I just returned from my first trip to a Nordic country this weekend, flying on SAS (nope not the Special Air Service), but (Scandinavian Airlines System) with the objective of seeing the Northern lights in northern Norway.
Having flown many low-cost airlines around Europe, I must say I was pleasantly surprised at the comfort of SAS. From an orderly check-in process, comfortable and spacious seats, generous luggage allowance without having to dump your bags in a cage before boarding to check it complies with size and weight allowances, and even complimentary tea and coffee on board! Yes the small things count.
I was so impressed I decided to do some digging around on SAS, and found that it had actually just emerged from a US bankruptcy reorganization, with Castlelake LP becoming the largest shareholder in the consortium.
What caused the bankruptcy?
All roads lead to the COVID pandemic – causing low demand and high operational costs. The airline lost close to a billion dollars in 2020 (using rough SEK/USD calculations), and then between $500m and $725m per year for the next 4 years as difficult trading conditions continued whilst the airline travel industry slowly recovered). In July 2022, the firm filed for Chapter 11 Bankruptcy in the US.
A tender process was initiated by the court, resulting in a consortium of investors emerging as tender winners, led by Castlelake LP, but also including Air France/KLM, Lind Invest, and the Danish State.
The winning bid was an injection of $1.175bn cash, including $475m of new unlisted equity, $700m in secured convertible debt, and $500m refinancing of a Debtor in Possession term loan, which was to be repaid after emergence from Chapter 11. What is Debtor in Possession Financing, or DIP? DIP is a secured financing arrangement, which enables a company to continue trading with creditors, after it enters a formal restructuring process.
As part of the reorganization, all of the existing shareholders will get zero from their investment, whilst $325m will be distributed out to unsecured creditors, in a combination of cash and equity, resulting in a recovery of 20-25% of their total claims being paid, and a “modest recovery” of investments for holders of commercial hybrid bonds. All of the existing equity was to be cancelled and the company delisted from the stock exchange.
Post the reorganization, Castlelake emerged with 32% of the equity and 55.1% of the convertible debt, with the balance of the equity and convertible debt being held by the other consortium members in varying proportions.
The convertible debt will be secured and have a maturity of 7 years, and interest rate of SOFR +650bp. SOFR is today 4.57%, so this implies a cost of debt of +11% per annum, and a drawdown fee of 1.5% payable upfront. At these high interest rates, the probability of the debt converting into equity at a later stage appears high.
Fastjet experience
Airlines are notoriously difficult businesses to get right. Legendary investor Warren Buffet has been critical of airlines, calling them “financial sinkholes”, attributing much of the blame to the ticketing system that airlines use which periodically bring the industry to its knees. When I was an analyst at an investment fund a few years back, we considered an investment into Fastjet, then an African focused airline company, listed on the London AIM, which was looking to raise funds. The company was bleeding money, with shareholders having invested a cumulative $400m in the company since inception, with no sight of being profitable. The airline faced low occupancy rates on its routes, caused by airlines which were too large for its needs, high operational costs including leasing and fuelling costs, and a very expensive head office function, to name a few of the problems. One of the aircraft leasing companies, Solenta Aviation, entered into a deal with the company to lease its aeroplanes to the company in return for shares in the company if the lease charges could not be repaid. Through this method, Solenta has built up a 67% share in the airline, which has now turned profitable. Solenta then lent the company $2m, which is now payable, and is convertible into more shares if the debt is not repaid.
Like the adage of being a provider of picks and shovels for mining rather than the mining company itself, the attractive part of the airline industry is often leasing the aircraft to the airlines, rather than operating the airlines.
Who is Castlelake?
Castlelake is a global alternative investment firm with $24bn in AUM. Founded in 2005 by Rory O’Neill and Evan Carruthers, the firm specialises in asset-based investing, and rotates across the risk spectrum as market conditions evolve, specifically focussing in discovering and pursuing asset-rich and cash-flowing opportunities in the private markets, across three main strategies including 1) Speciality Finance, 2) Real Assets (real estate, infrastructure and their associated loans), and the biggest focus on 3) Aviation with over $21bn invested here. Castlelake has recently sold a 51% equity stake to Canadian owned Brookfield Asset Management for $1.5bn. Brookfield manages over $1 trillion of assets globally, one of the biggest Alternative Asset managers worldwide.
When it comes to buying companies/assets out of a bankruptcy process, one experience comes to mind with a private equity company which I was involved with some years ago in southern Africa. The PE company already owned a majority stake in one of the country’s largest cash and carry retailers. After notoriously difficult trading conditions including hyperinflation, the distressed company, Metro Peech & Browne, emerged with assets of $12.8m and liabilities of $21.7m, resulting in a negative NAV of $8.9m. Only a small proportion of the liabilities were secured with the majority being unsecured.
Ironically, the investor in the insolvent company was a Scandinavian private equity company, called Spear Capital, having made its initial investment into Metro-Peech in 2013.
The company went into Business Rescue and 10 companies submitted their bids to acquire the company, with SSCG winning the tender, agreeing to acquire the assets of the company (including fixtures and fittings and some properties) for $5.2m, whilst agreeing to invest $8m into working capital into a new, clean, SPV, to restock the stores and restart trading. The $5.2m would be distributed to creditors, with unsecured creditors getting a payout of 32c on their dollar. The company has been restructured and is trading well again.
The learnings here from these two transactions are:
- Companies often go into bankruptcy from a specific event, which tends to affect many companies (systematic risk). In these two cases, it was the Covid pandemic and a hyperinflation event which affected all companies in those sectors, but the companies with weaker balance sheets, and that had exhausted all capital raising efforts, were the ones that tended to enter into bankruptcy processes.
- Buying companies out of bankruptcy provides an opportunity for a fund to acquire distressed assets at below market value. Funds need to act quickly, and have a good idea on what assets are worth to submit bid, without overpaying and getting winners remorse. In both these cases, the funds had strong track records operating in the industries (airlines and wholesale cash & carry), and were able to win the tenders with competitive bids.
- Bankruptcy is a very painful process for shareholders and unsecured creditors. Shareholders will generally get nothing back, whilst unsecured creditors will often have to settle for cents on the dollar that they are owed, with the funds often only being paid once the reorganization has been court approved.
I look forward to following the progress of SAS Airlines as they start a new lease of life, and of course look forward to my next trip to a Nordic country. Despite very cold and snowy Arctic conditions, I am pleased to say I managed to see a glimpse of the Northern Lights.
