Deluxe Entertainment Services Group Inc. – Agrees Prepackaged Chapter 11 with Term Loan Lenders, Looks to Shed $800mn in Debt-for-Equity Restructuring and Emerge Within the Month

October 3, 2019 − Citing difficulties in transitioning its businesses to meet rapid technological changes, privately-held Deluxe Entertainment Services Group Inc. and 26 affiliated Debtors (“Deluxe” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Southern District of New York, lead case number 19-23774. The Debtors, a global video creation to distribution company wholly-owned by Ronald Perelman's MacAndrews & Forbes Media Group Inc. (“MAFCO”), are represented by Jonathan S. Henes of Kirkland & Ellis, LLP. Further board-authorized engagements include (i) AlixPartners, LLP (“Alix”) as financial advisors, (ii) PJT Partners  LP (“PJT”), as investment  banker and (iii) Prime Clerk as claims agent. Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) Skadden, Arps, Slate, Meagher, & Flom ($9.2mn professional services claim, (ii) Canada Cinema Distribution Inc. ($2.3 trade debt) (iii) Paul, Weiss, Rifkind, Wharton & Garrison ($1.5mn professional services claim). Partners at Skadden, which has seen more than one alum ensconced as the Debtors' General Counsel, will be chagrined with that headlining (and head turning) spot on the Debtors' list of unsecured creditors. 

In a press release announcing the filing, the Debtors stated, “Deluxe Entertainment Services Group…today announced that it is taking the final steps in its previously announced comprehensive financial restructuring process that, once completed, will reduce the Company's long-term debt by well more than half and raise $115 million of new financing. As the Company finalizes the process in the coming weeks, Deluxe's day-to-day operations will continue without interruption and with no impact on employees, customers and vendors.

Deluxe previously entered into a restructuring support agreement that contemplated the exchange of all of the Company's existing term loan debt and priming term loan debt for, in the aggregate, 100 percent of the reorganized company's common stock. All parties involved determined that the best way to implement the debt-for-equity exchange is through a controlled, efficient Court-supervised process, and today the Company took steps to start that process.

Deluxe commenced the formal process of soliciting votes from lenders in support of the comprehensive financial restructuring and filed pre-packaged cases under Chapter 11, outlining a proposed plan of reorganization (the ‘Plan’) that details the terms of the financial restructuring, including the debt-for-equity exchange. Deluxe has requested that the Court schedule a confirmation hearing to approve the Plan on October 24, 2019 and expects to implement the transaction shortly thereafter. Once completed, the Company expects to emerge from the refinancing process with significantly less debt and additional new financing to support its operations and investments.   

Overview of the Plan

The Plan is currently supported by over 53% in number and over 70% in amount of Existing Term Loan Claims and over 91% in both number and amount of Priming Term Loan Claims. Given the overwhelming support for the Debtors’ restructuring, the Debtors are pursuing the transactions contemplated under the Restructuring Support Agreement and Plan via prepackaged chapter 11 cases to maximize the value of their estates by minimizing both the costs of restructuring and the impact on the Debtors’ businesses. 

The Plan contemplates that all trade and general unsecured creditors…will have all of their claims Reinstated as of the effective date. In addition, if confirmed and consummated, the Plan will: 

1. significantly deleverage the Debtors’ balance sheet; 
2. provide the Debtors with working capital to fund ongoing operations post-emergence; 
3. bifurcate the “Creative Services” and “Distribution” businesses; 
4. distribute, among other things, the Restructured DESG Equity Interests to Holders of Priming Term Loan Claims and Existing Term Loan Claims; and 
5. maintain critical business relationships with customers and vendors.

The transactions contemplated by the Restructuring Support Agreement will be implemented through the Plan and will reduce the Debtors’ indebtedness from an estimated $1.1 billion to an estimated $300 million at the closing and minimize the time and expense associated with the Chapter 11 Cases. The Debtors have also secured a $115 million commitment under the DIP Term Facility to fund the chapter 11 cases and the restructuring transactions contemplated by the Restructuring Support Agreement. In addition to providing near-term liquidity and funding day-to-day operations, the DIP Term Facility will provide the liquidity necessary to implement the Debtors’ business plan, including funding working capital, operational initiatives, and capital expenditures. With access to the DIP Term Facility, the Debtors will commence these chapter 11 cases with a strong message to the market that the Debtors are both well-capitalized and have the liquidity necessary to maintain their operations. Additionally, under the Restructuring Support Agreement, the Debtors have secured the New Term Loan Facilities, aggregating $194 million, to fund the Restructured Debtors’ working capital and operational needs upon emergence from the Chapter 11 Cases."

