Checking Out

Debt restructurings are seldom simple. Throw in a popular brand-name, a substantial real estate portfolio, a difficult macroeconomic environment and heavyweight lenders, and you have a recipe for a taxing process.

Dubai International Capital acquired Travelodge, the UK’s second-largest hotel operator with more than 500 sites, in 2006 for £675 million from buyout group Permira. The deal was financed using £478 million in debt, which was added to debt already on the company’s balance sheet. It was a typical boom-era buyout, and provided a lucrative exit for Permira, which is understood to have more than doubled its money on the deal.

Six years later, DIC handed over the keys to Goldman Sachs and New York-based hedge funds Avenue Capital Group and GoldenTree Asset Management following a company voluntary arrangement (CVA), overseen by KPMG. Clifford Chance restructuring partner Mark Hyde advised Travelodge, with Kirkland & Ellis restructuring partner Kon Asimacopoulos advising the Goldman, GoldenTree and Avenue trio. Freshfields acted for Travelodge’s senior lenders, who including Barclays Bank, Babson Capital, Investec and RBS.

So what went wrong in the interim?

The company’s performance has been far from subdued, despite the economic climate. Travelodge increased revenues every year since acquisition, from £68.5 million in 2006 to £335.1 million in 2010, according to data provider Debtwire. Adjusted earnings before interest, tax, depreciation, amortisation and rental costs climbed steadily from £32.8 million in 2006 to £154.3 million in 2010. At the time of writing, the company had yet to file its full year 2011 accounts.

 So the business was cash-generative, but alongside its growing revenues, its significant debt burden was proving difficult to service. The chief culprit was a Eurobond taken out to finance DIC’s buyout of the business in 2006. The Eurobond’s first £349 million tranche was paying interest of 17 percent, according to Debtwire. Its second, £21.7 million tranche, paid out 6.8 percent in interest. Both were due to mature in 2016.

In addition, senior secured bank debt amounted to £334.6 million, mezzanine £114.8 million, and a PIK note accounted for another £78.1 million.

Net financial debt rose from £707.1 million in 2006 to £758.6 million in 2010, rising each year in between, according to Debtwire.

In total, Travelodge was paying out nearly £100 million a year to service those debts. It is not clear if DIC extracted any equity in the business during its period of ownership, before relinquishing control of the company. Reports suggested DIC wrote off about £400 million in equity on the deal. The firm declined to comment.

A restructuring appeared inevitable. In August this year, a proposal was put to creditors to restructure the debt. The CVA, managed by KPMG, won approval from lenders less than three weeks later.

“There’s no doubt the company was too highly geared, but it was a deal done near the top of the market,” explains KPMG partner Brian Green, who led the CVA process. “The good thing is that Travelodge is very EBITDA positive, and continues to grow. The future, post-CVA, looks bright.”

Goldman, Avenue and GoldenTree agreed to inject £75 million of new capital into Travelodge as part of the restructuring, £55 million of which was earmarked for use in refurbishing some of the group’s older hotels.

Avenue and GoldenTree , which have reportedly owned Travelodge debt since 2006, provided a £60 million loan to the business in February which would have ranked ahead of other senior debt in the event of insolvency. Two months later, Travelodge chief executive Guy Parsons left the company, to be replaced by executive chairman Grant Hearn who helped to broker the restructuring process.

As part of the restructuring deal, £233 million of bank debt was written off, while £71 million was repaid. The measures mean overall group debt was reduced from £635 million to £329 million, the company said in a statement. The Eurobon was written off completely.

The remaining debt’s maturity was extended to 2017, while cash pay interest was reduced to 0.25 percent above LIBOR through to the end of the 2014, the statement said. Travelodge – which rents rather than owns the premises it operates hotels from (understood to be a legacy of Permira’s period of ownership) – sought rent reductions for about 109 hotels (347 hotels remained untouched). However, it also began the process of offloading 49 hotels to other operators. Until alternative operators could be found, rent on these premises was reduced by 45 percent, KPMG said. Travelodge said it envisaged “no hotel closures or job losses”.

“Landlords would obviously prefer there was no process, but when we explained that the alternative to a CVA was potentially administration, and in that scenario the outcome for them would be much worse, they were almost uniformly in favour,” says Green.

Travelodge chief executive Grant Hearn said in a statement: “The financial restructuring, including the CVA, will leave Travelodge in a much stronger position and will ensure a long-term, sustainable future for the business. Travelodge’s debt, interest costs and lease liabilities will be significantly reduced. This new appropriate level will provide greater security for our staff, suppliers, landlords and developers. This is a successful brand with millions of customers and the company will emerge in excellent shape from this process.”

The inference, of course, is that the debt level previously was inappropriate.

It’s interesting that the groups left holding the equity aren’t so-called ‘vulture funds’ which swept in to seize an ailing company, but canny investors in debt who have been with the company since its buyout in 2006. The deal shows that while over-geared, boom-era buyouts are more likely to encounter serious issues – even where performance has been strong – than more modestly levered post-Lehman deals, the solution to those problems needn’t spell the end for the business.

Travelodge is in good company too – a host of other private equity-owned businesses of a similar boom-era vintage have suffered a similar fate this year. Examples include Italian directories business Seat Pagine Gialle, and Blackstone Group-owned Klöckner Pentaplast, which was taken over by distressed investor Strategic Value Partners in July.

Travelodge is self-evidently in better shape now than it was 12 months ago. It just took some hard-nosed negotiating, and some painful haircuts, to get there.