Envision rewrites book on liability management exercises

Editor's note: The following was originally published to LevFin Insights and CreditSights on Sept. 9. It reflects conversations/depictions shared with LFI from multiple involved parties and sources familiar with the transactions on a background basis.?It is part of the recent integration of LFI news content with fundamental research focused exclusively on special situations, soon to include Covenant Review. To browse the new platform, click?here.

When the smoke cleared from?Envision Health’s flurry of high stakes negotiations and dealmaking last month, the company had managed to raise $1.4 billion in new capital and push out all meaningful maturities through 2026 while hardly adding any incremental debt. Envision’s private equity sponsor KKR had effectively resuscitated hope that it could salvage?? and even make a return on?? the $3.5 billion it had plunged into the $10 billion buyout four years ago, its largest-ever equity check.?

With so much money on the line, and extremely flexible credit docs, Envision gave its legal and financial advisors the go-ahead to pull out all of the so-called creditor-on-creditor violence tactics to extend the runway. As a result, holders of what was ultimately $5.7 billion in term loan debt have been scattered across an altered capital structure, a medley of winners and losers determined by the size of their positions and perceived threat they represented to block the transaction or sue. Of that term loan, just $153 million remains. That stub, which was initially a first-lien facility, is now essentially in a fourth-lien position at an issuer that no longer gets credit support from the valuable ambulatory surgical center business, AmSurg.

Play-by-play

Envision’s business began to struggle less than a year after the 2018 LBO, raising fears amongst lenders and bondholders that Envision could “pull a?Chewy” with AmSurg – credit speak for transferring a portion of the company’s most valuable assets through the use of available restricted payment and investments baskets, as BC Partners-owned?PetSmart?did with its online retail arm. Financial straits and asset transfer fears were exacerbated in 2020 as Covid hit. Bond trading levels fell to the 30s. Envision management and an initial set of advisors attempted to reign in leverage through a distressed exchange transaction where junior bondholders swapped into incremental first-lien term loan debt at a discount. The deal shaved off just $330 million in debt?? not nearly enough to stave off a reckoning.?

Between the first exchange and the start of 2022, restructuring professionals, building on precedents such as?Caesars,?J.Crew?and Chewy, began experimenting with different, more aggressive liability management exercises in other deals. Heavily indebted companies with loose covenants and decimated by the pandemic met a debt market flush with capital. On the lender side, the climate was also taking on a survivalist tone. Distressed investing funds looking to take advantage of the brief distressed cycle were more than willing to disadvantage their fellow creditors?to salvage their principal or get an outsized return. Even some CLO funds historically known to be conservative were willing to get in on the action as they took up sizable principal positions in term loans. Among the first pandemic LMEs,?Revlon?in 2020 executed an aggressive “drop-down” transaction?? where assets were transferred or “stripped” into entities that are not obligors for the existing loan obligations. In these drop-down transactions, as in Revlon, the newly asset-enriched unrestricted entities are used to incur debt backed by those assets.?

Soon after came?Serta Simmons, where a group of CLO investors banded together to execute an “uptiering” transaction that allowed one group of lenders to provide new capital and exchange into a new facility, all of which would be senior to the existing lenders, taking priority liens on the existing collateral assets. The uptiering was done in part to prevent any rival investor group from benefiting from a potential drop-down deal that might be in the offing. Two more equally if not uglier uptiering transactions followed shortly thereafter in?Trimark?and?Boardriders. Litigation followed in every case, three of which are ongoing (after myriad plot twists, Revlon’s drop-down transaction will likely face a reckoning in bankruptcy court).?

Divide and capital raise

After the 2020 exchange, Envision was left with nearly $6.5 billion in secured debt?? primarily a $5.7 billion term loan?? due in 2025 or sooner, and just over $1 billion in unsecured debt due 2026 or later. Envision appeared to have rebounded from the depths of the pandemic in 2021 and the market valued the term loan at nearly 90 cents on the dollar after it reported strong second-quarter 2021 results, up from the 60s in March 2020.?

Then reality started to set in. CEO Jim Rechtin warned of a “material decline” in revenue as a result of legislation passed in 2020 called the No Surprises Act, along with increasing labor costs and rate pressure from payors. The No Surprises Act was signed into law Dec. 27, 2020, as part of the year-end omnibus spending bill, aiming to reduce high medical costs from out-of-network providers, and it was set to take effect Jan. 1, 2022. While the final rules would be hashed out over time, it would clearly have a negative impact on Envision. The company entered 2022 already struggling under the weight of its debt, still suffering from the impact of Covid, with the NSA’s expected impact as backdrop. The company was going to need to either raise money and slash debt, or file for bankruptcy, and everyone knew it.

