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Junk Bond Carnage, One Company at a Time

Storied weapons maker, Colt Defense LLC, is in a pickle. But it’s not the only junk-rated company in a pickle. The money is drying up. Selling even more new debt to service and pay off old debt is suddenly harder and more expensive to pull off, and holders of the old debt – your conservative-sounding bond fund, for example – are starting to grapple with the sordid meaning of “junk”: Colt announced on Wednesday that it might not be able to make its bond payment in May.

Colt’s revenues plunged 25% to $150 million for the three quarters this year. It’s spilling liberal amounts of red ink. It has $246.5 million in assets, including $61.5 million in Goodwill and intangible assets. Without them, Colt’s $185 million in assets are weighed down by $416.8 million in liabilities, leaving it a negative “tangible” net worth of -$231.8 million. Cash and cash equivalent was down to $4 million. In its 10-Qreleased on Wednesday, Colt admitted that there was “substantial doubt about the Company’s ability to continue as a going concern.”

Moody’s rates the company a merciful Caa2, reflecting “its very high leverage and weak liquidity position,” with negative outlook. This babe is deep into junk territory – and headed for default.

As is to be expected after this much financial engineering, the company is largely owned by a private equity firm: Sciens Management holds “beneficial ownership” of 87% of Colt’s LLC interests.

Last week, it got some reprieve, if you can call it that: Morgan Stanley agreed to provide a $70 million senior term loan. This new money replaces Colt’s existing $42.1 million loan that the company said it would have defaulted on by the end of December. That’s how that original lender got bailed out: new debt to pay off old debt.

The new loan will also permit Colt to make a $10.9 million interest payment. Otherwise, the company would have been in default by December 15. That’s how those bondholders got bailed out (for the moment): more new debt to service old debt.

The loan would leave Colt with an additional $4.1 million in cash: new debt to pay for new losses.

It also disclosed that “notwithstanding the additional cash the Company obtained from the MS Term Loan, risk exists with respect to the Company achieving its internally forecasted results and projected cash flows for the remainder of 2014 and 2015.” And if a number of miracles fail to occur, “it is probable that the Company may not have sufficient cash and cash equivalents on-hand along with availability under its Credit Agreement, as amended, to be able to meet its obligations as they come due over the next 12 months….”

So management has a plan to deal with its “increased liquidity challenges”: in addition to a number of operational goals, it would be “seeking ways to restructure the Company’s unsecured debt.” Owners of that unsecured debt are going to squeal. And if that doesn’t work, well….

This scenario is starting to play out company by company, hitting the most fragile ones first, as investors are becoming at least somewhat reluctant to throw good money after bad. That reluctance has to be overcome with additional compensation in form of yield, thus a greater expense for the companies when they can least afford it.

The junk-debt-funded oil and gas shale revolution is particularly on the hot seat. Its ever-faster moving fracking treadmill of steep decline rates and costly drilling is now smacking into the plunging price of oil [read…  How Low Can the Price of Oil Plunge?].

Hoping that the price of oil and gas would only go up, energy companies have drilled $1.5 trillion into the ground since 2000, and they’re now shouldering a huge pile of debt – much of it junk rated.

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