More Hedge Fund Sour Grapes

Further to the hedge funds vs Porsche spat I highlighted recently, CityAM has reported another merry tale where a company appears to have outsmarted the hedge funds, who have promptly threatened to take the company to Court:

BIG Brother producer Endemol is involved in a fracas with a powerful group of hedge fund owners. The hedge funds, which own Endemol's £1.9bn debt, have accused the television giant of financial engineering to avoid breaching its loan agreement.

The spat broke out over a complex scheme in which Endemol was buying back its own debt at a discount from the original price and booking a profit on the purchases, thereby inflating its bottom line. The hedge fund owners, including Goldentree Asset Management, Centrebridge Partners and Stanley Advisors, say the scheme has artificially inflated Endemol's earnings by as much as €81m (£70m) – a third of its profits...

In case you're wondering what this means, it is yet another cunning variation on the debt-for-equity swap. Endemol borrowed money by issuing bonds at 100p in the £. If they are trading at less than par, let's say 80p in the £ (because Endemol is seen as not such a good bet or because interest rates have risen etc), and Endemol has a bit of spare cash, it can improve its net assets position (i.e. shareholders' funds) by taking £80 out of its bank account and redeeming bonds with an accounting value of £100. This reduces the assets side of the balance sheet by £80 but it reduces the liabilities side by £100, hey presto, under accounting standards, this is a £20 "profit".

Although the profit is not normal trading income as such, it is definitely a gain from the shareholders' point of view; is in no way "artificial"; and that is the end of that - if the lenders' covenant stipulates certain minimum ratios and the new look balance sheet complies with these, then frankly, what is the hedge funds' (i.e. lenders') problem?