Gajah Tunggal, Southeast Asia's biggest integrated tire manufacturer, proposed late Friday an exchange of its outstanding $420 million 10.25% bonds which mature on July 21, 2010, for a new five-year bond with a step-up coupon structure.
This is effectively a proposed distressed debt exchange. According to its March 2009 accounts, Gajah Tunggal has just $21 million of cash, which is not enough to cover the $21.5 million owed on the semi-annual coupon payment date on July 21. That payment will be "capitalised" as principal and distributed on a pro rata basis to takers of the new bonds.
The plan is for the exchange to be a straight par-for-par swap with no "hair-cut" on the old bonds, which were issued in 2005 by GT2005 Bonds BV and are guaranteed by Gajah Tunggal. Investors will not be forced to exchange their bonds at a discount, but they will suffer a haircut on their interest payments.
The new bonds will pay a 5% annual coupon for each of the first two years, stepping up to 6% in year three, then 8% in year four, and back to 10.25% in the final year. The company could raise the coupon to 10.25% at any time before that, but if it does that, it cannot then reduce it. However, there will be an incentive for the company to lift the coupon to 10.25% at an early date -- if only to keep shareholders happy -- because until it does, Gajah Tunggal won't be allowed to pay dividends on its ordinary shares.
Holders of the new bonds will have structural seniority over holders of the old bonds, because they will have a first legal charge over three factories and the land they stand on, which together has been valued by a leading Indonesian surveyor at $140 million.
However, yesterday the response of two major ratings agencies was ambivalent. Their rating criteria meant they had to downgrade the existing bonds, identifying the exchange offer as an intent to default. Yet, they recognised that a successful completion of the transaction might ease Gajah Tunggal's liquidity problems.
Standard & Poor's said it had lowered its long-term corporate credit rating on Gajah Tunggal and the rating on the 2010 bonds to CC from CCC+, with a negative outlook. S&P explained that if the proposed exchange offer is completed, it "would view the exchange offer as coercive, hence tantamount to default for two key reasons".
"First, we regard the proposed change in the coupon rate, the capitalisation of $21.5 million interest into the new bonds and extending of maturity until 2014 (beyond the original 2010) as a loss of value to investors because of lower yield," said S&P credit analyst Wee Khim Loy.
Second, if the proposal is not accepted, then S&P believes that Gajah Tunggal is unlikely to be able to service all its debt obligations over the next year or remain in compliance with its covenants.
Moody's also downgraded the bonds from Caa1 to Ca, but affirmed the Caa1 corporate family rating of the company. Its outlook for the ratings remains negative.
"If successful, the transaction will constitute a distressed exchange, which is a default event under Moody's definition. The downgrade of the 2010 bonds to Ca considers this default and our assessment of the economic loss in comparison to the original payment promise for the bonds," said Wonnie Chu, a Moody's analyst. "The Caa1 corporate family rating reflects our forward-looking view of the company, assuming that the transaction closes as proposed," added Chu.
Moody's recognised that a completion of the exchange offer will address Gajah Tunggal's near-term refinancing risks and improve its coverage ratio because of an associated reduction in interest expenses.
S&P also acknowledged that the completion of the transaction would ease Gajah Tunggal's liquidity difficulties and remove the element of refinancing risk.
S&P added that if the tender offer is not completed or it fails to solicit any response, "the rating on the company could remain at CC, in view of uncertainty over paying the coupon on July 21, 2009, and the refinancing risk of the $420 million in July 2010".
Moody's is retaining a negative outlook because of that same uncertainty. "If the exchange offer fails to go ahead, the corporate family rating will be lowered further to reflect the higher probability of default and lower expected recovery rate", it said.
Moody's last downgraded the company to Caa1 from B2 on April 16, 2009. At the time, it said that Gajah Tunggal still had a high level of leverage, with a first quarter 2009 annualised debt-to-Ebitda ratio of eight times, putting pressure on financial covenants agreed for its working capital facilities.
S&P said that Gajah Tunggal's credit profile had deteriorated sharply in the first quarter of 2009 because of weak global demand for tires (the company's most well-known brand is its GT Radial tires) and muted domestic sales growth. The company produces tires for motorcycles, cars and commercial and heavy equipment vehicles. Giti Tire, a Chinese tire manufacturer, is a 27.9% shareholder through its subsidiary, Denham Pte Ltd.
Gajah Tunggal's 2010-dated bond is a Reg-S issue governed by English law, so a minimum of 21 days is required for holders to make a decision, and the offer closes on July 3. But, Gajah Tunggal and its advisors, Credit Suisse, have introduced an "early bird" deadline of June 26, whereby holders who agree to the terms by that date will enjoy the par-for-par swap. Holders who miss that deadline will only receive 95% of the par value.
