KKR Could Grab “Biggest Bankruptcy”

We’ve seen the size of PE bankruptcies increase as the year toils on, with Linen’s ‘N Things (purchased by Apollo for $1.3 billion) narrowly topping Mervyns (purchased by Sun Capital and Cerberus for $1.2 billion). Those could soon be outdone by KKR’s C$3.2 billion purchase of Masonite International, if the company files for bankruptcy. It’s not a sure bet, but is beginning to look better than even money.

On Friday, the company went into default on a $42 million interest payment to its $768.9 million senior sub notes due 2015. Yesterday S&P lowered its rating to D and Moody’s lowered its corporate rating two levels to Caa3.

This payment miss is surprising for two reasons. First, $43 million should not be a back-breaking chunk of cash for a global company with $486 million in annual revenue. The residential door and fiberboard maker recently drew down the remainder of a $350 million revolver, but wasn’t permitted to use it for interest repayment because it would’ve put the company in covenant breech. In the next thirty days, Masonite needs to pony up the money or renegotiate its loans.

The former option isn’t likely. Masonite’s products exclusively serve the residential market, and it has been suffering from top line shrinkage since the downturn of housing in 2006. The company’s annual EBITDA decreased 9.9% as of March of 2008. The levers have been pulled, the cutbacks have gone deep.

The latter isn’t too sunny a prospect either. This might be the worst time to renegotiate covenants on a loan, especially when you’re levered 6.71 times, as Masonite is. (The number represents debt to TTM EBITDA up to March.) Last week Bloomberg reported that KKR holds part of the company’s bank loans, citing people familiar with the situation. The article reported that KKR will be negotiating on both sides of the table, though I doubt the firm’s influence as a debt holder will be that large, since it only owns 5% of Masonite’s bank debt.

Even though this deal seemed plagued from the start (with initial financing and pricing disagreements), Masonite could be a harbinger of things to come. Think about it-the deal was struck at the very beginning of the buyout boom, while interest rates were still slightly rising and the high yield bond market had hit a pause. The deal had covenants and a relatively standard 20% equity check ($550 million). What’s going to happen when covenant-light deals with 15% equity in the retail, print media, homebuilding and automotive industries mature?