As with Elders beforehand, Atlas Iron keeps on giving to the restructuring industry. The Turnaround Management Association, Australia recognises Atlas Iron as winner of the 2016 Restructuring of the Year award.
In FY15, operating costs were slashed as key operating counterparties exchanged contract rights for equity and some profit distribution rights. This left a heavy senior debt load on the company in the form of Term Loan B instruments. Those instruments were held by a range of US and Australian financial investors, including a large Australian bank for which we act.
The key question for 2016 was how to right size senior debt spread across dozens of holders of paper.
Where did Atlas Iron come from?
Let's recap from last year. Atlas Iron listed on the ASX in December 2004, as a gold company. All did not glitter. Instead, it was David Flanagan in 2006 who changed the focus of the company to one of iron ore, a decision seemingly made good when Pardoo came into production in late 2008 and other projects came to be added to reserves. Atlas Iron debt gearing was low until December 2012 when the company wrote Term Loan B instruments to fund the expansion of production programs.
TLBs are a covenant-lite product mirroring senior debt, funded by large corporates, funds and nonfinancial services institutions (though some banks looking to spread risk also like to take a piece of these investments). In common with other high yield products, TLBs feature incurrence rather than maintenance covenants, making these instruments attractive to miners like Atlas Iron exposed to revenues variable against commodity prices, foreign exchange rates, high cost burdens and logistics risks. The instruments are usually written under US law, both exposing the issuer to currency risk and differing, in some material respects with Australian law, particularly in terms of the other funding instruments the borrower is allowed to enter into, without TLB consent.
This is fine so long as relationships stay strong with the holders of TLBs. In the case of Atlas Iron, the relationship became strained as iron ore prices tumbled below $50 per tonne and looked like plummeting below $40 per tonne. As fast as Atlas Iron chased down costs, pricing took a steeper descent.
The FY2016 restructure
Senior debt paused in standstill during the 2015 restructure. This was principally a P+L restructure, with some balance sheet surgery as contractors swapped contract rights for equity and profit participation. In itself, this solution was novel, requiring contractors to compromise debt and shareholders to approve moderate equity dilutions to improve liquidity.
Atlas Iron spent the remainder of CY15 establishing a track record of successfully managing its operating costs and contractors. With profitability achieved, the focus turned to long-term debt support for the business. This required a leap of faith on the side of senior debt, asked to swap half debt for equity positions and on the side of existing equity, who were again to be diluted.
Initially Atlas Iron proposed a form of bilateral agreement between itself on the one side and a nonrepresentative senior creditors ad hoc committee on the other side.
The formation of an ad hoc committee advised by specialist investment bankers and lawyers is an idea imported from American restructures. It is an idea starting to find form in Australian restructures involving international capital. In each of Atlas Iron, Peabody Coal, Ausgroup, Mirabela Nickel and smaller restructures, we have advised or dealt with ad hoc committees formed of holders of notes, bonds or TLBs.
The US style indentures supporting these investments are generally bespoke. A common feature is to differ between the rights afforded creditor majorities, trustees, agents and advisers to change the rights of holders or deal with their interests in an enforcement or claim situation. While most instruments distinguish between and provide majorities' rights to alter the indenture or aspects of an indenture in administrative actions, changes in the substantive rights of these creditors usually require unanimous consent. Ultimately, the evolution of the debt for equity swap, the application of section 444GA of the Corporations Act, and transfer for new rights and other burden lifts within restructurings are creating the opportunity to be novel in how these rights operate in a practical setting.
Atlas Iron at least knew who held the senior debt, unlike Mirabela Nickel where even the trustee has an imperfect register of senior holders (once a secondary market evolves, tranches or segments often trade in dark pools making it near impossible to identify holders until the trustee asks for screen shots and ownership verifications from those choosing to vote on resolutions).
The majorities, though, were determined to maintain control over how senior debt restructured, potentially impairing the rights of non-majority holders (including Australian financial and American corporate institutions). After some negotiation, it became apparent that the ad hoc committee was not representative of all TLB holders, which meant the restructure needed to be formally approved by the Court by way of a scheme of arrangement. The Court has the power to change instruments on approval of majorities (50% in number and 75% in value of voting TLBs).
The scheme provided for a significant compromise in the value of the senior debt and some resetting of the indenture provisions. In return Atlas Iron shareholders, including those granted equity as part of the 2015 restructure, agreed a substantial dilution in favour of TLBs. As between themselves, the latter received shareholdings in proportion to their holdings in the TLBs.
The scheme completed as part of an accelerated program in April 2016.
The future and lessons
On 27 July 2016, Atlas announced cash generation of $30m after interest and profit sharing arrangements, shares climbing 10% on the back of the announcement. Now, that is a good news story.
Atlas Iron has positioned itself as a good mid-cost producer, with a properly leveraged balance sheet. It has used a combination of restructuring techniques to achieve this outcome, both on the balance sheet and P+L side. The restructuring involved bilateral and then multilateral negotiations with counterparties, issue of new equity (highly dilutionary of existing equity on two occasions), negotiations with ad hoc committees of senior debt holders, a scheme of arrangement and operational side changes to maintain liquidity and profitability.
The restructures were driven by a readiness to accept the short-term pain of equity dilution to sustain value in the company, jobs and suppliers. The Atlas Iron shareholders, although heavily diluted from pre-2015 positions are doing so much better than would have been the case if the company had fallen into administration and then liquidation. If this had happened, TLBs may have been repaid, employees possibly, with some creditors also receiving a return. Shareholders, though, would have seen equity positions all but wiped out. Instead, net asset backing improvements achieved in the restructures have the capacity to significantly contribute to a better return on equity.
The Atlas Iron restructure was a strong result brought about because of the engagement of restructuring specialists by the board of Atlas Iron (Lazard, Deloitte) and TLBs (Houlihan Lokey). These advisers, together with the lawyers involved, including ourselves, Ashurst and Gilbert + Tobin, utilised decades of experience in saving companies through long-term planning and implementation of turnaround plans.
The future bodes well for boards willing to engage advisory teams early to devise and implement turnaround plans. Doing so can only be aided by the Government's proposed innovation in introducing safe harbour protections to boards in these situations.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.