When a company’s bond prices plummet to single-digit cents on the dollar in the secondary market, it tends to indicate a bankruptcy is imminent. In early 2009, residential real estate brokerage leader Realogy Corp.’s bond prices would have led many investors to that conclusion, a situation compounded by the fact that residential real estate—Realogy’s bread and butter—was falling off a cliff. Two years later, however, the company, which had $4.1 billion in 2010 revenue and owns such brands as Cold- well Banker, Century 21 and ERA, persuaded its lenders to participate in a massive restructuring that extended maturities on most of its debt and prepped the company—and its stakeholders—for a housing market recovery. Realogy’s bonds are now trading at or above par.
In the first quarter of 2009, the credit markets were frozen and companies much larger th,an Realogy had declared bankruptcy, so there was plenty of panic impacting bond prices. Nevertheless, Realogy’s owner, the deep-pocketed leveraged buyout firm Apollo Management, stated its full support for the company.
In fact, Apollo purchased even more bonds at those steeply discounted prices, a move that attracted other investors, including Paulson & Co., the hedge fund that had recently made bundles betting on the housing market’s collapse. By last summer, Parsippany, N.J.-based Realogy’s bonds had rebounded to trade above 80 cents on the dollar.
The restructuring was accomplished in a series of transactions between December 2010 and February. The goal was to push out the maturities as much as possible for Realogy’s $6.6 billion of debt, $3 billion of which was unsecured debt coming due in 2014 and 2015.
“Step one was to push out the maturities of the unsecured debt, because secured debt holders want to be sure they’re paid back first,” says Tony Hull, Realogy’s CFO and treasurer since it was spun off from Cendant Corp. in 2006.
Realogy managed to extend the maturities on 90% of that unsecured debt by three years, in part through an exchange offer that provided bondholders with notes that mature in 2018 and are convertible into stock if the company issues stock.
Realogy then worked on its secured debt. It issued $700 million in 1.5-lien senior secured bonds—halfway between first- and second-lien debt—maturing in 2019 and used the proceeds to repay the same amount of first-lien loans. And in what David Katz, an analyst at J.P. Morgan, describes as a savvy move, Realogy got approval under an amended credit agreement to exempt those 1.5-lien notes from its senior secured leverage ratio.
“Realogy maintained approximately the same total debt balance, but it was able to remove the 1.5-lien notes from the covenant numerator,” Katz says, noting that the company’s debt-to-income ratio dropped to 3.88-to-1, providing plenty of cushion below the maximum of 4.75-to-1 set by the credit agreement.
Another smart move, Katz says, was Realogy’s exchange of the $2.1 billion in unsecured notes for subordinated convertible notes. If those notes are converted to equity, it would slash the company’s annual interest expense by $230 million.
Realogy currently pays $600 million a year in interest. That includes $55 million incurred by the restructuring, which Hull describes as “a modest increase in overall interest-expense costs” to push out maturities by three or more years.
Christopher Jacobs, a senior analyst at Western Asset Management and head of the big bond investor’s distressed and special situation investment effort, says exchanging notes for convertible debt typically occurs when a company is in a severely distressed situation and bondholders have little other choice. Although Realogy was and remains highly leveraged, it was nowhere near the brink of bankruptcy.
“This was more of a proactive debt-for-equity exchange,” Jacobs says. “We took it as a positive, a way to improve the capital structure and future returns.”
Realogy arguably has too much debt today, and its long-term health ultimately depends upon eliminating a significant portion of it, Katz says. The company can call the convertible unsecured subordinated notes due in 2018 at 90 cents on the dollar following a qualified equity issuance of $200 million or more. Since, in the event of an IPO, the notes probably would be trading well above that level—they are quoted at around 110 cents on the dollar now—this essentially gives Realogy the right to force a conversion.
Hull says that convertible feature will lower Realogy’s total debt-to-EBITDA ratio from 10 times to six times in one fell swoop.
Private companies rarely issue convertible debt because there’s no benchmark on which to base the equity value, Katz says. “The investors here appeared comfortable doing it because they placed a high value on the ultimate upside, given the possibility of an eventually strong recovery in the housing market.”
Jacobs says several factors must be in place before a company can discuss such a significant restructuring—and its unusual components—with investors. First is an attractive business model bolstered by very strong market share. Second is the caliber of management and its ability to articulate the restructuring benefits to banks, bondholders, equity holders and other constituents.
In Realogy’s case, part of its story was already well under way. The company “cut costs in a smart way while preserving market share and the ability to do business in the future,” Jacobs says.
Realogy pared its operating costs to $1.2 billion in 2010, from $1.8 billion in 2006. Across its businesses, which include title and settlement services and an outsourced employee relocation unit, it has cut its head count by a third, to 10,000 employees.
Realogy also consolidated its bricks and mortar, especially at NRT, the company-owned brokerage operations. For example, Coldwell Banker NRT remains in 35 major metro areas, but it has reduced the number of sales offices to 750 from 1,100, cutting back-office staff and making operations much more efficient.
Without the financial restructuring, however, Realogy probably would have faced major hurdles before the recovery arrived.
Hull was an investment banker early in his career, and prior to joining Cendant spent seven years as CFO at DreamWorks, the animation studio, which used innovative financing techniques, such as securitizing portions of its film library, to obtain additional capital.
“DreamWorks taught me how precious liquidity is and how closely it needs to be managed,” Hull says, adding that in times of stress, “a company needs to access capital when it’s available and not count on the market to be there when you need it most.”