Jul 8, 2011

Gajah Tunggal & covenant breach?

Standard & Poor's Ratings Services said on July 6that it had placed its B long-term corporate credit rating onIndonesia-based tire manufacturer PT Gajah Tunggal Tbk (GJTL) on credit watch withnegative implications. 
"We also placed our B issue rating on the company'ssenior secured notes on credit watch with negative implications. We placed the ratings on Gajah Tunggal on credit watch to reflect the risk that the company's liquidity could significantly weaken if its recent dividend payment constitutes a covenant breach under the terms of its 2009 restructuredbonds." 
On June 30, 2011, Gajah Tunggal paid Indonesian Rp41.8 billion in dividends out of its 2010 profits. The company made the payment before July 21, 2011, the date on which the interest rate on the restructuredbonds will increase to 6% from 5%. 
"We need more clarity on whether such action constitutes a covenant breach,"said Standard & Poor's credit analyst Xavier Jean. 
"The covenants of Gajah Tunggal's restructured bonds restrict the company from making dividend payments under a number of circumstances, including before the intereststep-up date. But the covenants also indicate that Gajah Tunggal may pay dividends before the interest step-up date if the Indonesian law requires the company to do so before that date." 
Gajah Tunggal does not consider the dividend payment as a covenant breach and has indicated that it will issue a formal response to its bondholders. 
"We believe litigation risks from holders of the restructured bonds could arise if the dividend payment constitutes a covenant breach. An accelerated repayment of the principal of the restructured bond would severely impair Gajah Tunggal's liquidity and heighten the risk of default, in our opinion."
The face value of the bond at about US$435 million (including US$10 million incontractual amortization to be repaid on or before July 21, 2011) issignificantly larger than the company's cash and cash equivalents of about US$130 million as of March 31, 2011. 
"However, we believe Gajah Tunggal's liquidity is adequate to service the partial principal amortization of about Rp85 billion and the coupon of the 2009 restructured bond in July 2011, given the company's cash balance of Rp466 billion as of March 31, 2011." 
The rating on Gajah Tunggal reflects the company's highly leveraged financial risk profile, its exposure to a cyclical and volatile industry, and itslimited financial flexibility. Gajah Tunggal's competitive cost position and leading share in the Indonesian tire market temper these weaknesses. 
"We may affirm therating and remove it from credit watch if the dividend payment does notconstitute a covenant breach.
Disagree the claim
In a press statement, Gajah Tunggal  understands that a party claiming to be a bond holder has written to its Bond Trustee to object to GT paying its FY2010 dividend payment. 
"We understand that subsequently an anonymous party has disseminated the letter on this matter to various parties. The anonymous party has alleged that the payment of the FY2010 dividend is not required by Indonesian law and GT is therefore in breach of the terms and conditions of the bonds."
The company disagrees with this claim and will issue a formal response to its bondholders shortly. Meantime, Gajah Tunggal has heard from a number of its larger bondholders who have expressed their disappointment with the approach taken by the anonymous party and have told us they remain supportive of management. 
"As our bondholders know, the company has consistently acted in good faith throughout the history of this Bond, remains committed to fully discharging its obligations to its bondholders and shareholders and is confident that this action is without merit and will not be supported by the market."
 
Disclosure: No position at the stock mentioned above.  

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