Lenders were wary of a potential transaction where they would find themselves in some way subordinated to new debt with or with less assets following a strip. A lender group organized with?Guggenheim?and?Jones Day?to form a game plan as well as threaten litigation if need be. The group, which comprised a mix of passive CLO and mutual fund investors on the one hand, and active distressed teams and hedge funds on the other, quickly showed divisions in their thought process. Ultimately, the Jones Day-led group held no direct discussions with Envision.?

At the time, the term loan was still quoted in the high 70s, and Envision’s advisors?? at this point?Kirkland & Ellis?and?PJT Partners?? understood that lenders were likely unwilling to accept much of a discount to par or to put in enough money, so they began to seek out third-party financing options. The design from the outset was to first fix the liquidity problem, then capture a discount in taking out existing debt, and then do something comprehensive with lots of participation.

A number of funds flush with capital were happy to step in and put in money that would prime existing lenders, and in short order Envision had lined up commitments from?Angelo Gordon?and?Centerbridge.?

The largest holder of the lender group was?Pimco, whose funds held as much as $900 million worth of the Envision term loan, far more than the next largest holders. Pimco, which had been building a more sophisticated distressed group over the past few years, connected directly with Envision, and by February had left the?Jones Day?group as it sought to play a part in the priming transaction that was soon to take place in conjunction with the third party lenders, a non-pro rata deal disadvantaging any lenders that were left out. The Jones Day mandate by this time fell apart, as the makeup of the group had shifted. Led by the CLO/mutual fund contingent, the group went on to retain?Gibson Dunn, hoping that Gibson Dunn dealmaker?Scott Greenberg?could corral enough of the disparate holders together to arrange a pro rata deal.?

AmSurg

As March 2022 turned to April, Envision advisors used the prospect of commitments from third parties to incentivize certain existing lenders – those with deep pockets and large Envision debt positions – to also write large checks. The Gibson Dunn group couldn’t offer up anything pro rata as attractive as the non-pro rata alternatives, and Envision and its advisors were able to create a prisoner’s dilemma and pick off members of the group looking to salvage their positions even while their fellow lenders would be decimated.?

The company privately announced terms of the deal on April 29, and more information began to leak out: Angelo Gordon and Centerbridge as third-party lenders were joined by existing lenders Pimco, HPS, Sculptor and King Street to provide $1.3 billion in a new-money investment. The new debt was lent against the ambulatory surgical center business, known as AmSurg, 83% of which was held in subsidiaries redesignated as unrestricted. The company estimated in disclosures associated with the transaction that the AmSurg business was worth $3 billion. This initial group of lenders was able to exchange $1.826 billion of the $5.72 billion term loan at a blended price of 66 cents on the dollar into $1.3 billion of second-lien debt supported by the AmSurg business.

With respect to those valuable assets, the transaction effectively layered $2.6 billion of debt in front of the $3.9 billion in term loans due 2025 that were left out of the deal. It was the first bomb that went off for those left on the sidelines, who saw their debt immediately quoted down 10 points to around 50 cents on the dollar.?

Below is the estimated pro forma capital structure following the AmSurg transaction:

A disposition by any other name

The deal was structured such that Envision redesignated the AmSurg subsidiaries as unrestricted, and those entities issued new first- and second-lien facilities, creating a goodco/badco, in order to grow the AmSurg goodco business while the Envision physician services emergency medicine group was expected to struggle. The legal team from Kirkland had to get over three main hurdles: find a way to strip out AmSurg that did not run afoul of the credit agreement, convince the term loan agent to release the liens on the AmSurg assets and then find a way to use money lent out of AmSurg at the remainco level without compromising the new AmSurg lenders.

It was debatable as to whether or not this was even possible. Envision’s advisors eventually got comfortable with a generous interpretation of the “specified disposition” definition in the existing credit agreement?? internally describing it as “clumsy” and “abysmally drafted”?? whereby the designation as an unrestricted subsidiary didn’t constitute a transfer. Even if AmSurg was restricted one moment and unrestricted the next, Envision still?technically?owned 100% of it; that’s not a transfer or a sale, the thinking went.?

