New York Times: An End Run Around Realogy's Lenders

By FLOYD NORRIS

It was as badly timed a takeover as there was during the private equity boom.

At the end of 2006, Apollo Management, the private equity firm headed by Leon Black, agreed to buy Realogy, a conglomerate with a number of franchised real estate businesses, among them Century 21 and Coldwell Banker, for $7 billion in cash.

That was a few months after house prices peaked. By the next spring, when the deal closed, subprime mortgage lenders were starting to go broke. The great housing bubble was bursting, and that was very bad news for a company whose revenue was based on how many homes it could sell and how high the prices were.

Now a struggle is emerging over how the unfortunate lenders should be treated. Realogy, under the direction of Apollo, is using a classic divide-and-conquer strategy. Bondholders are screaming that the tactics are illegal.

The strategy is simple: Just tell one group of bondholders that they can move up in the capital structure (and thus be more likely to be paid if the company goes broke). But first, they have to agree to forget about collecting most of the money they are owed. They are being asked to trade in old bonds for new loans with much smaller face values.

Overindebted consumers can only look on with envy, wishing they could pull off something similar, perhaps by telling one credit card company that they will pay another card company first unless the first company agrees to forgive most of what it is owed.

No owner of Realogy bonds has to make the exchange, of course. But if a bondholder turns it down, and others do make the exchange, that bondholder may find that he is much farther back in line, with even less probability of being paid anything.

Part of what makes the tactic irritating is that it is being planned by the people who are supposed to be at the rear of the line in case of bankruptcy — the people who own the equity. In theory, they should not get anything unless all the creditors are first paid in full. In reality, they often can get away with changing the rules.

Realogy wants to make up to $650 million in debt disappear, trading $500 million of new loans for $1.15 billion of old bonds.

The new loans have no guarantee of being paid off, either, but they are not only senior to the old ones, they also mature a few months earlier. There is a possibility that the bondholders who refuse the deal will receive nothing in the end.

All this is possible because companies, in most cases, do not owe fiduciary duties to their bondholders, as they do to their creditors. This transaction is a contractual one, and if a tactic is allowed by the contract, the courts generally will not stop it.

Realogy claims it has the approval of senior creditors to issue more debt, and says that is all that is needed. Of course, those creditors have no reason to care. Their claims will remain senior to everyone else’s. It is sort of like getting Jimmy’s permission to hit Bobby. Bobby may not think Jimmy was the right person to ask.

Realogy has yet to violate the covenants on its bonds, but its business is suffering and it is reasonable to think that covenant violations are possible. Revenue so far this year is down 21 percent, and the company has not been able to cut costs that fast. Losses are rising.

One part of Realogy’s business is faring well. Revenue is soaring at a subsidiary that sells foreclosed homes. It reports that in the third quarter business was up 91 percent compared with a year earlier in the Sacramento area. But that is not enough to offset the growing problems in other operations.

The bonds are trading as if disaster is all but certain, all at prices under 20 cents on the dollar. Some of them are going for prices that assure a profit if the bond simply pays interest for the next 18 months before becoming totally worthless.

Realogy disclosed this week that a lawyer claiming to represent owners of a majority of one class of bonds had threatened to sue, arguing the offering violated bond indentures. The company did not identify the lawyer, but one person involved in the case said Carl C. Icahn, the financier, owned the bonds. Mr. Icahn declined to comment.

Realogy became an independent company in July 2006, just a few months before Apollo swooped in to buy it. It began trading when Cendant, a franchising conglomerate that had fought back from what was, before Enron, the largest accounting fraud in American history, split into four pieces.

Realogy was the only one of the four that worked out for shareholders, selling to Apollo for 19 percent more than the shares were worth just after the split-up. The other three — PHH, a mortgage services company; Wyndham Worldwide, which franchises hotel brands like Days Inn and Ramada; and Avis Budget, the car rental company — have all plunged in the recession. PHH, with a 72 percent decline, is the best performer of the three. Avis Budget, down 97 percent, is the worst.

As it turned out, Cendant split up not long before bad times arrived at virtually all of its businesses. Apollo, which did not see what was coming, now wants those who lent it money to share the pain.

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