Description

Thesis: Buy Tenneco (TEN) 8% 2028 1L bonds at $80 (13.5% YTW, ~+900 z-spread). Low hurdle to grow EBITDA from ~$1bn in FY'22 to $1.6-1.7bn in FY'24E driven by $660mm of cost cuts (sponsor says fully in run-rate by YE'23) and OE production growth (supply chain improvements with further support from lower than normal inventory levels). Bonds should trade to +700 z-spread or better in one year, implying a forward price of $89 and 22% 1y total return. Accounting for poor guarantor coverage, 8% '28s create the company at 3.6x 2023E EBITDA of $1.3bn and 2.8x 2024E EBITDA of $1.7bn at market and 4.7x/3.6x at par.

Tenneco is now a private issuer following its acquisition by Apollo. Citi is the agent on the term loans A and B, and bondholders can contact [email protected] for access to the bondholder site.

Business description: Tenneco is a tier 1 auto supplier with top 3 market positions across virtually all products. Highly exposed to internal combustion engines (37% of revenue directly exposed to ICE production). Operates in four business segments: 

• Clean Air: Products that regulate and manage emissions, heat, and noise associated with ICE (particulate filters, exhaust systems, etc. 
• Powertrain: Key building blocks of ICE engines
• DRiV: Aftermarket business, powertrain agnostic
• Performance Solutions: OE components critical to enhanced ride handling and safety; powertrain agnostic

Relevant history & ownership: Apollo closed its acquisition of Tenneco in November 2022. Banks were hung with buyout financing, which they brought to market in August 2023 (this bond was priced at $85 and has traded off since). Tenneco equity had been publicly traded since 1987. Tenneco acquired Federal-Mogul from Icahn Enterprises in 2018, roughly doubling revenue and EBITDA. TEN intended to spin the non-ICE assets (DRiV and Performance Solutions) to shareholders but delayed when the auto market weakened in mid- to late-2019. 

Tenneco has been written up several times on VIC. Some other links of interest: 

• TEN investor presentation from 2018 acquisition of Federal-Mogul
• Merger background section from merger proxy

Key risks and mitigants:

• 37% of revenue is directly exposed to OE production of autos with internal combustion engines: Powertrain-agnostic revenue likely to grow 3-4% per year through 2030, driving flattish to 1% annual overall revenue growth
• Apollo replaced 100% of the management team last November, giving rise to potential business continuity issues: New management has been in place now for almost a full year. They have since improved sourcing, and quality control, and reaffirmed the $660mm cost save target (upsized from the original ~$400mm) by year-end 2023
• The merger proxy highlights Apollo's lack of interest in the non-ICE assets, and Apollo has significant flexibility under the credit documents to move value away from the collateral pool: The credit documents are indeed very loose (right out of the gate, permits ~$1.2bn of structurally senior debt and ~$2bn of combined restricted payment and permitted investment capacity), but (i) Apollo's desire to improve its image suggests it won't pursue the most extreme maneuvers right off the bat, and (ii) if Apollo comes anywhere near their cost cut goals, $1.6-1.7bn and ~$500mm of free cash flow to the equity should be easily achievable with flat auto production next year.

Valuation: Blended 2024E should be 4.5x-6x based on 30% aftermarket, ~40% ICE-exposed powertrain, and the remainder CTOH (commercial truck and off-highway). Implies ~$6bn to $10bn TEV vs. $4.6bn 1L debt. 

Ch. 11 recoveries are in the low-80s assuming $1.3bn of EBITDA ($900mm underlying EBITDA + $400mm realized cost saves) valued at 4.5x EBITDA. If TEN fully draws its $1.1bn ABL and incurs $500mm of structurally senior debt, 1L recoveries fall to 65c. If TEN moves $2bn of value away from 1L lenders following a full ABL draw and incurrence of $500mm of structurally senior debt, 1L recoveries fall to 51c. 

Key value drivers:

• Cost savings: Apollo originally targeted $400mm annual cost savings when it closed the deal last November. Increased target to $660mm when it remarketed the deal in August 2023. Now says $75mm of cuts were realized in 2023 2Q; $300mm have been executed and are 'run-rate' and the full $660mm will have been executed and run-rate (and therefore realized) by year-end 2023, i.e., realized in 2024E EBITDA. Apollo and management believe they will reach >$700mm with ~$300mm cost to achieve, mostly incurred in 2023
• Improving fill rates at aftermarket business: Apollo said TEN's aftermarket business was weaker than anticipated pre-deal. The business had been starved for growth and required $100mm working capital investment to bring fill rates at retail partners from the 70s back to 90s %
• Capital policy/leverage target: Most baskets have been tightened since banks brought the deal in November 2022 but covenants are still relatively loose. If the business performs reasonably as anticipated, Apollo expects to pay down debt until it can refi the structure at a lower cost

Catalyst

• Resolution of UAW strike: TEN is relatively insulated compared to auto supplier peers with 40% of the business in Europe, 20% in Asia, and just 10% of revenue from the Detroit big 3. Apollo estimated risk at $20-40mm per month of revenue if OE production shut down completely. JP Morgan estimated a $32mm monthly impact to EBITDA (see table)
• $300-400mm of sale-leaseback activity (German and Belgian property) in 2H 2023
• Ongoing turnaround of Performance Solutions subsegments currently losing $50mm of EBITDA
• Clarity on achievement of cost cuts through YE 2023