Covenant Review?took a strong view that the transfer of the AmSurg unit could not be accomplished under the specified disposition definition, though it noted that the measures preventing any such transfer could be overturned with a simple majority. It turned out not to matter anyway. Envision advisors were prepared for litigation the whole time?? and in fact were bolstered by the Trimark and Boardriders transactions that Kirkland also designed: Trimark ultimately just had to cut in the rest of its lenders, not unwind the transaction, and the Boardriders transaction, completed in October 2020, where lenders immediately sued, has yet to even make it past the motion-to-dismiss stage nearly two years later.?

Envision went ahead with the transaction without any vote.?Covenant Review’s Ian Walker suggests that this type of maneuver has become the norm, and is no longer the exception.

"What we’re seeing is the new sponsor playbook for liability management transactions,” says Walker. “It doesn’t matter what the documents say. Even if it’s not permitted, go ahead and do the transaction and then figure out how to get your creditors to allow it ex-post. It’s the same playbook we saw with PetSmart. They weren’t allowed to do the Chewy transaction. They went ahead and did it anyway and got enough people to agree that they could do it by using coercive negotiation tactics. It was the classic prisoners' dilemma.”?

Don’t call it a guarantee

Under the existing credit agreement, Envision’s remainco was not allowed to guarantee debt of an unrestricted subsidiary. This presented a problem, since it needed about $1 billion of that $1.3 billion just raised at the remainco level. Thus, instead of simply upstreaming money to Envision remainco, the lawyers determined they would structure it as a loan so that AmSurg was lending money to Envision, governed by an intercompany credit agreement. When the documents were released, parties were surprised to see that the interco credit agreement had a rolling one-year maturity. Surprising much of the market, this wasn’t accomplished using the intercompany credit basket. The creativity was brought up as an argument for a group of lenders that would later organize with Kasowitz Benson to potentially sue: That the transaction included an intercompany loan that the group could argue was not being made in the ordinary course of business, as it exceeds what’s normally loaned both within the definition of the applicable baskets, and it has been effectively structured with no maturity.?

The way Envision accomplished the interco deal, however, instead tapped into the incremental accordion and voluntary prepayment baskets which had no more than one year maturity, thus necessitating the strange structure. The view was this was not the same thing as having a guarantee.?

Call my agent

The transaction required?Credit Suisse?to release the liens on AmSurg assets. While Credit Suisse had ostensible conflicts?? the bank reaps enormous fees bringing KKR deals to market?? there had been previous deals where the existing agent would just resign, preferring not to risk litigation: Citi had resigned as agent in the Chewy transaction, for instance. Planning for this, Kirkland and PJT had worked with Angelo Gordon and Centerbridge to design their commitments where the evidence of the lien release would not be a condition to funding the AmSurg loans, which was part of the reason they beat out other offers.?

Envision’s advisors made an extensive presentation to Credit Suisse, who was advised by Davis Polk, as to why first, they shouldn’t resign, and second, they should release the lien. Primary details in the presentation described in detail the argument that the designation of an unrestricted subsidiary is not a transfer. The valuation work was done with all of the calculations as to how the transaction would work with the interco structure. Ultimately, Credit Suisse agreed, and upon the April 29 announcement of the transaction, the agent released the liens.

Not only that, even after lenders left out of the deal retained Kasowitz and sent a letter to Credit Suisse requesting the declaration of a default and/or the agent’s resignation, Credit Suisse held firm.?

Tierjerker?

The AmSurg transaction was always meant as just a first step?? there was still more than $4 billion of debt maturing in 2025. So no sooner than it had safely closed did Kirkland and PJT get to work on the next steps. Now lenders were sufficiently concerned, as the loan had traded down to 40 cents on the dollar. Some commercially minded funds like Brigade and GSO were already looking to cut a deal to ensure they wouldn’t be subordinated further. Other lenders organizing with Kasowitz and threatening litigation essentially provided Kirkland and PJT?? who were recipients of constant intel as loyalties were so irretrievably splintered?? with a list of who to cut in on the next deal, approaching nearly every firm that had joined the Kasowitz mandate early on.

By July, the advisors had enough support to proceed with the next transaction, and on July 22 announced that more than half of the remaining lenders had jumped on board yet another priming transaction, this one an uptier transaction within the remainco business. Lenders would provide $300 million of new money in a first out tranche at remainco while creating a tiered structure that allows consenting lenders to exchange a portion of their holdings into a second out tranche. Brigade and GSO led a steering committee from within the Gibson Dunn group, looping in Oak Hill and then King Street, who still had debt left over to exchange into the second out tranche at a 17% discount, with favorable participation in the first out tranche. Octagon, Blackrock, CIFC and other large holders would later jump on board to exchange their debt into the second out tranche as well.?

