Description

FXIHLD’s 12.25% note is an asymmetric risk-reward with limited downside (first dollar secured risk and the note is attached from roughly 0-40% loan-to-value), pays a ~15% cash-on-cash at current low 80s prices (down -30 pts YTD), and has a ~40% return profile to a likely 12-18 month play (~106 call protection through end of 2023) as think the asset is very likely going to be sold / monetized by the 2 private equity sponsors (One Rock and Bain), just a matter of when / not if. Creating the biz through the 12.25% note closer to ~$1Bln versus a very likely price tag on sale at $2.5+Bln (see below). Lastly, the 2 sponsors have been invested in the biz since 2016 – 2017 (One Rock bought FXI in 2017, Bain bought Innocor in 2016), so its likely go-time for them to monetize, take the victory lap IMHO (question is if there’s a strategic who wants to play).

Ultimately, like the heads in win / tails I win (see below, base case >40% return, downside case ~10% return). And one of higher conviction top-of-structure trades right now given ~40% LTV, ~15% cash-on-cash, v high probability event that bridges an equity-like >40% return. Analog for this biz reminds me of PlyGem many years ago. Market was skeptical, but the resilience of the biz model was over-looked and the market additionally ignored the strategic interest in the asset (suppliers to PGEM , similarly FXI, benefit from the vertical integration as likely results in >$75 - $100MM of savings on day 1). Having this strategic angle is helpful in framing the v limited downside risk to first-dollar risk already trading in the low-80s w/ close to ~20% YTM (upshot, less of a risk on HY beta).

Market view: Market has a negative “old-school perception” of legacy Foamex, and views it as cyclical especially as its largely tied to mattress volumes. My view in return – market misses the fact that the industry has significantly improved over the past 15-years – what was once a ~8+ player industry less than 6-years ago is now essentially a rational ~3 player oligopoly (FXI, Carpenter and LEG which paid low-teens EBITDA multiple for Elite Comfort). Additionally, market has “old-school” perception of FXI as auto-exposed as it previously had ~40% of its biz tied to foam into auto seating. My view - given the acquisition of Innocor couple years back, majority of the biz is mattress (~70%+) and furniture (~20%) w/ engineered solutions / auto at less than ~10%. Lastly, market misses the fact that FXI largely serves relatively stable end-markets as it is agnostic on how it gets to consumer = i.e. ecommerce, private label retail, bed-in-box, and brick-mortar. And lastly, foam is a market share gainer in mattress industry as it will continue to take share from traditional innerspring (this tailwind benefits FXI as well as its 2 competitors). Ultimately, given the rational oligopoly structure, FXI should sustainably generate ~15 – 20% EBITDA margins (likely more toward the upper end) and given limited capex needs (less than $25MM per annum), the unleveraged margins should approach ~15% margins.

Why the opportunity: As high yield has sold off, anything that has a whiff of cycle risk has traded off, the FXI 12.25% notes have traded down from ~112 (start of year) to low 80s current (over -30 pts drop). At ~18% YTM on the 12.25% note, no longer as exposed to HY beta IMHO (this is less about rate risk, more about fundamentals as well as the market serving up something based on S/D around the issue).

Divergence: Market over-reacted to 1H 2022 results which were negatively impacted by mattress volume slow-down (TBD on when the recovery occurs) and more importantly margin squeeze as there’s a 3-6 month lag on large portion of biz in passing through output pricing w/ input inflation. Given these negative headwinds, FXI generated ~11% EBITDA margins in 1H 22E.

Looking forward, inputs are starting to fall off (given global demand), FXI is ahead of pricing (particularly on its retail customers) and margins will  likely expand to 16%+ in 2H 23E. My guesstimate is that the biz will generate closer to ~$270MM+ of EBITDA in 2023E even absent a recovery in mattress units (though I think the pent-up demand from mattress will ultimately be a net benefit at some point be it 2024E-onwards). At the current prices, creating FXI for less than 3.8x 2023E EBITDA (and given the minimal capital expenditures, equates to less than 4.25x EBITDA-capex)

LTV coverage: Rumor in market that Sponsors pursuing a sale of FXI. While the cycle risk over past few months might have neutered timing of this, but don’t think changes the course. My guess is that the biz likely generates real strategic interest particularly from manufacturers of the input (TDI/MDI/polyol) as tremendous benefits to vertical integration … and / or interest from players such as LEG (that bought Elite Comfort for ~13x+ EBITDA in 2018 = i.e. ~$1.25Bln PP for ~$600-620MM of revenues). Compare that to FXI that generates closer to ~3x the revenue as Elite Comfort … don’t think it’s a stretch to assume One Rock and Bain might be sitting on a $2.5 - $3.0Bln TEV biz (versus ~$1Bln create through the 12.25% at current prices). I ultimately think we get clarity on a sale process over the next 12-18 months and 12.25% notes will prove out <50% LTV coverage.

Financials: Quick snapshot of financials below, my 2018-2020 figures give 50% partial credit to Innocor synergies. The company ultimately exceeded their synergy targets and the figures in 2021 – onwards don’t give any further credit. My guesstimates on 2022E and 2023E below FWIW.

Capital structure: v straightforward, 2 top-structure securities: 1) 505MM of 7.875% due end of 2024 and 2) 12.25% due end of 2026. My view is that both securities come out together likely in a sale and the 12.25% are the superior trade given coupon + call protection.

Base Case: As market grows increasingly comfortable in the margin profile recovery of the biz (back to 15-20%) and better understands the glidepath for 2023E (i.e. >$250MM even in current recessionary environment), the notes should trade healthier given the ~15% cash-on-cash pay. Ultimately think the 2 sponsors pull the rip cord and sell the asset at some point in 2023. If not, they need to refinance the late 2024 maturing notes and I think they do a holistic refinancing (but sale is the most likely play). Getting 12.25 pts of coupon over next 12-mths and >22 pts of OID to ~106 call protection = >34 – 35 pts on ~83-84 entry of >40%

Downside Case: Cycle is nasty / i.e. GFC … volumes continue to fall off hard, but margins should win as inputs are falling (strong evidence of this already). Let’s assume revenue falls off by -20% , but margins expand closer to ~18-19%, still implies something close to ~240 – 250MM of EBITDA. Let’s assume margins go haywire as well and compress to ~14%, still likely in the ~$200MM EBITDA context. Even at these lower levels, biz is generating ~$40+ of FCF (14% margins) and ~$90MM+ of FCF (~18-19% margins). Maybe the market requires a better than ~18% YTM on the 12.25% (i.e. let’s assume spreads gap out another 200 bps for HY and FXI gets taken down alongside), that implies a ~79 px on the note (or down -4 pts give / take) … getting 12.25 pts of coupon along the way offset by -4 pts of price = still get 8.25 pts on ~83-84 entry or ~10% return profile. Most importantly, the set-up at ~79 (~20% YTM) is even more attractive and allows to play for bigger outcomes.

Disclaimer: Intended for information purposes only (not investment advice) and should not be relied upon as a basis for investment. Author holds a position in the issuer and undertakes no obligation to update any future changes in the position or in the investment opinions expressed herein. FXI bond portal access provided by FXI, probably best to reach out to [email protected] 

Catalyst

2H 2022 margins

2023 commentary / glidepath

Updates on any strategic process (2016 / 2017 vintage LBOs by One Rock and Bain)