UPDATE 1-Phones 4U PIK in free fall on Vodafone news

Mon Sep 1, 2014 11:05am EDT

* Bonds plummet after Vodafone abandons UK retailer

* Snap conference call fails to halt slide

* EE now only major network left at Phones 4U (Updates with conference call details, fresh levels)

By Robert Smith

LONDON, Sept 1 (IFR) - Phones 4U's deeply subordinated payment-in-kind note lost more than 50 points on Monday morning after the UK phone retailer announced that key partner Vodafone would not be renewing its network agreement.

On a hurriedly arranged conference call, Phones 4U's management reassured investors and analysts that they still expect to pay the PIK note's next coupon in cash. But the bonds resumed their descent after the call ended.

The company, majority-owned by private equity firm BC Partners, put the PIK in place in September 2013 as well as £25m of cash on balance sheet to pay its owners a £223m dividend.

The Vodafone contract, which ends in February next year, was crucial to the business. 27% of the retailer's post-pay connections and 16% of its pre-pay connections were made with Vodafone in the last 12 months to the end of July.

That translated into £212m of revenue and £18.5m of Ebitda over the period. One high-yield investor said the company generated just over £100m of Ebitda last year.

The £205m 10% 2019 PIK toggle was issued at 99 to yield 10.25% last year, and was bid as high as 103 in January as rumours of an IPO swirled.

The investor saw the notes quoted at a bid of 52 at 8:15am on Monday morning, a drop of 35 points from their opening price.

The bid collapsed even further as the morning progressed. The bonds were quoted as low as 30 by 10:00am on Tradeweb, less than a third of their face value.

The company's £430m 9.5% 2018 senior secured notes also fell, losing 20 points to 80 bid.

"It is very bad news," the investor said.

"The business model is so binary; when it's broken it really breaks. While management are good, they won't get much sympathy after the private equity owners used the PIK to pay a dividend."

NO PLACE TO GO

After a disastrous morning for Phones 4U bondholders, the company fielded questions for nearly two hours on the call, which began at midday.

A crucial point for PIK holders is whether the 10% coupon will continue to be paid in cash. Phones 4U has to pay in cash if it has capacity; if not the coupon steps up to 10.75% and is paid with additional bonds.

On the call, management confirmed they had a £93m cash balance at the end of July and expect this to remain positive by year-end. On this basis, they expect to be able to pay the next coupon due in February in cash.

While the PIK held steady around 32 bid during the call, the notes plunged to just 20 shortly after it finished, according to Tradeweb prices. The investor saw one broker quoting bonds even lower at only 13 shortly after 3pm.

He said the drop was due to the lack of a real response from management, coupled with a lack of liquidity in the market.

"Their only plan at the moment is to replace volumes as best they can," said the investor. "There's no marginal buyers and banks are not using their balance sheets so there's no place for the bonds to go."

TORRID YEAR

The Vodafone news caps a torrid year for holders of the PIK notes. In January mobile operator O2 dropped Phones 4U as a retail partner, but even more damaging was the news in February of rival Carphone Warehouse's merger with electronics retailer Dixons.

The merger, which has since completed, was described by one investor as "a slap in the face for Phones 4U". The company had a partnership with Dixons allowing it to operate store-in-stores in more than 150 Currys and PC World outlets.

This agreement expires in May 2015, and management said during the call that they have at least two replacement retail partners.

Vodafone's decision leaves the retailer in a precarious position. Its only remaining network agreements are with EE - which comprises T-Mobile and Orange - and Virgin Mobile. EE is the UK's biggest mobile operator, and the company announced in June that it is reviewing sales through third-party retailers.

The EE contract expires at the end of September 2015, and can only be cancelled if a minimum volume commitment is breached.

Phones 4U also operates LIFE Mobile, a virtual mobile network that piggybacks onto the EE network. LIFE is primarily aimed at customers who have been turned down by the other major networks for credit reasons.

BC Partners held 91% of the company's equity when the PIK was issued, with management owning the rest. On the conference call, a representative of BC Partners confirmed that it does not own any of the company's PIK debt.

"They have to be looking at buying the debt now, but the market is so thin that if they do anything in scale everyone will see it," said the investor. (Reporting by Robert Smith, Edited by Helene Durand, Julian Baker)