The rest of the Gibson Dunn group was then invited to exchange at different participation levels, allowing them to exchange a majority of their holdings into a second-out tranche, though any holdings they did not exchange into the second out tranche would be exchanged into third out debt.?

Nearly 50 lenders agreed to this lower participation level in phase one, including funds of Eaton Vance, Benefit Street, Canyon, First Eagle, BAML, Invesco, Mariner, Wellfleet, Victory Capital, Oak Hill, Broadriver, Brigade, Octagon, Apollo, Birch Grove, HPS and Marathon.?

Lastly, in phase two, the remaining lenders who were not part of the Gibson Dunn group were offered the chance to exchange about 30% of their holdings into the second out tranche, with the balance left as third out for those who consent. Lenders who didn't consent retained their term loan holdings, structurally subordinated to the first-out, second-out and third-out tranches.?

To anyone left out of both the AmSurg transaction and the new steering committee for the uptiering transaction, this was gut-wrenching.

“Unlike Apollo and Oaktree, KKR was always considered one of the good guys,” said a lender who was not invited to participate in AmSurg or phase one. “We woke up and were shocked that they did AmSurg, then shocked with the uptier transaction and then were shocked about the 70/30 split.?We felt like one of the kids in Animal House who had to stand outside the frat without being invited to the rush party.”?

Participating in any of these phases required consenting to not pursue any litigation as a result of the transactions. Importantly, if there was more than $200 million in holdouts, it left in place a springing maturity in 2025 for the rest of the new first-, second- and third-out tranches, which are all due in March 2027. There remained some risk that not enough funds would hold out.

Kirkland and PJT’s profiling of which funds had the appetite for litigation or fighting the transaction appears to have been prescient. By Aug. 5, the final participating left just $153 million of the original term loan outstanding, effectively in a fourth-out position, with $2.2 billion in the second out, and $1 billion in the third-out tranche. The silver lining for the holdouts was that their debt became the inside maturity, with the fourth-out tranche now quoted at a premium to the third-out. The bad news is that the quote is still in the mid-30s (bid only, no offer).

Below is the estimated resulting capital structure after the last uptiering transaction:?

The architects

Even though there were unique factors and especially weak documents in the case of Envision,?Covenant Review’s Walker thinks the market will continue to see similar transactions as overlevered companies run into trouble.?

“This won’t work for every deal, since there are other factors at play including the underlying credit story and market conditions. But, I would not be surprised to see other Sponsors use this playbook going forward,” Walker said.?

Armies of advisors and lawyers advised the company and its lenders in the series of negotiations, transactions and legal threats. In particular, LFI heard repeatedly that it was the teams from Kirkland & Ellis and PJT Partners who were mainly responsible for the design and strategy executing this combination of liability management transactions.?

Sources told LFI that the banking team from PJT was led by Josh Abramson, while Kirkland’s debt finance strategy and design was headed up by debt finance partner David Nemecek, with restructuring partners who worked on the deals including Ed Sassower, Josh Sussberg and Nicole Greenblatt. Abramson’s profile on the PJT website notes that he’s held roles in the restructurings of Caesars Entertainment, J.Crew, PetSmart, Revlon and?Travelport. Nemecek’s profile on Kirkland’s website says he has “led the design of some of the most complex and novel liability management transactions completed in recent years” including for Travelport, TriMark, Boardriders, PetSmart,?Neiman Marcus?and?Cirque du Soleil.?

Epilogue

Envision delivered results for the quarter ended June 30 on Aug. 12, following up with a call that resumed management’s previous format, consisting of prepared remarks followed by pre-submitted Q&A. The update was the first after the company completed its out-of-court LMEs.

CFO Henry Howe said that the company would not provide financial guidance other than projections it is required to submit to lenders. He closed the call by noting that the company’s first half performance had not met expectations, but that the AmSurg unit had performed according to plan and continues to benefit from positive industry dynamics. Reimbursement rates, clinical compensation, and hospital subsidies would be key metrics to achieve going forward, he said.

Liquidity of $1.233 billion at the end of the quarter consisted of $1.383 billion of unrestricted cash with $150 million unavailable for corporate purposes, plus $0.6 million available under the ABL facility net of $120.2 million letters of credit - and this was before the additional $300 million raised in the uptiering transaction completed after quarter-end. Howe said he expects the company’s cash balance to decline through the end of the year, reiterating that management’s priority is to maintain sufficient liquidity and manage the balance sheet.?