Swaponomics II: Blackstone, BlueCrest and the Great Paper Caper

  • Secured bondholders suing Norske Skog to block debt exchange
  • Groups accusing each other of trying to profit from a default

The great paper war is heating up.

On one side is a group led by the mighty Blackstone Group. On the other is a camp including BlueCrest Capital Management, run by billionaire Michael Platt.

In the middle is a digital-age equivalent of a buggy-whip maker: a paper company.

Everyone agrees the Norwegian company, Norske Skogindustrier ASA, is in deep trouble. It’s been losing money for 11 years, and its business may only get worse as the Internet hungrily devours traditional newspapers and magazines.

That doesn’t mean the hedge fund crowd will stop trying to make some money off of it. To the contrary: Blackstone’s credit arm, GSO Capital Partners, and Cyrus Capital Partners are engaged in a legal fracas with a group of senior-secured bondholders including BlueCrest, New York-based Marathon Asset Management and Finnish insurer Sampo Oyj, with each accusing the other of trying to drive Norske Skog into the ground.

Court Battle

The long-simmering dispute burst into the open earlier this month in Lower Manhattan courts. Behind this scrape are credit-default swaps, which first came to widespread attention during the 2008 financial crisis.

Bennett Goodman’s GSO and Cyrus, which hold unsecured bonds due in 2016 and 2017, reached an agreement with Norske Skog to exchange those notes for ones with longer maturities. BlueCrest, once one of the world’s largest hedge-fund firms, Marathon and Sampo are suing to head that off.

“This is a clear fight between two sets of bondholders,” says Rahul Gandhi, an analyst at CreditSights Inc.

Time is short. Holders of 326 million euros ($362 million) of unsecured notes due this year and next have until Feb. 26 to accept the exchange or face steep losses as the company’s debts are restructured. The deadline will probably be extended because of the lawsuit, according to Norske Skog spokesman Carsten Dybevig.

Negative Effects

If the exchange doesn’t go through, “the most likely scenario then is a comprehensive balance sheet restructuring under Norwegian legal processes,” Dybevig said in an e-mail on Thursday. The court’s temporary block on the exchange has “severe negative effects,” for the company, he said.

The debt exchange would only postpone the company running out of cash, according to Jeffrey Cope, an analyst at independent brokerage firm Stifel Nicolaus in London.

What makes this fight so unusual is that who wins and who loses may come down to the workings of the $13 trillion market for credit-defaults swaps.

GSO raised its stake in Norske Skog in December in hopes of keeping the company afloat long enough to avoid paying out on credit insurance it sold, people familiar with the matter said at the time. 

Restructuring Plans

Norske Skog, Europe’s third-largest maker of newsprint, needs to restructure about $1 billion of debt after its revenue plummeted along with readership of newspapers and magazines. It agreed to GSO’s plan in December, saying the exchange would reduce borrowings and strengthen the company’s financial position.

The senior-secured bondholder group had sought instead to cut debt, a move that might have triggered payments on credit-default swaps, according to people familiar with the matter.

The gloves came off this month, when a lawyer for Norske Skog, James Warnot, told the U.S. court that the bondholders suing to block the exchange wanted to drive the paper company into bankruptcy to collect payouts on the derivatives. 

Clay Pierce, a lawyer representing Citibank, the trustee acting for the secured bondholder group, countered that GSO and Cyrus Capital Partners were trying profit from the swaps. He wrote in a letter the day before that they were seeking “Norske’s short-term survival but slightly longer-term demise.”

Activist Investing

Both groups have said they want to turn the company around and declined to comment on the dispute. BlueCrest said it’s not concerned about the swaps.

Representatives for Cyrus in the Blackstone camp and Sampo on the BlueCrest side also declined to comment, while officials at Marathon couldn’t immediately be reached.

Credit-default swaps, which first garnered attention during the 2008 financial crisis, are emerging as a powerful tool for a new brand of activist investing. These new activists often stand to make more money on swaps than on the underlying bonds or loans.

Investors have been known to buy stocks, bonds or provide loans in order to gain influence over how the derivatives pay out. With this strategy, timing is everything. The idea is to speed up or delay a default in order to make money before swap contracts expire.

Default Swaps

The premiums GSO stands to collect on the swaps are among the highest in the world. Sellers last year demanded an average of about 3 million euros upfront and 500,000 euros annually to protect 10 million euros of Norske Skog’s debt for two years, according to Standard & Poor’s Capital IQ. The contracts now cost 4.5 million euros in advance, the data show.

Investors who sold insurance on Norske Skog’s debt would have to pay as much as $299 million to settle swaps should the company default, according to data compiled by the Depository Trust & Clearing Corp. That net value accounts for offsetting positions. In all, about $7.4 billion of contracts were outstanding as of Feb. 12, DTCC data show.

“The options for the company are very limited,” CreditSights’ Gandhi says. “You get to a point where you can’t fight the reality that the business cannot support this kind of debt.”

Peter Grauer, chairman of Bloomberg LP, the parent of Bloomberg News, is a non-executive director at Blackstone.

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