What could this mean for one of its big creditors, the ECB?
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Spanish supermarket chain Dia, once one of Europe’s largest grocery chains, has just unveiled its results for 2018 and they do not make for pretty reading. In what it describes as “probably its hardest year ever,” the company racked up €352 million in net losses. EBITDA (earnings before interest, tax, depreciation and amortization) of €246 million plunged by 47% from a year ago. Net sales dropped 11% from a year ago to $7.2 billion. And its total debt soared by 50% from the end of 2017 to €1.45 billion.
The firm’s shares, reduced to a penny stock, have slumped almost 90% since Jan 1, 2018. Its credit rating — investment grade until October 2018 — was cut serially to deep in junk following a succession of profit warnings.
Put simply, Dia is about as close as a company can get to bankruptcy without actually being officially bankrupt. It is, in market parlance, “technically bankrupt”, meaning that it lacks the ability to pay its obligations and would most likely qualify for bankruptcy protection but is yet to file for it in a bankruptcy court.
If Dia does go into liquidation, it will have knock-on effects not only for big Spanish lenders like Santander, BBVA, CaixaBank and Banco Sabadell and European heavyweights like Barclays, Société Générale, and Deutsche Bank, but also the ECB which holds at least €200 million worth of Dia’s debt. Due to Dia having been rated investment grade until October 2018, its bonds qualified for the ECB’s corporate sector purchase program, or CSPP.
By the end of 2018 those bonds were trading at 68 cents, 60 cents, and 57 cents on the euro (in order of maturity dates 2019, 2021 and 2023). In other words, the ECB’s “investment” in Dia had lost over a third of its value.
In a bid to stave off default, Dia has announced it will cut up to 2,100 jobs (out of a global total of around 40,000) as well as close around 300 stores. In December, management proposed a €600 million capital expansion, to be backstopped by Morgan Stanley, which helped pull the supermarket group from the brink.
On Tuesday, the Luxembourg-based investment fund LetterOne, owned by Russian billionaire Mikhail Fridman, announced a long-expected takeover bid for Dia, which propelled the group’s shares from €0.43 to €0.70 and left its bonds trading at 83 cents, 75 cents and 72 cents on the euro. L1 has been buying up stock in Dia since July 2017 and already owns 29% of the group’s shares, at a total cost of around €700 million. With Dia’s market cap worth just over €450 million today, that investment is deeply underwater.
If L1’s takeover bid gets a green light from Spain’s market regulator and Dia’s shareholders, who have been offered €0.67 for each share, Fridman says he will launch his own €500 million capital expansion for Dia, to be backstopped by Goldman Sachs, which is currently Dia’s second largest shareholder.
Firdman also says he will negotiate with Dia’s lenders to try to “reach a satisfactory agreement.” According to the Spanish financial daily El Confidencial, what Fridman wants is to secure from Dia’s creditors, including, presumably, the ECB, a three-year grace period during which the retailer will not have to make any debt payments or pay interest on any of its debt. This, it says, will give the supermarket group enough financial breathing space to complete its turnaround.
It’s a big gambit. Dia’s creditors have already said they will not accept any haircut on the debt, and that presumably includes a three-year amnesty. But with €850 million of Dia’s debt scheduled to come due at the end of May, time is of the essence. That the shares are now hovering almost 10% above L1’s offer price would suggest that investors believe they can hardball Fridman into coughing up a little more for each share.
Doubts remain as to how viable Dia’s business model will be even after a takeover and recapitalization. It will still face intense — and intensifying — competition in many of its key markets, including from online retailers. This is particularly true of its domestic Spanish market where the supermarket giant Mercadona now controls almost a quarter of the entire grocery market after years of ruthless cost cutting, while the German discount chains Lidl and Aldi are rapidly wresting market share from domestic low-cost retailers like Dia.
As has happened in many other corporate collapses of recent years, there are also allegations that executives at Dia engaged in accounting fraud to conceal the true extent of the firm’s losses while picking up hefty bonuses and stock options along the way. According to Ernst&Young, which was hired to drill down into Dia’s accounts over the last two years, executives in Spain and Brazil deliberately withheld key financial information from the board, the auditor and shareholders.
If true, Dia will became the second company after global retail giant Steinhoff to have issued large amounts of corporate debt that was hoovered up by the ECB only to then proceed to a debt restructuring partly as a result of accounting fraud. In the case of Steinhoff, the ECB ended up selling its position in the bonds at a multi-million euro loss. Time will soon tell whether it will have to do the same with Dia. By Don Quijones.
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Don,
Thanks once again for an informative piece.
Another shining example of the wave of defaults headed to the ECB. Socialized losses for the taxpayer. Bang up job, Mario.
The Yellow Vests won’t like this.
Excellent article! Lately the Wolf’s have been on fire
Note “investment grade until 2018” and “investment grade until 2018” in the body of your article
I’m not sure what you mean. Moody’s downgraded Dia from Baa3 (investment grade) to Ba2 (junk) in October 2018
Got it. Found the “2017” on second try. Thanks.
DQ
Why would L1 invest hundreds of millions in Dia equity instead of buying its (now discounted) bonds? Creditors, not shareholders control in bankruptcy. Equity is the first to get wiped out as bond holders & other creditors haggle over the carcass.
Guess it depends on how strongly you believe in the turnaround scenario.