Restructuring Support Agreement (“RSA,” attached as Exhibit B to the Disclosure Statement)

In July 2019, the Debtors began negotiations regarding potential restructuring transactions with the Ad Hoc Group and MAFCO. On August 30, 2019, the Debtors, MAFCO, and, certain holders of approximately 77% of Priming Term Loans and 60% of Existing Term Loans entered into the RSA to effectuate a comprehensive restructuring of the Debtors. The RSA contemplates, among other things, that Debtors would commence the plan solicitation as set forth in the Disclosure Statement. On October 2, 2019, the parties to the RSA amended the RSA to memorialize the results of their ongoing conversations regarding the terms of a comprehensive restructuring. The Plan is currently supported by over 53% in number and over 70% in amount of Existing Term Loan Claims and over 91% in both number and amount of Priming Term Loan Claims. Please see also the "Restructuring Term Sheet" attached as Exhibit A to Amendment No. 1 to the RSA (page 225 of the Disclosure Statement pdf)

DIP Financing

The Restructuring Term Sheet (and attached DIP Term Loan Facility Term Sheet) provides a brief summary of anticipated debtor-in-possession ("DIP") financing: "In order to implement the Restructuring, the Company shall obtain a $115 million senior secured debtor-in-possession, multiple-draw term loan facility (the 'DIP Term Facility'), pursuant to the terms set forth on Exhibit 1-A annexed hereto, to be provided either by (1) certain Priming Term Loan Lenders that execute the Restructuring Support Agreement (and any Existing Term Loan Lenders that (i) elect to participate in the DIP Term Facility and purchase a pro rata portion of the Priming Term Loans at par pursuant to syndication procedures to be determined by the Requisite Consenting Creditors (the 'DIP Syndication Procedures'), and (ii) execute the Restructuring Support Agreement), and/or (2) third parties acceptable to the Company and the Requisite Consenting Creditors, and in the case of either (1) or (2), which shall repay all amounts outstanding under the Senior Priming Term Loan Facility and provide the Company with incremental liquidity (subject to an approved budget), upon such terms and conditions (and subject to definitive documentation and the entry of interim and final orders of the Bankruptcy Court) and in form and substance acceptable to the lenders under the DIP Term Facility, the Company and the Requisite Consenting Creditors."

The DIP Term Loan Facility Term notes that $55.0mn of the DIP facility is to be made available on an interim basis. Interest is: (x) in the case of LIBOR loans, LIBOR plus 7.50% and (y) in the case of ABR loans, an adjusted base rate (to be subject to a 2.50% floor) plus 6.50%.

Prepetition Capital Structure

As of October 2, 2019, the Debtors are obligors (either as borrower or guarantor) on a  principal amount of pre-petition funded indebtedness totaling approximately $1,105.0mn, as summarized below:

Events Leading to the Chapter 11 Filings

The Debtors' Disclosure Statement details the challenges of transitioning a huge, complicated, technology-dependent company in a period of continuing technological change, to meet "a change in consumer demand for access to content in greater volumes, in every format, and everywhere around the globe," especially when smaller groups can challenge the Debtors in discrete areas of their multi-pronged business. In addition to meeting challenges (and competitors) on many technological fronts (especially as to the integration of automation and cloud-based technology into their service lines) ; the Debtors also have to deal with "significant infrastructure-related fixed costs associated with legacy workflows and challenges related to integrating shared services and new acquisitions into its existing business."

The Disclosure Statement provides: "The Company operates in the complex and rapidly shifting media and entertainment market. Despite Deluxe’s market-leading position of both its Creative services and Distribution business, a change in consumer demand for access to content in greater volumes, in every format, and everywhere around the globe has required Deluxe to rethink its processes and workflows. To address these industry changes, Deluxe has been investing heavily in new tools, a cloud-based infrastructure, and enhanced automation, including through Deluxe’s cloud-based platform, Deluxe One. The Company has marketed Deluxe One as utilizing a 'software as a service' subscription model where customers would pay a minimum, recurring fixed fee for using the platform. While Deluxe believes these changes and investments are necessary to adapt to an industry moving away from brick and mortar service providers to those with a virtualized presence and automated services, the sales cycle for this type of new product and model has proven to be longer than initially anticipated, as many customers engage Deluxe for specific services on project-by-project basis.

In addition to the significant up-front costs that Deluxe has incurred to integrate automation and cloud-based technology into its workflows, Deluxe also has significant infrastructure-related fixed costs associated with legacy workflows and challenges related to integrating shared services and new acquisitions into its existing business. Efforts over the last few years to right-size the employee base, integrate service units, and standardize workflows are in process but have not progressed fast enough to off-set certain fixed costs that remain high.

Industry-wide technological innovation has also allowed competitive companies to develop in specific service lines similar to certain discrete services provided by Deluxe. Because these companies typically have a lower fixed-cost structure, they have been able to offer lower costs to clients, though they generally do not offer the breadth of services that Deluxe brings to the market. Advances in technology have also made it possible for many clients to “in source” technology and services they once procured from Deluxe.

Deluxe believes that a continued commitment to offering greater scale, end-to-end breadth of services, experiences, and relationships, as well as their investments in new technology, has positioned the Company well for stability and success going forward. However, the Company’s existing fixed costs, including interest payments due under its substantial debt obligations, are unsustainable in the current market environment. Consequently, the Company has negotiated a prepackaged plan with the Existing Term Loan Lenders and the Priming Term Loan Lenders to deleverage its balance sheet and provide operational liquidity to effectuate the Company’s business plan."

