Crunch time for Culligan Man

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A new lawsuit is threatening to derail the restructuring of the filtration specialist. What are the implications for other highly levered companies?

The battle to save Culligan International from bankruptcy took a new turn at the end of last month with the filing of a $575 million lawsuit alleging that the company’s owners bled the company dry, leaving it unable to service its huge debt pile.

The plaintiffs, which include many of Culligan’s dealers around the US, allege that “in just over two years of ownership, CDR [Clayton, Dubilier & Rice, which owns 90% of Culligan] managed to take a company with relatively no debt and $145 million in cash flow, and turn it into a company saddled with over $800 million in debt and not enough cash flow to service the ongoing payments”.

Balloon redemption payments on Culligan’s outstanding obligations, which include a $542 million first-lien term loan due in November 2012 and a €175 million second-lien term loan due in March 2013, have long threatened to tip the company over into bankruptcy, particularly given its perilously inadequate cash position – estimated in the lawsuit at about $135 million.

The sale of Culligan’s refill business to Primo Water for $109.1 million in November 2010 and the subsequent divestiture of its Canadian bulk water exchange business for $4.8 million seem to have been insufficient to keep the company afloat, especially after Culligan sold the shares in Primo Water it received as partpayment for the refill acquisition at a loss at the time of Primo Water’s secondary offering last summer.

In particular, the plaintiffs in the new lawsuit take issue with the fact that CDR paid itself an “excessive” $15 million management fee in the context of the $612 million leveraged buyout from Veolia in 2004, and subsequently awarded itself a $375 million special dividend following a recapitalisation of the company in 2007.

“The allegations in the complaint are meritless. The actions by Culligan and its board leading up to the 2007 dividend were entirely fair and proper from a business and legal perspective,” CDR said in a statement seen by GWI.

Nevertheless, with the subsequent decline in the company’s ratings since the recapitalisation, the junk loans ended up trading at mere cents on the dollar, allowing distressed debt houses Centerbridge Partners and Angelo, Gordon & Co. to swoop in and buy up large chunks of the debt at a fraction of its face value.

Now, Centerbridge is understood to be on the cusp of completing a restructuring exercise at Culligan – which according to CDR has 100% approval from both the first- and second-lien debtholders. Under the proposed terms of the exchange, Centerbridge will exchange the portion of the company’s second-lien debt it owns for a 47% stake in a new holding company, into which 100% of the equity in Culligan Investments will be transferred. A further $90 million cash payment will be used to pay down a portion of the first-lien debt held by Angelo Gordon, while the majority of the cash on Culligan’s balance sheet will go towards extinguishing a further portion of the first-lien notes.

The remaining $350 million of first-lien notes will then be termed out into equally sized tranches maturing in five and six years, respectively, although these will bear significantly higher interest rates than the existing loans.

Ratings agency Standard & Poor’s downgraded Culligan International to “CC” on 22 May, stating that it views the proposed exchange as “distressed” on account of the fact that noteholders stand to receive less than the face value of the notes under the terms of the debt swap. While the downgrade is largely academic, given that the majority of the debt-holders are directly involved in the restructuring exercise and own the debt well below the exchange threshold, the simultaneous withdrawal of the ratings suggests an even lesser degree of transparency going forward. Moody’s, too, is understood to be ready to downgrade its rating from the current Caa3 level once the restructuring is completed, and will then cease coverage of the company.

While the imminent resructuring will reduce leverage and ease the debt service burden on Culligan, it is a worrying example of how private equity practices can bring a company to its knees.

With Norit currently looking for a buyer, it raises the question of how wary potenial suitors will now be, considering the company’s total borrowings increased by 127% last year to the extent that its interest expense bill exceeded net operating income.