Source: Investment Dealers' Digest
 
On Friday Dec. 10, 2004, Swiss airline caterer Gate Gourmet called a meeting with its creditors at a large conference center in Citigroup's London offices. David Siegel, who had been brought on as CEO six months earlier, shortly after winning major labor concessions at USAirways, explained to the audience of about 100 that the company would temporarily have to cease principal payments on its bank loan of Sfr423 million and interest payments on its Sfr269 million in mezzanine debt.
 
Over the last 18 months, however, under the aegis of its private equity owner, Texas Pacific Group, Gate has successfully reorganized, renegotiating its labor contracts and coming to an agreement with its creditors without going through bankruptcy. The reorganization should officially be completed early next year. "The lenders cooperated with the company and didn't force us into Chapter 11, although they could have," says Marc Puntus, a managing director at restructuring specialist Miller Buckfire, which managed the reorganization for Gate and TPG.
 
One of the keys to the deal was that the creditors had confidence in TPG's and Gate's management. TPG Founder and President David Bonderman made his name turning around Continental Airlines, and Gate's Siegel had been instrumental in that effort. "To TPG's credit, they devoted substantial resources to fixing the business," says one of the debt holders. The firm made no commitment of additional capital early on, however, indicating to the lenders that it would consider kicking in more money as the situation evolved.
 
TPG bought Gate from British Airways in December 2001 for Sfr1 billion, betting on a recovery in the airline industry following the Sept. 11 attacks on the World Trade Center and the Pentagon. However, competition from low-cost carriers was causing the large airlines to cut back on food service. It soon became clear this change would be lasting, says Rick Schifter, a partner at TPG. In addition, "uncompetitive labor rates and some operational difficulties" caused Gate to fall short of sales targets needed to service its debt, says Duncan Priston, a senior VP at Houlihan Lokey Howard & Zukin, which advised the mezzanine lenders.
 
The senior lenders, which included Citigroup, Eaton Vance, RBS and ABN Amro, were well protected and would be repaid in full some 15 months later. Some holders of the mezzanine debt immediately sold their positions as the price fell from the 90s to 60% of par. Others formed a committee, led by GSC Partners, Deephaven and RBS. In the ensuing months, Angelo Gordon and Davidson Kempner built large positions in the mezzanine debt, eventually replacing GSC and RBS, while Deephaven remained.

Labor Negotiations The success of the reorganization hinged on the fate of Gate's labor contracts. "It was extremely difficult to properly assess the value of the business prior to understanding what savings could be obtained in negotiations with the labor unions in the US and the UK," says Puntus. "Ultimately, the company was able to achieve significant savings through labor deals and a renegotiated contract with British Airways. Once these deals were finalized, the valuation picture became clearer."
 
In the US, things went smoothly, with both sides agreeing to binding arbitration with the Teamsters and the hotel workers' unions. The arbiters ruled that the unions were to reduce wage costs by $40 million, the amount Gate requested. In the UK, however, negotiations derailed in the summer of 2005, and when management brought in temporary workers, the permanent employees walked off the job. By megaphone, some 600 employees were informed that they had been fired. Workers from British Airways, Gate's former parent, struck in sympathy, shutting down Heathrow airport for 24 hours. Fortunately for Gate, however, much of the blame for the shutdown fell on BA, which has had trouble with its unions in the past.
 
In any event, Gate's turnaround team finally found cost savings of some Sfr100 million, according to a source close to the negotiations, and a deal was struck between the investor groups in the form of a debt-for-equity swap and a refinancing. TPG also decided in late 2005 to sink another Sfr30 million into Gate.
 
For the refinancing, Goldman Sachs, which had approached Gate's management before its Dec. 10 meeting with lenders, won the underwriting mandate. The company placed new first and second-lien notes worth Sfr600 million.
 
The loans consisted of a Sfr475 million first-lien tranche priced at 275 bps over Libor and a Sfr125 million second lien at 550 bps over. They were syndicated in March. Both were trading at 101-102 last week.
 
When the loan was in the market, investors' first reaction was, "aren't these the guys who shut down Heathrow Airport?" said one executive involved in the note sale. "But when it was explained that this was a British Airways issue and a wildcat' strike not officially sanctioned by the union, the deal went through smoothly."
 
The proceeds were used to repay the company's Sfr415 million bank facility, to pay Sfr100 million in cash to the mezzanine holders and for working capital. In addition to the cash, the mezzanine lenders received a 45% equity stake in the company, while TPG retained a 35% equity stake.
 
In order to bridge a valuation divide between TPG and the mezzanine holders, the remaining 20% of the equity was placed in an escrow account to be distributed to TPG and/or the mezzanine holders based on a formula tied to the company's Ebitda for 2006. If the company exceeds its business plan, most or all of the equity in escrow will be distributed to TPG. The equity has traded up significantly in the weeks following the closing of the restructuring, suggesting TPG will get the entire 20% stake.
 
"What's in my view remarkable about what has occurred is we were able to complete the reorganization in 15 months without going into Chapter 11 or any other judicial process," says TPG's Schifter. "We got 100% consent from our mezzanine debt holders for the exchange of debt into equity, and because the equity, has performed well, they didn't lose any money. We're also pleased with the equity stake we have retained in the company, as we're finally seeing some recovery in the airline industry."