UFC Holdings follows market trend of reducing ‘debt cushion’

May 17, 2019

The Wall Street Journal reported late last month that the UFC was paying off its junior loan utilizing a senior one in order to reduce its overall debt load.  The move comes on the heels of an exclusive PPV deal with ESPN and the lack of concern that the Federal Reserve will raise interest rates.  The reduction of ‘debt cushion’ is a market trend by some companies to the chagrin of senior debt holders.

UFC Holdings, the official name of the entity for the UFC, sold $435 million of an add-on to an existing $1.44 billion loan that was due in 2023 and now has been extended to 2026.  The addition to the loan was sold at $99.75 on the dollar which included a discount to where the existing debt traded.  The company also paid existing loan holders a modest fee to allow the transaction.

The new debt will be used to pay off a more junior loan which eliminates a ‘debt cushion’ for senior lenders as junior debt (i.e., bonds and loans) are typically the first pieces of debt to absorb losses in bankruptcy.  Essentially, if the company were to go bankrupt the junior loans would be the most vulnerable in not being paid back as the most senior creditors would have the first chance at the assets which may leave junior debt out of luck in repayment. In this case, the junior loan had a higher interest rate than the senior loan.  The floating interest rate on the junior loan has been the London interbank offered rate plus 7.5%, or 4.25 percentage points higher than the rate on the senior loan.  Thus, the move aids in eliminating interest on the junior debt.

The transaction seems to be a growing trend in debt financing as more companies are reducing ‘debt cushion.’  This occurs in instances of speculative grade loans and instances where the junior loan has a higher interest rate than the senior loan.  To the chagrin of senior debt holders, paying down a junior loan is not favored as one might recognize that paying down a junior debt means that in the worst-case scenario for a senior debt holder, if a bankruptcy were to occur, assets previously used to pay off the junior debt will not be there to pay off the senior debt.

Via WSJ:

Last year, buyers of first-lien loans were paid 0.83 percentage point above the benchmark London interbank offered rate for every multiple the loans exceeded a measure of borrowers’ cash flow, according to LCD. That was the smallest amount since 2007, when lenders were paid just 0.69 percentage point.

Also, according to WSJ, 27% of first-lien loans, mostly held by senior type of debt held by investors were not backed by companies that didn’t have junior outstanding debt.

If you were wondering, this is analogous to using a credit card to pay off one with a higher interest rate.  Using a loan to pay off another might not seem like the most financially secure way to address debt load issues for a company and concerns senior debtholders that hold priority over the junior debtholders.  But a number of factors (as outlined above) likely made this move prudent.  First, Disney’s 7-year agreement to pay a “fixed license fee” to air its PPV fights exclusively in North America was seen as to “dramatically reduce the volatility” of UFC’s business.  Secondly, the market to purchase debt is on an uptick.

Here’s another reason that reducing debt cushion is a thing.  According to Moody’s, the company’s debt to EBITDA would fall to 5.5 times from 7.8 times which is said to potentially put lenders in a stronger position even without a debt cushion.  UFC Holdings’ existing loans in 2016 were said to have an EBITDA of $170 million by one measure and $300 million by another which was based on speculative future TV revenue.  Regardless, it borrowed another $100 million in 2017.

Of course, we may now know a little more about the TV revenue since its deal with ESPN.  Moreover, the deal likely assuages lenders about the debt.  Essentially, the speculative nature of the deal became less speculative.

The move pays off the interest rate of the junior debt but senior debt holders are weary as there is potential for not being made whole at the end.  But, it lowers its overall multiple which would allow it to be more lucid in investing and future debt restructuring.

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