The PreferredPlus 8.375% Citizens Communications Certificates Trust CZN-1 (“PIY”) is a $25 face value trust which was formed to own 7.05% Debentures of Citizens Communications (“underlying securities”) which is now Frontier Communications. Frontier is the nation’s fourth largest ILEC. On April 14, Frontier - a filed a voluntary petition for bankruptcy supported by a significant proportion of the existing debtholders.
An interesting structural trade exists because of the structure of the PIY trust. PIY was over-collateralized with underlying securities by a factor of 18%. Unsecured Frontier bonds currently trade in the 28-32 context. If we use the a midprice of 30 that would imply a fair value for the PIY of 8.85 (30/100 * 25 * 1.18).
On April 1, Frontier failed to make an interest payment on the underlying securities which while not an event of default at that time for the 7.05s (due to a 60 day cure period), did constitute a Default under the terms of the PIY trust agreement. An 8-K released by PIY declared that if Frontier declared a voluntary bankruptcy within 60 days of the failed payment, it would constitute an acceleration of the underlying securities which would trigger a distribution of the securities under Section 3.04 of the Aug 2001 Series Supplement document. Alternatively, if there was no filing then the Trustee would instruct the Market Agent to liquidate the securities and distribute the proceeds. The April 14 bankruptcy filing should therefore trigger a distribution.
We view a distribution versus a liquidation as highly preferable. First, the PIY holder retains optionality to simply sell the securities themselves or to hold the securities through the bankruptcy process. To be clear, the thrust of our investment thesis is the disconnect between the PIY and the market value of its underlying securities and we do not have a very strong view on the ultimate restructuring value of Frontier. Nevertheless, we would note a few points. Under the currently proposed restructuring plan, unsecured debtholders will receive $750MM in third lien notes and most of the post-restructuring equity. A price of 30 on the unsecured debt creates Frontier at approximately 3x EBITDA and 7X FCF (with the significant caveat that these numbers are unadjusted for the COVID crisis). A view that the correct valuation for Frontier is in the 4-4.5x context means that recoveries on the underlying securities bonds would ultimately be in the 50-70 range or $14.75-$20.65 on the $25 par value PIY.
Alternatively, the PIY holder can sell the securities upon receiving the distributed securities. We were concerned with the potential for a Trust liquidation ahead of the Frontier filing as we feared a sloppy forced bulk sale of the underlying securities by the Market Agent could lead to painful slippage. That risk appears to be off the table now that the securities will be distributed instead. We do not have information on the timing of the distribution yet but hope for more clarity in the near future.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.