How Credit Suisse helped breathe new life into Thomas Cook

Too often, people use the word 'transform' when all they really mean is 'change'. But Thomas Cook’s recent £1.6bn ($2.46bn) recapitalisation, embracing a rights issue and share placing, a bond issue and the tricky renegotiation of a revolving credit facility, really does seem to have transformed its once dismal prospects.

“It is one of the most complex corporate recapitalisations we have seen in recent times,” says Sebastian Grigg, a vice-chairman of investment banking at Credit Suisse, which oversaw the plan.

'Complex' could describe the entire history of this venerable UK tour operator, whose ups and downs and epic changes in ownership are exhausting merely to contemplate. Founded in the early days of rail travel, its owners have included the eponymous Mr Cook and his family, Wagons-Lits, the UK's Big Four railway companies, the UK government, Midland Bank, Trusthouse Forte, the Automobile Association, WestLB and KarstadtQuelle.

Having merged with its UK competitor, MyTravel, in 2007, it then survived the bankruptcy of its majority German shareholder. But the synergies envisaged for MyTravel and other acquisitions never quite made it out of the boardroom, and a collection of sizable brands and businesses, including four airlines, continued to trade more or less within their own silos. Despite the company’s multi-billion pound turnover, profit margins were wafer thin.

Time running out

By the summer of 2011, serious cracks were beginning to show. The company, whose falling share price had already seen it ejected from the FTSE 100 Index, was clobbered by a UK leisure spending squeeze and the Arab Spring, which hurt the north African holiday trade. After his third profit warning, the chief executive resigned. A possible £400m rights issue was aborted, and probably just as well, since the market capitalisation had sunk below the £100m mark.

Over the next year, the top team was completely refreshed, starting with a new chairman, Frank Maysmans, a one-time marketing director of Douwe Egberts. A bank group was already providing a £1.2bn credit facility. To that was added an emergency £200m super-senior facility in late 2011, to stop the company running out of cash. If he was going to coax a high-calibre new CEO on board, Mr Maysmans knew he had to get some breathing space from the banks. A maturity extension was negotiated, albeit on harsh terms, including cash sweeps with associated penalties, and warrants.

The facility was now due to be repaid in 2015, shortly before another €400m in senior notes – the bank group insisted that the borrowing matured before the bond. So by the time the new CEO Harriet Green took office in July 2012, the Thomas Cook locomotive had bought itself a bit more track, but it was still steaming headlong towards the potentially fatal buffers of a £1.5bn maturity wall. That was roughly five times the company’s 2012 earnings before interest, taxes, depreciation and amortisation.

“It was a good business, but [had] a bad balance sheet, and it was in need of a new breed of management,” says Mr Grigg. “The new team inherited a highly leveraged business, and they were all under pressure to make change happen quickly. But it was the market background that made this [recapitalisation] so exceptional.”

Tough conditions

Equity markets were choppy, for starters, but what made the situation altogether more complicated, and the company more vulnerable, was the fact that the bank market was busy reshaping itself. Banks are deleveraging as they adapt to the demands of Basel III, which has made Thomas Cook’s sub-investment grade and unsecured credit harder to hold. Indeed, quite a few of its banks had already sold the debt on into the distressed market. Only about half the facility remained with the core banking group, and the rest was now held by hedge funds and similarly hardline investors.

Basel III is also making banks more selective along national lines, as they use their scarce capital to look after their own. Various non-UK lenders were reducing their exposure accordingly. Conversely, in the new lending group, UK banks are well represented.

Simon Taurins, the Credit Suisse managing director responsible for Thomas Cook coverage, worked with incoming chief financial officer Michael Healy in his previous incarnations at both UK automotive repair company Kwik-Fit and online travel agency ebookers. One possible and, for some, familiar solution was a debt-for-equity swap, which MyTravel had used to extricate itself from a deep hole back in 2004.

“We thought we could try and solve this in the capital markets, rather than use the blunt instrument of giving the banks equity – which means you are then in the hands of work-out groups,” says Mr Taurins.

But any transformation had to start within the business, not the balance sheet. A capital markets solution could only work once a turnaround was in progress and markets had started once again to believe in the company’s future. The need to sustain the customer’s trust in this very high profile brand merely added to the challenge.

Contingency planning

The new management set about consolidating operations, cutting costs, selling assets, replacing managers and reducing headcount. When Ms Green arrived, the shares were trading at 13p, and the market cap was about £150m (the fuel bill for 2012 was six times that figure).

Plan A was to negotiate a new, smaller bank facility with a longer maturity, having replaced some of the borrowing with equity and bond finance. In early 2013, the team began talks with Thomas Cook’s lead lenders in the core group, moving into higher gear shortly thereafter.

“It was not lost on the core bank group that, if these discussions were not successful, plan B would be more drastic and, at worst, could involve debt for equity,” says Rahul Srinivasan, a director in the Credit Suisse leveraged finance and restructuring team. “We needed to find a critical mass among the core bank group to build a recapitalisation. We could not do 100% equity, so we needed them to participate in size and then we could fill the rest by going to the bond market. There was a lot of fine-tuning and interconditionality.”

With each pool of capital hoping that the others were larger than theirs, the solution was a delicate balance between all of them. However, striking it while the equity was trading publicly was hard work. The share price had been recovering since publication of the financial year 2012 results in November 2012. This was both welcome and, in one sense, unwelcome. It allowed the bank group to take the view that the company was not as distressed as first feared, and so it felt less pressed to make concessions.

“Trying to do a recapitalisation in the public arena makes it hugely more complex,” says Anthony Leung, a director in the Credit Suisse investment banking division.

But management was doing a convincing job of restoring confidence.

“It’s not just a matter of having a plan,” Mr Taurins observes. “Management had to demonstrate that they had control of the business.” News of progress was regularly fed to the markets in order to build momentum. If anything, momentum got ahead of all the back-office organisation required, such as preparation of an equity prospectus, which can take six weeks or more.

Going to market

Eventually all three legs of the stool were in place. As a measure of how far the company had travelled in a relatively short time, when the button was pushed on May 16, the market capitalisation stood at about £1.3bn, more than eight times the figure when the new management arrived. A new, smaller £691m banking facility, with a smaller group of lenders, replaced the old 2015 facility. The bulk of it matures in 2017, with a small tranche to address the 2015 senior notes. The rest of the 2015 facility was addressed through £435m of new equity and €525m in new 2020 senior notes, with Jefferies as joint bookrunner on both.

The equity element of the exercise raised £431m, largely via a two-for-five rights issue priced at 75p but with a smaller placement of shares at 137p, a 5.3% discount to the previous day’s close. If that sounds like bending over backwards for existing shareholders, remember that Thomas Cook had been a penny share investor’s dream come true, and many of those on the share register had invested at 20p or 30p. So where most rights issues offer shares at a discount to existing investors, this one asked many of them for a premium.

The share price has come off a touch as some of those retail investors have taken their (handsome) profits. But this recapitalisation shows that the capital markets can provide a viable solution to companies with stressed balance sheets, the bankers say. And there may be more of them.

“The impact of Basel III on company balance sheets is poorly understood,” Mr Grigg maintains. “Companies that are stressed across this transition period are doubly vulnerable.”