Impaired Bank Loans and “Zombie Funds” — Private Credit’s Next Big Opportunity
Is private credit’s next big opportunity found in impaired bank loans and “zombie funds?”
A deeper look into the balance sheet refinancing of Regis Corporation (NASDAQ: RGS) that welcomed an infusion of private credit to replace secured bank lenders at a meaningful discount — a move that appeared to shift significant value from the company’s lenders to its public shareholders.
Configure Partners Director Matt Guill authored a piece about a recent example of how private credit solutions should be evaluated to ensure the broadest view of strategic alternatives. Private credit will no doubt be waiting to help.
Read the full article below.
Impaired Bank Loans and “Zombie Funds” — Private Credit’s Next Big Opportunity
Late in June, Regis Corporation (NASDAQ: RGS), a global leader in beauty salon and cosmetology education, refinanced its balance sheet with an infusion of private credit to take out secured bank lenders at a meaningful discount. This move appeared to shift significant value from the company’s lenders to its public shareholders.
For those unfamiliar with Regis, the company’s business is franchising hair salons under Supercuts, SmartStyle, Cost Cutters, First Choice Haircutters, and Roosters brand names. The company owns and operates 68 salons while franchising 4,795 locations. Regis negotiates directly with landlords in strip malls and Walmart Supercenters and then enters into agreements with franchisees to occupy salon space. The company then treats rent as a pass-through, which franchisees must pay. This “franchise rental income” accounted for nearly half of Regis’ revenue in 2023. In addition to paying rent, franchisees must also pay royalty fees to Regis, a revenue stream that accounts for substantially all of the company’s profitability. Despite the capital-lite and high-margin nature of royalty revenues, Regis had a net income loss of over -$200M and a cash loss from operations of nearly -$150M cumulatively from 2021 to 2023.
Enter private credit with its flexibility and substantial dry powder. On June 25, 2024, Regis announced a refinancing that paid off nearly $190M of senior secured bank debt with $105M of new private credit financing. The ~$85M delta between the new capital and retirement of Regis’ legacy bank debt represents a discount to face value that incumbent bank lenders accepted.
Immediately following the announcement of the deal, Regis’ shares quadrupled from $5 to over $20 per share. However, the company’s enterprise value is lower today than when the refinancing closed. How could this be? The answer lies in a more nuanced view of Regis’ capital structure(1) and illuminates difficult choices incumbent bank lenders may face as maturities draw near while the borrower may not perform and/or in the face of unreceptive credit markets. The deal is instructive for private market participants, including private credit lenders looking to deploy and private equity sponsors who may own assets facing maturities in the face of underperformance.
With Regis’ bank debt coming due next year and facing the prospect of a refinancing with a potential Going Concern opinion in an audit, Regis’ management adeptly approached the credit markets to refinance its debt in the first half of 2024. Based on the transaction, one can infer that credit markets were unwilling to refinance the existing bank credit facility dollar for dollar. With less than auspicious feedback from the credit markets and only $6M of cash on the balance sheet as of March 31, 2024, Regis’ management sought creative solutions from the private credit market.
The incumbent lender no doubt faced a series of difficult questions. With only $12M of market cap against approximately $190M of debt, was the market imputing anything other than option value to the equity? If the company required incremental funding, would the lender demand a Chapter 11 filing and the protections associated with it as a mechanism to monetize its position? If a Chapter 11 reorganization was the best path to monetization, how might the lender estimate recoveries in light of multiple, difficult-to-analyze variables? Ultimately, the lenders decided that a discounted payoff provided with funds from a new financing delivered the highest recovery with the greatest surety of closing.
The new financing came from private credit lenders who effectively re-created a more normalized capital structure marked by 4.4x leverage through the first lien, leases and franchisees staying in place, and a revolver available to support Regis’ working capital needs. In return, the new lenders also received higher spreads on their debt and upside optionality from a warrant package.
Configure observes many private equity portfolios with companies that have a looming maturity or for which a new lending relationship may be beneficial. Bloomberg recently reported a similar theme noting the prevalence of “zombie funds” with fearful LPs concerned that GPs may be unable to return capital as expected. While private credit may not be a panacea, it has demonstrated and will likely continue to exhibit great utility in providing liquidity to public and private markets alike.
Private equity sponsors looking to extend the runway for portfolio companies facing difficult operating, financing, or M&A environments would be well-served to evaluate private credit solutions to ensure the broadest view of strategic alternatives. Private credit will no doubt be waiting to help.
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(1) And also, in the difference between calculating enterprise value based on the face value of debt rather than the market value.
Matt joins Configure Partners from Greenhill & Co.’s Financing Advisory and Restructuring practice, where he most recently was a Principal. Prior to joining Greenhill, Matt worked on the restructuring teams at Rothschild & Co and Millstein & Co. Matt has advised companies, lenders, sponsors, and governments on an array of complex financing and restructuring issues, M&A activity, and general strategic advisory assignments. He started his investment banking career at Cary Street Partners.
Matt graduated Phi Beta Kappa from Hampden-Sydney College where he was the captain of the basketball team. He also holds an MBA from Columbia Business School. Matt is a FINRA General Securities Representative (Series 63 & 79).