Distressed debt shows weakness for some traders; Harrah's down as MGM wraps IPO; Sbarro sinks

By Stephanie N. Rotondo and Paul Deckelman

Portland, Ore., Oct. 19 - A trader said it was "kind of a sloppy day" for the distressed debt market on Tuesday.

"The market tried to open weaker with the weakness in the equity markets," he explained. But with "a lot of cash around," and better buyers than sellers, it ended somewhat mixed on the day.

Even Harrah's Entertainment Inc., which had gained ground on Monday, reversed itself, ending down over a point from the previous day's levels. MGM Resorts International Inc. paper meanwhile closed softer as well - though in thin trading - as the company completed its previously announced initial public offering.

The general market weakness also did little to help Sbarro Inc.'s downward-spiraling debt. Market sources saw the bonds dropping anywhere from 8 to more than 12 points during the session. One analyst opined that the bonds were finally trading at levels that make sense.

Elsewhere, First Data Corp.'s bonds dropped weight, after Bank of America posted a loss of more than $7 billion for the quarter. The bank attributed the loss to a write-down taken to prepare for new rules related to the amount bank's can charge merchants for debit card purchases.

And, Nortel Networks Inc. announced yet another asset sale. But the news resulted in a mixed reaction in the bonds.

Harrah's reverses direction again

Harrah's Entertainment's 10% notes due 2018 were "active again," a trader said, but still lower than Monday's levels.

He pegged the paper around 841/2, calling that down about a point.

Another trader said the 10% notes were off by as much as 1½ points at 84½ bid, 85 offered.

The Las Vegas-based casino operator's debt had traded up during Monday's session after the company filed a plan for a $575 million initial public offering. But not everyone in the market expressed good feelings toward the proposed IPO, which would fund the company's development projects in Las Vegas and Ohio.

"It looks like its private equity owners are looking to spend their way out of the overleveraged balance sheet," wrote Gimme Credit LLC analyst Kim Noland in an afternoon report to clients. "We view this as risky business for new investors (and not good for creditors either given the slow pace of the recovery in Las Vegas and other gaming markets."

Noland noted, however, that Harrah's owners could be taking advantage of an "opportunity," especially as rival MGM Resorts International Inc.'s $500-plus million IPO was deemed successful. Still, using the proceeds for project development did not sway with Noland, who pointed out that "while other privately owned companies have filed equity offerings this year to take advantage of the improving markets, the use of proceeds has usually included debt reduction."

MGM quiet as IPO done

In MGM debt, a trader said there "wasn't much trading" in the credit, even as the company announced the completion of its stock offering, bringing in $511 million.

Another market source saw the 6 5/8% notes due 2015 fall over a point to close at 86¾ bid.

MGM Resorts sold 40.9 million shares of stock in the offering. Proceeds will be used, in part, to repay debt. The underwriter of the deal also has an option to buy another 6.1 million shares over the next 30 days.

Additionally, Kirk Kerkorian's Tracinda Corp. said it had sold off 27.8 million of its shares in MGM, with an option to sell another 4.2 million shares.

MGM Resorts will not see any of the proceeds from the Tracinda sale.

Sbarro remains weak

Sbarro paper continued to lose ground during Tuesday trading, though a trader said the decline was not "significant."

The trader said there were "not many trades," in the 10 3/8% notes due 2015, and of the trades that did happen, most of them were odd-lots around the 35 level.

"So it's down, but it's not significant," he said.

He added that there was an odd-lot offer of 42 in the Street, with no bids.

Another market source deemed the notes down over 12 points, at 42½ bid.

At another desk, a trader said that Sbarro "was the only real distress-y thing out there," seeing the bonds trade "below 40."

Another deemed trading in Sbarro's bonds as fairly active. In Tuesday's dealings, the 10 3/8% notes were seen gyrating around at levels as high as 45 and as low as just under 35, hitting the lower end of that range with several $100,000 trades - but there were no trades seen larger than that.

A trader at another shop heard the bonds last offered at 40, but he said that he "did not see a lot of activity. They're ending up at 40 cents on the dollar, but there's not a lot of trades to speak of at all.

"Quoted lower - but not a lot of activity."

Another trader said that Sbarro's "continues to kind of slide today," down into the upper-30s.

The Sbarro bonds' slide down to their current levels comes as no surprise, according to senior analyst Aqeel Merchant at Knight in Greenwich, Conn. Knight Research put out a bearish note on Sbarro in August, just after the company put out its second-quarter results. At that time, the bonds were trading in the high-70s, but Merchant had then noted the proper mid-value for the bonds would be around 35.

