According to a notably focused and clear analysis by Laura J. Keller of Bloomberg, Colt’s bonds’ rating has been dropped from an abysmal CC to D, as low as ratings go, sometimes called in the finance world “D for Default.”
Standard & Poor’s reduced Colt’s rating two grades to D from CC, according to a statement Tuesday from the credit grader. The new rating means S&P considers the company “in default or in breach of an imputed promise” and that it has ruled out the possibility the manufacturer will make good on a missed interest payment during a 30-day grace period.
As we mentioned in comments to our last report on Colt’s Perils of Pauline fiscal drama, they were technically in default as soon as their interest payment came due and they did not have cash on hand to pay it.
The weapons maker didn’t pay the $10.9 million due May 15 to holders of its $249.4 million of 8.75 percent unsecured notes due November 2017, according to S&P. Colt had warned in November it was “probable” it wouldn’t have the cash to make the payment if it didn’t meet internal sales forecasts.
Colt received an unsecured loan from Morgan Stanley for $70 Million in November, just barely avoiding default at that time, by using the loan proceeds to pay the bond interest increment ($10.9M) and fund ongoing operations. Most of that cash is gone now, with only $8.4M in unencumbered cash available at the end of April (and another $10.9M payment due May 15th). (Colt has a few million more than that, but the cash was used as security for a loan, and paying that specifically earmarked “restricted” cash back takes priority over other debt, in a bankruptcy scenario).
The Sword of Damocles hanging over the bond holders is the probability that they’ll be zeroed out completely in a bankruptcy. Colt had hoped that imminent threat would get them to accept a 70% haircut to roll their bonds over into newer and even more speculative debt. When they didn’t bite by 12 May, they rolled the dice for another week, and then, on the 18th, rolled the dice again. Colt’s net assets, per Bloomberg, are over 100% collateralized, meaning in a bankruptcy, bondholders are left with an empty bag.
In a bankruptcy scenario, not much would be left for holders of the 8.75 percent junior notes, according to S&P. Since the $102 million of collateral available to Colt’s secured lenders is just shy of the $103 million they’re owed, S&P estimates holders of senior unsecured debt would recover between zero and 10 percent of their investment.
In other words, even in a liquidation, these bondholders get to the head of the line only after all the juice has been squeezed.
Naturally this has an impact on the market for the bonds:
The junior notes traded in odd-sized lots at 27.75 cents on the dollar at 4:37 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
It’s a little surprising that they’re worth that much in the market, because it’s hard to imagine any way to get a 25¢ recovery on these bonds at this point, unless Colt’s intellectual property brings a lot more at bankruptcy auction that the market values it at.
Elsewhere in the Industry
Colt is not the only firearms maker in the news. Cerberus, a hedge fund, has announced that it has failed in its attempts to sell its firearms holdings, now organized as Remington Outdoor, and instead is offering to cash out institutional investors, including politically-managed California public employee pension funds, that have the vapors over buying guns. Cerberus managers have claimed that because of public perceptions of guns as naughty things, they couldn’t even get the underwriting to take Remington public.
This is nonsense. Look at how Morgan Stanley stepped up to make that unwise $70M loan to Colt, and consider how low and even negative interest in “safe” investments has investors taking wild, inadvisable risks. But the nonsense may serve Cerberus’s ends well. If they can get CALPERS, etc., and other “socially conscious” investors out and bring their former stakes in-house before going public, they would likely leave Cerberus investors with the best kind of financial problem: how to handle massive capital-gains taxes on a hugely successful investment. But the Remington story has already been spun as a sign of the “collapse of the gun market.”
It is only a matter of time before writers for the anti-gun daily media start combining these stories (and HK’s woes in Germany, which are political and don’t financially threaten the firm, yet) to crow that the gun industry is dead: only, it isn’t. For example, here’s a paragraph from New York Times
anti-gun activist reporter Michael de la Merced, emphasis ours, from their report on Remington’s cash-out offer (which the Times illustrated with a photo of their close allies, professional protesters at an antigun rally):
Compounding the problem has been the reluctance of big lenders to participate in the sales process for fear of potential hits to their reputation. Banks like JPMorgan Chase and Credit Suisse have rarely advised or lent money to deals involving firearms makers, making it more difficult for potential buyers to afford Remington….
(Emphasis in the above is ours. We guarantee you that timidity about reputation is not what drives Wall Street). The more key revelation is buried in the report and apparently unnoticed by de la Merced: the cashout values Remington at 880M, about the size of S&W’s market cap, far lower than the $1B-plus Cerberus earlier estimated for the firm’s value. (Of course, valuation of a private company is one of the thorniest problems in finance; in the end, value is what you can actually sell it for, and funds like CALPERS, which would long ago have been bankrupt if they had to meet the financial requirements of private firms’ pensions, have to decide how big a bath they want to take for the sake of political purity).
While 2014 sales for the industry may have been down from the 2013 peak, they weren’t down much and indicate that panic buying has subsided into a new and higher level of ongoing sales. There are many of indicators of this. For example, in 2014, the FBI’s National Instant Check System was overwhelmed with call volume, leading to unprecedented delays in answering calls:
Many call center operations have a target goal of answering 80 percent of calls within 20 seconds. However, the NICS Section’s goal is to answer Transfer Process calls (background checks for firearm purchases transferred from the NICS Contracted Call Center to the NICS Section’s staff) within 9 seconds. Based on historical data specific to transaction and call volumes, the NICS Section is able to forecast anticipated levels of staffing needed to effectively process incoming work. In 2014, the NICS Section’s Transfer Process calls were answered on an average yearly rate of 109.27 seconds due to several months of high call volume.1
If their usual objective is 9 seconds and “several months” of high volume blew their delay out to almost two minutes, think about the mathematics of that… those peak periods had really high volume, then.
Also, when the media writes that gun sales are down… bear in mind that 12.7 unadjusted NICS checks were done in 2008, the last year before the Salesman-in-Chief amplified gun sales. 2014’s down number rounds to 21.0 million, from 2013’s 21.1 million… to two places, it’s so far down it’s 99.41% of prior years.2 (We used to call that “flat,” but we just have an MBA, not a J-School sheepskin, so what do we know?)
As readers of WeaponsMan.com know, Colt’s problems stem only partially from the company’s struggle with new products and market forces. Colt’s traditional products, the 1911A1 pistol and AR-15, M16 and M4 rifles remain popular worldwide (42% of the value of sales is overseas, according to the firm’s most recent SEC filings). The real mortal wound was inflicted by the company’s own managers: the company was overburdened with a fatally toxic load of debt. They did this, not as fiduciaries for the company, but in their capacity as the individuals who personally pocketed much of the money.
When Colt goes bankrupt, an event we see as unavoidable now, expect the innumerates of the New York Times to crow that the failure results from some imagined unpopularity of guns and increasing popularity of New York style gun ban regimes. Politicians who believe them and act accordingly will likely be slaughtered at the polls in all but the six or seven states where gun bans are legitimately popular.
The Bloomberg report on Colt Defense’s financials is concise and accurate, though, so do Read The Whole Thing™. Hat tip, Daniel Watters in the comments to our last Colt report.
- Federal Bureau of Investigation. 2014 NICS Operations. Page 6. Retrieved from: http://www.fbi.gov/about-us/cjis/nics/reports/2014-operations-report
- Ibid., p. 12.