IBI Group Plummets Some More

A few weeks ago, I discussed IBI Group's (OTCPK:IBIBF) debt as a potentially attractive risk/reward. Unfortunately, the company has since issued a very ugly quarterly report that has resulted in IBI's debentures falling to less than 40 cents on the dollar.

At the time, there were two major reasons I felt the downside was protected:

1) IBI's current assets covered the company's total liabilities at the market price of the company's debt, and

2) Unused portions of the company's credit line were large enough to pay off the company's debentures

Both of these "protections" disappeared in the company's latest results! First, the company wrote down about $58 million in receivables and inventory. This amount alone could have paid off the debentures due in one year.

Second, the company's results were so poor that it violated the EBITDA covenant on its line of credit. As a result, the company had to renegotiate this financing, resulting in a reduction in the line of credit to just $70 million. This facility can thus no longer be used to make good on the debentures.

Management has admitted that the company's project management has been sub par. As a result, it has taken steps to rectify this issue, from better, centralized process controls to changes in compensation structure to improve profitability and cash collections. Unfortunately, it will take time for the company to work through projects on which it never should have bid, so further write-downs are likely.

At the same time, however, cash flow has improved. The company's CEO expects an ongoing net cash flow run rate of $2-3 million per month, following net cash flow of $12 million in October due in part to some one-time items.

So where does that leave investors? Fortunately for potential investors in the company's debt (and unfortunately, for current holders), the price of the debt has readjusted downward dramatically so that once again the company's current assets cover the debt. But the question is still open as to how the company will repay the principal of the debt due in 13 months.

The company anticipates announcing its plan in January, which would likely include at least one of the following:

1) New debt that replaces current debt

2) Make the repayment in shares

3) Come to an agreement to push out the maturity of current debt

For current debt holders, option #1 would be best, and would result in returns of some 150% based on the current price of the debentures. Unfortunately, the company may not be able to do this on attractive terms, based on how the market currently views the company.

Option #2 appears to be the least likely to me, at least for now, as management holds a significant equity stake in the company, and this would almost wipe that out. However, if conditions don't improve next year, this could be a last resort. Debt holders should be prepared to have to endure this option if things get worse.

Option #3 is the most likely, from my perspective. In return for a higher return, the company may convince current holders to push back the maturity date.

Each of options #2 and #3 require that debt holders have some confidence in the company as a profitable going concern. Myself, I continue to believe the company has some competitive advantages and an attractive business model that should allow it to be profitable. For example, the company's expertise in particular areas (e.g. building design) allow it to charge for similar work it has already provided on other projects. I added to my debt holdings at around 35 cents.

At the same time, there continues to be the risk that management can't get its act together. If the company continues to experience cost overruns and poor controls, there could be a permanent impairment of capital here. I remain cautious on this name, and therefore want to avoid it becoming a major portfolio holding.

Good luck!

Source: IBI Group Plummets Some More

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: I am long IBG.DB

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