There was no specific development or negative news that caused the sudden slide on Friday after several weeks with no large trades. Rather, Merchant says, "As people have run numbers again and again, probably a holder who has held this for a very long time realized this is it," because of the company's deteriorating financials, "it's going to go lower, and has just decided to get out of the situation.

"I believe [the current trading levels] are simply a reflection of value at this point."

Choked by cheese prices

Sbarro is being hurt, he says, by continued weak traffic in the shopping malls, where about half of its approximately 1,000 restaurants are located (the company operates these outlets itself; another 536 are operated by franchisees at non-mall locations). Merchant says that shopping-mall traffic shows no sign of picking up amid what he terms the currently "tepid" economic recovery.

He also sees the company being choked by cheese prices - a key factor for a restaurant chain specializing in such dishes as pizza and lasagna. Right now, these costs show no sign of going down.

Sbarro has been in trouble for a while. Back in the fourth quarter of 2008, Merchant noted, the company was about to breach its loan covenants; however, its equity sponsors negotiated with the banks and paid down some of the first-lien obligations, providing the company with a second-lien loan.

"At that time, this was considered by most bondholders as a temporary crisis, and the fact that it was averted and liquidity was offered to the company once again was a cause to cheer and the bonds actually went up."

Fast-forward to the present, and "EBITDA has continued its decline, mall traffic hasn't improved and cheese prices don't look like they will go down." The analyst estimated that full-year EBITDA, which stood at $58 million in 2007, currently stands at $41.6 million on a last 12-month basis. He projects that for the full 2010 year, that key measure should slide below $40 million, which would put Sbarro in violation of its covenant.

The minimum EBITDA covenant right now sets a $40 million floor - and that is scheduled to go up to $43 million for the fourth quarter of this year, putting the company between the frying pan and the fire.

Merchant says another rescue by the equity sponsors is possible, but says the cash infusion would likely be at the second-lien level so "it's not going to do anything for the recoveries for the bondholders, unless EBITDA makes a comeback."

While Sbarro has a whole plate load of problems before it, there have been some positive signs for the larger restaurant sector, which recently has seen well-received new issues from the likes of Burger King Holdings Inc. and DineEquity Inc., owner and franchisor of the Applebee's and IHOP casual-dining chains, as well as the deal over the summer to fund the buyout of the Dave & Buster's chain.

However, Merchant points out that those companies "have either had assets for sale, ongoing free cash flow or a plan to shore up the same by reducing capex over time, building up free cash flow that way."

Comparing the respective leverage levels of the companies, he notes that Burger King's leverage is around 6.0 times EBITDA, Dave & Busters is about 5.8 x and DineEquity around 5.8x. By contrast, Sbarro's leverage ratio is up around 8.2x - and it could hit 8.9x by year-end.

"So you are entering territory which none of these [other] guys are in," he concluded.

First Data turns sour

First Data's debt lost about a point on the day in active trading, according to market sources.

One source said the 9 7/8% notes due 2015 dropped "about a point, 11/4" to 831/2, while another pegged the bonds a point weaker at 84 bid.

The weakness in the Atlanta-based electronic payment processor's debt came as Bank of America posted a $7.6 billion loss for the third quarter, due in part to a more than $10 billion write-down the company took to prepare for the "Durbin Amendment."

Without the write-down, the Charlotte-based bank made a $2.8 billion profit.

The Durbin Amendment is part of a financial reform bill and limits the amount banks can charge merchants whenever a debt card purchase is made. Bank of America claims that the new rule would practically erase its debit card revenue.

The bank makes nearly $3 billion per year from debit-card fees. The company estimates that the rule will cut that amount by as much as 80%.

Nortel mixed on asset sale

It was a mixed bag for Nortel Networks bonds, as the company announced yet another asset sale.

A trader called the 10¾% notes due 2016 up slightly around 83, while the 10 1/8% notes due 2013 fell to 82 3/8. The floating-rate notes due 2011 meantime closed "about unchanged" at 801/4.

The Toronto-based telecommunications equipment producer said Tuesday it would sell its Ottawa campus - which includes about 370 acres of land and 11 interconnected buildings - to the Canadian government. The sale will bring in C$208 million, or $202 million.

The latest agreement is one of many since Nortel's January 2009 bankruptcy filing. The company has divested itself of some of its units, in part to focus on its core business and also to raise enough cash to pay back debtholders.

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