Engility bond covenants called flawed but unlikely to have killed deal

By Cristal Cody

Prospect News, June 22 - Engility Corp.'s $250 million seven-year senior note deal included bond covenants with "flaws," according to one analyst who looked at the deal's documentation, but any problems likely played little part in the company pulling the offering and opting instead for all bank debt financing, according to market sources.

Chantilly, Va.-based Engility had planned a $250 million bond issue as part of the financing for its spinoff from defense contractor L-3 Communications Holdings, Inc.

L-3, a New York-based provider of communications, information technology and other services to the U.S. Department of Defense, the Department of Homeland Security and other federal agencies, intends to separate some of its businesses into an independent, publicly traded government services company later this year.

Engility's bond issue launched on June 14 with an investor call and presentations. It would have been sold under Rule 144A with registration rights and was to have been brought to market by joint bookrunners Bank of America Merrill Lynch, Barclays, Credit Agricole Securities (USA) Inc. and SunTrust Robinson Humphrey and co-manager Stifel, Nicolaus & Co. Inc.

According to a report from Covenant Review, an independent credit research firm, the issue had several drafting flaws.

Robert Matz, an analyst at Covenant Review who wrote the report, said the drafting flaws could have been changed easily.

"The flaws were potentially big, but in reality, a few tweaks here and there, they all could've been taken care of," he said.

The drafting flaws could have caused the incremental secured debt capacity to be greater than expected, Matz's report said. In addition, the restricted payments covenant would allow a substantial amount of investments to be made in joint ventures and other entities not subject to the restrictive covenants.

Several of the issue's other covenants, including future guarantors, debt and liens, asset sales and reports covenants, also were problematic.

"The liens covenant will allow a significant amount of incremental debt to be secured, and due to flaws in the liens covenant, the company may be able to secure more incremental debt than expected when the consolidated secured leverage ratio exceeds 2.75 [times]," the report said. "Based on $188 million of adjusted EBITDA for the 12 months ended March 30, 2012, pro forma, the company would have been able to secure approximately $517 million of debt under this carve-out alone."

The asset sales covenant would have allowed the company to repay any debt ahead of the notes with proceeds from asset sales, according to the report.

The reports covenant also had pitfalls for investors, namely that the company would not be required to file reports with the Securities and Exchange Commission or post reports to its website before the consummation of the registered exchange offer for the notes, the report said.

"Generally, a drafting flaw doesn't kill a deal," Matz said. "This may just have been cheaper alternative financing. The coupon rate on the bank financing will be so much less than it would be on the bond."

In fact, bond sources said on Thursday that the yield investors demanded had become unattractive to the company. Engility representatives could not be reached for comment.

The company opted to drop the bond issue and a planned $300 million credit facility to fund a special cash dividend to L-3 and instead upsized the bank loan portion of the financing to $385 million, according to market sources. The bank debt originally included a $200 million term loan tranche and a $100 million revolving credit line, but a market source said the revolver had been lowered to $50 million and the term loan portion increased.

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