It looks like L1 is counting on a form of debt restructuring, where creditors forego principal and interest payments for three years. If it gets that relief and is able to get new funding, and is able to turn the place around, those shares could be worth. But if, if, if…
Buying the debt of a retailer ahead of bankruptcy has turned out to produce iffy results in a bankruptcy that leads to liquidation because by that time, usually all the good assets (real estate) has been sold off or mortgaged. But it does give the buyer a seat at the table during the bankruptcy, and that could be helpful. And those creditors could end up with the company if it can be kept alive.
Buying a troubled retailer is immensely risky — whichever way they’re doing it. If they can pull off a turnaround, kudos.
A history lesson
I once bought Rolls Royce Loan Stock at £10.00
I was very naive then (1971? ) and sold it at £12.00.
HM governvernment was forced to step in and keep the Company alive due to freak circumstances surrounding a £300 million contract with a U.S. Aeroplane manufacturer.
Eventually the shares revived from 9p to 20p, I think because of ‘bear closing’. But a miracle happened ; the loan stock and debentures were repaid in full courtesy of the tax payer!
(A new Company, Rolls Royce 1971 Ltd, was formed to buy the assets from the original Company. )
This though is the only example I can remember in the last 50 years when this has happened on such a scale. Certainly a good example of ‘ buy the debt not the equity.’
I’m living in Barcelona and I don’t see in hope for Dia. Originally it was pretty ghetto, cheap and very low quality, then about 6 years ago they tried going with the gourmet supermarketvtrend, and the last two years a kinda “quickie mart” concept, each time completely redesigning the stores. And none of those ideas worked with customers. Plus there is intense competition. We’ve all been waiting for this to happen, and there are other chains that look like they could be next. I’m guessing Condis, Consum and Caprabo.
Kinda interesting to read of Dia’s ghetto-to-gourmet transmogrification. Not too surprising Marc C said it failed (presumably quickly).
I have this vision of shady characters sitting around the marketing department, saying “Well, we haven’t invested in our stores in so long that all of them look like ghetto properties; why don’t we re-paint them this weekend, chase away all the homeless and rats, raise prices, and call them gourmet shops?
I gotta get a marketing job.
Seems to be just another excellent example of the ECB trying to keep zombie companies alive!
The ironic thing is that the ECB’s Zirp/Nirp politicies created all of these zombies in the first place!
A case of the ECB ensuring its own survival?
In Spain grocery stores have been in perpetual evolution in terms of ownership , that speeding up over the last fifteen year. In the eighties you had a few local supermarkets, maybe one from a national chain, one from a regional group, and if in a larger town a “normal” large supermarket labelled as a mall (shoping centre in English :-/) . In cities there would be a true mall equivalent , usually single store Corte Ingles. Since two thousand a whole load of competition has appeared, and the older companies merged into them or bankrupted. The list is long, and added to this are many new malls. Dia is unusual though, it sort of is but isn’t, it just doesn’t connect as a store that any particular group of people will feel at home with. Mercadona is active and well stocked, the Spanish take to it, but you walk out something like having been attached to a social Van der Graaf somehow. Aldi is sensible. Other lower cost are like ransacking shelves. But Dia… I am not sure if it is a front, or something being tried by outsiders, or if it is a working south American version that doesn’t fit.. it is hard to catch what it is about, and the older, tattier, less well stocked stores I have watched it take over just lost custom afterwards. Just providing some own anecdote to add to the story.
Totally agree. It doesn’t seem to appeal to any customer base. And what about Suma? Here in Catalunya (not sure about the rest of Spain) they are everywhere, high priced for low quality, are filled with too many employees for the size and volume, and seem to be a way for people to legally enter Spain more than about a supermarket business.
It seems the standoff is between the current CEO, backed by Morgan Stanley, who have put together a refinance deal and a further capitalisation which is said to be able to keep the company liquid to 2023 vs. Fridman backed by Goldman Sachs and previous managers of Dia when it was part of Carrefour, who are offering share purchase and further capitalisation in return for a three year hiatus on existing debt. Fridman et al have towards 50 % of shares , but if I read correctly around 35% of Dias capital is needed to approve the Morgan Stanley deal. So it is a takeover bid. Now what is odd maybe is that all of these players are looking to pour money into a firm that is into losses, in a very competitive environment, where the economy is also likely to be shrinking soon.
https://www.gurusblog.com/archives/resultados-de-dia-algo-mas-que-un-mal-ano/30/10/2018/
has an earlier look at the company’s finances and singles out that around 50% of stores being franchised is a further weakness.
Bankers: From what I can see both parties are only putting borrowed money into this zombie!
When money is cheap, it has little value, so people who have access to this free money often do some pretty stupid things with the money!
I guess some people only feel they have earned money when they get to spend it, but for the rest of us it adds up to what you have to do before getting paid. I don’t mind being part of the latter as it brings its own meaning, but I do my best to avoid being in a circumstance of being completely obliged to work just for money . That is a reason why debt is not good, but it is very easy to fall for. Unfortunately much debt is created in our name and without our direct consent, I try to ignore this but still end up paying for it, and being ordered around by the people I pay. It is very humiliating at a certain level, and that explains why tolerance of government is such a fine line, and one that is easily crossed by those that are rewarded for that authority. Basically people are saying “you are right” all the time, it does not take much of that to make others arrogant, or corrupt. Only mankind could devise such a system of torture, but then I suppose it provides a kind of certainty.
The ECB and its fellow Keynesian fraudsters at the Fed and central banks have managed to keep their rackets and swindles going for far longer than I would’ve thought possible. But as their financial house of cards totters under the weight of its own fraud and fictitious valuations, it seems a matter of time before the long-deferred financial reckoning day exposes these charlatans as con men and grifters for all to see.
Was KPMG the auditor? If so, this could be the death knell for them.