Last weekend European high yield investors woke up to find that the owners of UK mobile handset retailer Phones4U had halted trading and called in bankruptcy administrators. A household name on the UK high street with over £1bn in annual turnover was unable to continue as a going concern after mobile network operators Vodafone and EE both announced that they would terminate their relationship with the retailer effectively leaving the business with nothing to sell. On 1 September Phones4U’s two high yield bond issues experienced one of the largest one-day falls in the European HY market’s history. Why then was the market not pricing in these risks the day before the company’s senior secured notes dropped from 102.5 to 38? The most likely explanation is twofold – complacency and the call feature.
The Phones4U seven-year non-call three 9.50% 2018 notes were issued in 2011 when both rate curves and credit spreads were a good deal higher. In April of this year the notes became callable at the option of the issuer. With its 9.5% coupon looking extremely high at a time when similarly rated European credits were yielding 4.9%, many investors just assumed that the company would redeem the bonds at their 104.75 call price before the end of the year. This prevailing wisdom made the bond a popular holding in short duration high yield funds and among those investors looking for some ‘safe carry’. What could go wrong? If you had paid attention to a litany of troubling events, the answer was, “A lot, in fact.”
Last September, BC Partners, the company’s equity sponsors re-leveraged the business and de-risked their investment by paying themselves a dividend with the proceeds of a £200m payment-in-kind (PIK) note. Shortly thereafter, the company reported disappointing results and revealed that UK mobile operator O2 would no longer sell its handset contracts through Phones4U. In May this year Carphone Warehouse, the company’s only competitor, announced that it would merge with the UK’s largest electronics retailer Dixons with the latter rejecting a counter-offer from Phones4U. Following this, the papers reported that BC Partners had written down the value of its equity stake by more than 80% to just £7m. Despite each of these clear warning signs, secured noteholders could have exited their position for as much as 102.5 right up until the 29thof August. On Monday the 1st of September the bid had dropped to 62. Two weeks later it was 18.5 as EE followed Vodafone in terminating its relationship with Phones4U.
Those of us who avoided the name cannot claim to have known that the company’s demise would come so swiftly and suddenly. However it was not difficult for watchful eyes to infer that both the business model and balance sheet were highly vulnerable such that clipping carry in anticipation of an upcoming call was poor compensation for the risk of no call at all. Phones4U serves as a timely reminder that even in low default environments, fundamentals do matter.