50 Shades of Gray For Penthouse Bond Holders

September 5th, 2012 by

(September 2012) Penthouse Bonds are now rated CCC by Standard & Poor’s as of August 22nd, 2012. Their current credit rating means Penthouse bonds are “vulnerable” to nonpayment.  In other words, while interest on the bonds is still being paid, S&P thinks there is good chance they will stop paying.

Penthouse is a textbook  example of how a profitable company can get  into trouble by taking on too much debt, and poorly structuring bond maturities.
 
 

Make no mistake “porn” is a profitable business.

The parent company of Penthouse, FriendFinder Network (FFN) which owns one of the most popular adult websites “Adult Friend Finder” makes lots of money. The company will make $70M in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).  However, the company owes over $500 Million in debt which will be coming due in the next 3 years. The stock has lost over 95% of its value and its debt is trading at less than 20 cents on the dollar. What went wrong?
 

Earn 10% Interest or more investing in consumer loans

 

FriendFinder Network is really a combination between two companies

  1. A money losing print magazine with a well recognized brand, Penthouse
  2. A highly profitable online dating site, Adult Friend Finder.  (There are persistent rumors that one the main sources of revenue for Adult Friend Finder are “escorts” which use the site as prospecting tool.)

When Penthouse acquired Adult Friend Finder, it paid the owner of the company with $401 Million in debt. The majority  of the company’s debt results from that transaction. I think that Penthouse management believed that a large portion of that debt would be able to be retired when the company went public.  However, the company was only able to raise $50 Million during its IPO in May of 2011.  (Want to learn how to do your own credit analysis?)
 

The company is now in very tough situation

In September of next year it has $213 million dollars of debt coming due. One year later, another $281 million comes due. The company has less than $15 million in cash and no back-up credit facilities. In other words, it must refinance its debt or declare bankruptcy. Had the company scheduled for its debt to be re-paid in chunks over a period of 7 to 10 years, it would not be in this precarious situation of needing to find new investors willing to bet on its ability to survive. (Learn what happens when a company goes bankrupt.)
 

There are major questions if the business can generate enough cash to pay off its debt.

The company’s debt / EBITDA ratio of 7 would be troubling for a company that was growing. FriendFinder Network is not growing, in fact profits are declining. The online dating space is very competitive and there is a tremendous churn rate. (Paying clients that turn off their subscriptions after a few months.) To quote, David Haines of Standard & Poors:

During the 12 months ended June 30, 2012, the number of subscribers at the company’s adult social networking sites fell 7.4%. We believe that competition from free sites and other pay sites with fresh content will continue to pressure subscription levels . . .Our base-case scenario of a low- to mid-single-digit percentage decline in revenues for full-year 2012 reflects our expectation of continued subscription weakness at the company’s adult Web sites.
 

Bottom Line

There are three problems with Friendfinder/Penthouse:

  1. Too much debt coming due in the near term, making finding alternative financing  and/or paying down debt too difficult.
  2. Too much debt compared to the the company’s ability to generate cash currently.
  3. A declining core business which limits its ability to grow out of its problems (or convince other it can)

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