributions were added as a condition of the waiver (if they weren't already present) - depends on the purpose of including the covenant).

 

The point of this type of covenant (from the bank's POV) is the bank lent to RCII and their current management. The bank may or may not want to lend to whoever the new ownership group ends up being. The primary purpose is to prevent the obligation from being automatically transferred to unknown owners/counterparties (and potentially, unknown stewards/managers).

 

You are correct in terms of the reasoning behind it and the perspective of the underwriters. This is absolutely accurate. I was more so referring to Mr.B's presentation of this covenant within the context of a proxy fight for board seats. Most often change of control is thought of in the perspective of a takeover or go private deal(PE type stuff as you mentioned). However it can also simply be a hedge fund taking 5/9 board seats at an Annual Meeting. The fear mongering comes into play when during a proxy fight you have company executives telling shareholders "if the dissidents take 5 seats we could be in default and have to liquidate/etc". I've seen that before and it's basically dishonest bullshit.

 

Gotcha. Agreed that if RCII execs are attempting to present this as anything other than a standard covenant than that is garbage. Also, I looked at prior ownership quickly and it seems more likely that the covenant is in place because creditors didn't have complete trust in management and not necessarily the presence of active funds, since the large active fund investors look to be relatively new. This would make Gregmal's explanation more plausible in RCII's case.

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In the recent Q it states "Events of default under the Credit Agreement include customary events, such as a cross-acceleration provision in the event that we default on other debt. In addition, an event of default under the Credit Agreement would occur if a change of control occurs. This is defined to include the case where a third party becomes the beneficial owner of 35% or more of our voting stock or a majority of Rent-A-Center’s Board of Directors are not Continuing Directors (all of the current members of our Board of Directors are Continuing Directors under the Credit Agreement). An event of default would also occur if one or more judgments were entered against us of $50.0 million or more and such judgments were not satisfied or bonded pending appeal within 30 days after entry."

 

However I checked back to 2015 and that language was there already, so it does not seem to be a recent reaction to Engaged (main activist), such as the following was

 

"On March 28, 2017, the Company filed a Form 8-K disclosing that, effective March 28, 2017, the Board adopted a stockholder rights agreement, or poison pill (the “Poison Pill”), generally preventing stockholders from acquiring 15% or more of the Company’s outstanding Common Stock, subject to certain exceptions. At the time the Poison Pill was adopted, Engaged Capital had beneficial ownership of approximately 16.9% of the outstanding shares of Common Stock and combined beneficial and economic ownership interest in approximately 20.5% of the outstanding shares of Common Stock (represented

by 16.9% of the Company’s outstanding shares of Common Stock and certain cashsettled total return swap agreements constituting economic exposure to an additional 3.6% of the Company’s outstanding shares, as further explained elsewhere in this Proxy Statement)."

 

Having said that Engaged is suing them nonetheless regarding the language around their debt,

"Arnaud van der Gracht de Rommerswael, derivatively and on behalf of Rent-A-Center, Inc. v. Mark Speese et. al. On April 3, 2017, another shareholder derivative suit was filed against certain current and former officers and directors, JPMorgan Chase Bank, N.A., The Bank of New York Mellon Trust Company, N.A., and, nominally, against us, in federal court in Sherman, Texas. The complaint alleges that the defendants breached their fiduciary duties owed to Rent-A-Center and otherwise mismanaged the affairs of the company as it concerns (i) public statements made related to the rollout of our point-of-sale system; (ii) compensation paid to Guy Constant and Robert Davis surrounding their resignations; and (iii) change-of-control language in certain debt agreements, which the suit alleges impacts shareholders’ willingness to vote for a slate of directors nominated by Engaged Capital Flagship Master Fund, LP. (“Engaged Capital”). The complaint claims damages in unspecified amounts, disgorgement of benefits from alleged breaches of duty by the individual defendants; an order declaring that certain language in the debt agreements is unenforceable; an order enjoining the lender defendants from enforcing certain provisions in the debt agreements; an order directing the Company’s board to approve Engaged Capital’s slate of directors; an order directing the Company to make unspecified changes to corporate governance and internal procedures; and costs, fees, and expenses.

 

In response to the motion to dismiss filed by the defendants on April 25, 2017, the plaintiff amended his complaint on May 9, 2017 and on May 19, 2017. The amended complaint alleges breach of fiduciary duty, unjust enrichment and waste of corporate assets related to alleged acts for the purposes of entrenching board members, including the approval of change-of-control language in certain debt agreements, the implementation of the point-of-sale system, and the severance compensation paid to Guy Constant

and Robert Davis."

 

It is noteworthy that Engaged has already been successful in getting three directors on the board and having one (Chairman) resign, while these terms applied, which would imply the that the covenants were waived as Schwab711 suggested.

 

Looks more like huffing and puffing then!

 

Thank you for your comments!!

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