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Bankruptcy Conflicts

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  • | 6:00 p.m. October 16, 2008
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Bankruptcy Conflicts

Kohlberg, Kravis, Roberts & Co. negotiates to avoid Masonite bankruptcy as both the company's owner and a major creditor. More such situations from private equity firms are expected.

finance by Jonathan Keehner and Pierre Paulden / Bloomberg News

Kohlberg, Kravis, Roberts & Co. has run into a familiar face as it wrangles with lenders over the fate of Masonite International Corp.: the one in the mirror.

KKR bought Masonite, a Canadian door-and fiberboard maker, for $1.9 billion in 2005. The New York-based private-equity firm also holds Masonite's bank loans, say three people involved in the talks. That puts KKR among lenders deciding whether to force it into bankruptcy for violating loan covenants, say the people, who declined to be identified because talks are private.

Masonite's creditors say they're concerned KKR isn't eager to join them in squeezing more from the company because as an owner it would prefer to have lower borrowing costs. Such conflicts may increase because buyout firms, including KKR and Apollo Management LP, own more than $80 billion in corporate debt after spending about $750 billion on companies last year.

"We'll definitely see portfolio companies facing bankruptcy where the private equity owner is also a significant lender," says John Bicks, a bankruptcy attorney at Sonnenschein Nath & Rosenthal LLP in New York. "That complicates a workout, because the battle moves to three fronts: pure lenders, unsecured creditors and the private-equity owner."

KKR spokesman David Lilly declined to comment on Masonite, whose Mississauga headquarters is about 7 miles southwest of Toronto. KKR bought Masonite in 2005, two years before the housing meltdown hurt the market for the company's main products.

Executives recused

KKR owned Masonite's debt through a wholly owned subsidiary known as KKR Financial Holdings LLC, whose operations are run separately from those of the buyout firm, according to a filing in June. KKR owns about 5% of Masonite's bank debt, two people familiar with the situation say.

"KKR's private equity executives will continue to recuse themselves from any investment decision that may suggest a conflict between a private equity investment and a fixed income investment," the company said in a statement in June.

Lenders are demanding stiffer terms, such as more fees and higher rates, to forgive broken debt payments after financial companies worldwide suffered $635 billion of losses and credit writedowns tied to the slumping home-loan market.

Masonite's lenders are keeping KKR's debt unit at arm's length as they discuss strategy, say two people involved in the talks.

"It doesn't make sense to include in a discussion among lenders the very people with whom they will be negotiating," says David Pauker, managing director at restructuring adviser Goldin Associates LLC in New York. A buyout firm "may say that they've developed a Chinese wall, but whether people believe them is another matter," says Pauker, who isn't involved in the negotiations.

Masonite breached loan covenants in the second quarter that dictated debt couldn't exceed seven times earnings before interest, tax, depreciation and amortization, according to a filing. The ratio surged to 8.25 times as of June 30 after Ebitda declined 44% to $56 million, the filing says.

Michael Freitag, a Masonite spokesman, says discussions with lenders are continuing. On Sept. 16, the company "entered into an agreement with our lenders that gives us additional time to work constructively to come to acceptable terms," Freitag said in a statement. That agreement expires on Nov. 13, according to Standard & Poor's.

Cash on hand

S&P lowered Masonite's bank loan three grades on Oct. 10 to CCC, the eighth lowest junk rating, saying the company may not make a $42 million interest payment due on Oct. 15.

The company's bank loans are quoted at 83 cents on the dollar, according to S&P. Its $412 million of notes due in 2015 are quoted at 24.5 cents on the dollar to yield 53 percentage points, according to Trace data.

The company probably has enough money for the October interest payment, with $241 million of cash on hand as of June 30, which is mainly the result of recently drawing down the rest of its $350 million secured revolving loan, according to S&P.

The default rate among high-yield, high-risk, non-financial borrowers may rise to 23.2% by 2010, the highest since 1981, S&P said in a report Sept. 25. The "worst-case scenario" estimate suggests 353 junk-rated borrowers outside the financial industry may default in the next two years, S&P said.

Buyout firms including New York's Blackstone Group, which manages $25 billion in GSO Capital Partners, and Boston-based Bain Capital LLC, with $33 billion assets in its Sankaty Advisors LLC unit, are among the most active buyers of corporate debt.

Scotia Capital, Deutsche Bank AG and UBS AG arranged $1.18 billion of term loans, a $350 million credit line and sold $825 million of bonds to back the acquisition and refinance existing debt. KKR invested about $650 million of equity into the transaction, according to an S&P report in 2005.


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