Two Years After Chinese Buyout, Lexmark Bonds Show Junk Risk

(Bloomberg) -- When dealing with the riskiest companies in the debt market, please make sure to mind the gap between perception and reality.

That’s a lesson bondholders of Lexmark International Inc. have learned over the last month as their holdings tanked almost 40 percent -- going from a safe credit bet to distressed virtually overnight after an earnings report. The selloff in the $341 million of bonds was accompanied by severe credit ratings cuts that pushed the supplier of printers and office supplies into the bottom end of the scale.

Less than two years after a Chinese consortium took Lexmark private, the new owners have limited the access to financial information and scaled back their discussions with creditors, according to people with knowledge of the matter. The company’s business has declined at the same time, the people said. Add to that a persistent fear among bondholders of being subordinated by other borrowings despite the management’s denials, said the people, who asked not to be identified as the information isn’t public.

“The expected performance and the actual performance is well below our expectations," Carl Salas, who covers Lexmark for Moody’s Investors Service, said in an interview. “What happened with other leveraged companies in China may have added to the concern, which caused the abrupt drop in pricing of the bonds.”

Bondholders have been concerned that Lexmark could secure its credit facilities without giving the bonds equal standing despite management’s assurances it won’t subordinate the debt, according to Salas.

Equal Treatment

Lexmark is working to ensure the outstanding bonds are treated pari passu with the other credit facilities, treasurer Art Richards said. The Lexington, Kentucky-based company may also host an investor call following the first-quarter results to clear up any confusion with investors, he said.

“The rating agencies are usually three steps behind,” said Shan Weijian, chairman of PAG Asia Capital which was part of the group that bought Lexmark. “2018 is performing ahead of budget.”

Lexmark has been investing in hardware, improved efficiency and reduced inventory levels under new ownership. That has put the company on a growth trajectory, even if it has led to a temporary rise in charges and expenses, he said.

Moody’s slapped Lexmark with a three-level ratings cut to B3 at the end of February, helping spur the selloff in the bonds. Fitch Ratings followed last week with a bigger scythe, pushing the company’s ratings into CCC territory, a level that indicates a real possibility of default, according to Fitch’s definitions.

Poor Performance

The notes, which traded above par most of February, dropped to below 64 cents on the dollar last month. They since recovered to about 75 cents on the dollar, and traded as high as 79.7 cents on the dollar after Bloomberg News reported the company’s comments Tuesday.

The 2016 buyout, which was seen as Lexmark’s chance to right itself after it fell on hard times amid the shift to digital documents, is now mired by questions of the new owners’ ability to dig the company out of the hole. Bondholder are concerned after other indebted Chinese companies have struggled in recent years, including HNA Group Co. which is under pressure to cut a massive debt load it took on in a spectacular buying spree around the world.

“If you look at Lexmark, the HNA complex and a handful of other situations, it’s fairly clear that Chinese parents are no longer superior,” said Christian Hoffmann, a money manager at Thornburg Investment Management.

Limited Disclosure

When Lexmark was taken private, bondholders had the option to return the notes, which had been issued in 2013, and get paid back because of the change in control. Only some of them chose that route, according to Salas of Moody’s. Then Lexmark came back and offered a fee to holders to stop reporting their financials publicly, which investors consented to. That’s a move that could make it harder to find new buyers when existing holders choose to sell -- such as after a big earnings miss.

A measure of their earnings for 2017 was 90 percent below what the expectation was just a year ago, according to Kevin McNeil, an analyst at Fitch. They’ve also limited how they disclose their financials to their bondholders, making it harder to determine how the various segments of the business are performing, McNeil said.

“Even compared to just before being taken private, the disclosure has become limited,” he said. “They severely underperformed expectations. It brings into question, whether or not the capital structure is sustainable going forward.”

The credit facilities provided by Chinese banks also raise the issue of its ability to refinance without facing a crunch.

“Our ratings are relying upon assumption that they will be able to obtain financing from existing lenders in Chinese banks,” Fitch’s McNeil said. “What if something changes onshore in china. It’s hard to handicap the outcome of refinancing onshore in China.”

--With assistance from Molly Smith and Edwin Chan

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net, Eliza Ronalds-Hannon in New York at eronaldshann@bloomberg.net, Cathy Chan in Hong Kong at kchan14@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Dan Wilchins

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