What could this mean for one of its big creditors, the ECB?

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

Spanish supermarket chain Dia, once one of Europe’s largest grocery chains, has just unveiled its results for 2018 and they do not make for pretty reading. In what it describes as “probably its hardest year ever,” the company racked up €352 million in net losses. EBITDA (earnings before interest, tax, depreciation and amortization) of €246 million plunged by 47% from a year ago. Net sales dropped 11% from a year ago to $7.2 billion. And its total debt soared by 50% from the end of 2017 to €1.45 billion.

The firm’s shares, reduced to a penny stock, have slumped almost 90% since Jan 1, 2018. Its credit rating — investment grade until October 2018 — was cut to deep in junk following a succession of profit warnings.

Put simply, Dia is about as close as a company can get to bankruptcy without actually being officially bankrupt. It is, in market parlance, “technically bankrupt”, meaning that it lacks the ability to pay its obligations and would most likely qualify for bankruptcy protection but is yet to file for it in a bankruptcy court.

If Dia does go into liquidation, it will have knock-on effects not only for big Spanish lenders like Santander, BBVA, CaixaBank and Banco Sabadell and European heavyweights like Barclays, Société Générale, and Deutsche Bank, but also the ECB which holds at least €200 million worth of Dia’s debt. Due to Dia having been rated investment grade until October 2017, its bonds qualified for the ECB’s corporate sector purchase program, or CSPP.

By the end of 2018 those bonds were trading at 68 cents, 60 cents, and 57 cents on the euro (in order of maturity dates 2019, 2021 and 2023). In other words, the ECB’s “investment” in Dia had lost over a third of its value.

In a bid to stave off default, Dia has announced it will cut up to 2,100 jobs (out of a global total of around 40,000) as well as close around 300 stores. In December, management proposed a €600 million capital expansion, to be backstopped by Morgan Stanley, which helped pull the supermarket group from the brink.

On Tuesday, the Luxembourg-based investment fund LetterOne, owned by Russian billionaire Mikhail Fridman, announced a long-expected takeover bid for Dia, which propelled the group’s shares from €0.43 to €0.70 and left its bonds trading at 83 cents, 75 cents and 72 cents on the euro. L1 has been buying up stock in Dia since July 2017 and already owns 29% of the group’s shares, at a total cost of around €700 million. With Dia’s market cap worth just over €450 million today, that investment is deeply underwater.

If L1’s takeover bid gets a green light from Spain’s market regulator and Dia’s shareholders, who have been offered €0.67 for each share, Fridman says he will launch his own €500 million capital expansion for Dia, to be backstopped by Goldman Sachs, which is currently Dia’s second largest shareholder.

Firdman also says he will negotiate with Dia’s lenders to try to “reach a satisfactory agreement.” According to the Spanish financial daily El Confidencial, what Fridman wants is to secure from Dia’s creditors, including, presumably, the ECB, a three-year grace period during which the retailer will not have to make any debt payments or pay interest on any of its debt. This, it says, will give the supermarket group enough financial breathing space to complete its turnaround.

It’s a big gambit. Dia’s creditors have already said they will not accept any haircut on the debt, and that presumably includes a three-year amnesty. But with €850 million of Dia’s debt scheduled to come due at the end of May, time is of the essence. That the shares are now hovering almost 10% above L1’s offer price would suggest that investors believe they can hardball Fridman into coughing up a little more for each share.

Doubts remain as to how viable Dia’s business model will be even after a takeover and recapitalization. It will still face intense — and intensifying — competition in many of its key markets, including from online retailers. This is particularly true of its domestic Spanish market where the supermarket giant Mercadona now controls almost a quarter of the entire grocery market after years of ruthless cost cutting, while the German discount chains Lidl and Aldi are rapidly wresting market share from domestic low-cost retailers like Dia.

As has happened in many other corporate collapses of recent years, there are also allegations that executives at Dia engaged in accounting fraud to conceal the true extent of the firm’s losses while picking up hefty bonuses and stock options along the way. According to Ernst&Young, which was hired to drill down into Dia’s accounts over the last two years, executives in Spain and Brazil deliberately withheld key financial information from the board, the auditor and shareholders.

If true, Dia will became the second company after global retail giant Steinhoff to have issued large amounts of corporate debt that was hoovered up by the ECB only to then proceed to a debt restructuring partly as a result of accounting fraud. In the case of Steinhoff, the ECB ended up selling its position in the bonds at a multi-million euro loss. Time will soon tell whether it will have to do the same with Dia. By Don Quijones.

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