The following is a summary of classes, claims, voting rights and expected recoveries (defined terms are as defined in the Plan and/or Disclosure Statement):

• Class 1 (“Other Secured Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan.
• Class 2 (“Other Priority Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan.
• Class 3 (“Existing ABL Facility Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan.
• Class 4 (“MAFCO Secured Debt Claims”) is impaired, deemed to reject and not entitled to vote on the Plan.
• Class 5 (“Senior Priming Term Loan Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan.
• Class 6 (“Priming Term Loan Claims”) is impaired and entitled to vote on the Plan. The estimated aggregate amount of claims is $73.0mn and the estimated recovery is 35%. Each Holder will receive its pro rata share of (a) either (i) the New Second Lien Term Loans, or, to the extent available, (ii) Cash proceeds from the New Second Lien Term Loans that may be issued by third parties; and (b) 35% of the Restructured DESG Equity Interests, in each case, subject to dilution by the Management Incentive Plan.
• Class 7 (“Existing Term Loan Claims”) is impaired and entitled to vote on the Plan. The estimated aggregate amount of claims is $783.5mn and the estimated recovery is 65%. Each Holder will receive its pro rata share of  65% of the Restructured DESG Equity Interests, subject to dilution by the Management Incentive Plan.
• Class 8 (“Canadian Loan Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $49.2mn and the estimated recovery is 100%.
• Class 9 (“MAFCO Unsecured Claims”) is impaired, deemed to reject and not entitled to vote on the Plan.
• Class 10 (“General Unsecured Claims”) is unimpaired, presumed to accept and not entitled to vote on the Plan. General Unsecured Claims shall be Reinstated.
• Class 11 (“Section 510(b) Claims”) is impaired, deemed to reject and not entitled to vote on the Plan. Holders of Section 510(b) Claims will not receive any distribution on account of such Section 510(b) Claims.
• Class 12 (“Intercompany Claims”) is Unimpaired/Impaired, presumed to accept/deemed to reject and not entitled to vote on the Plan.
• Class 13 (“Intercompany Interests”) is unimpaired/impaired, presumed to accept/deemed to reject and not entitled to vote on the Plan.
• Class 14 (“Existing Equity Interests in DX Holding”) is unimpaired, presumed to accept and not entitled to vote on the Plan.
• Class 15 (“Existing Equity Interests in DESG”) is impaired, deemed to reject and not entitled to vote on the Plan.

Further Engagements

The senior lenders have engaged FTI Consulting, Inc. as financial advisor and Stroock & Stroock & Lavan LLP counsel.

The Disclosure Statement attached the following Exhibits

• Exhibit A: Joint Prepackaged Plan of Reorganization
• Exhibit B: Restructuring Support Agreement (and exhibits thereto)
• Exhibit C: Liquidation Analysis
• Exhibit D: Valuation Analysis
• Exhibit E: Financial Projections
• Exhibit F: Corporate Organizational Chart

About the Debtors

According to the Debtors, "Deluxe Entertainment Services Group (Deluxe) is the world's leading video creation to distribution company offering global, end-to-end services and technology. Through unmatched scale, technology and capabilities, Deluxe enables the worldwide market for premium content. The world's leading content creators, broadcasters, OTTs and distributors rely on Deluxe's experience and expertise. With headquarters in Los Angeles and New York and operations in 38 key media markets worldwide, the company relies on the talents of more than 7,500 of the industry's premier artists, experts, engineers and innovators."

The Disclosure Statement provides: "DESG, together with its Debtor and non-Debtor affiliates, is among the world’s leading content creation-to-distribution companies, utilizing their scale, technology, and expertise to enable the worldwide market for professionally created content. The Debtors have been trusted partners to Hollywood studios, independent filmmakers, television networks, online content producers, brands, and anyone looking to bring stories and experiences to audiences for more than 100 years. Providing one of the industry’s most comprehensive suite of end-to-end digital media services, the Debtors believe they are uniquely positioned to transform, manage, localize and deliver content to any type of device at any time.

In 2006, the Debtors were acquired by MacAndrews & Forbes Media Group Inc. (“MAFCO”), which remains the sole equity owner today. 

The Debtors broadly operate their business in two primary segments: Distribution and Creative. The Distribution business focuses on the transformation, management and delivery of content to any screen around the globe, and consists primarily of the following business lines: Localization (e.g., subtitling and dubbing content for assorted languages), delivery operations (e.g., physical and digital fulfillment services and playout services), and digital cinema services (e.g., mastering and distribution of content for cinemas), which business lines are supported by the Debtors’ cloud-based platform, Deluxe One. Launched in late 2018, Deluxe One is a cloud-based platform that simplifies how clients’ content is created, stored and delivered to audiences. Through the platform, content creators and distributors can integrate their systems and vendors using Deluxe One’s open-API architecture, providing a central hub to manage virtually every step of the workflow from creation to delivery.

The Debtors’ Creative business enables content and commercial creators around the world to bring their visions to life. The Creative business is made up of industry leading visual effects and post-production brands, including Method, Stereo D, Encore, EFILM, and Company 3. The Debtors’ Creative business provides state-of-the-art visual effects and post-production services, including editorial, color, and finishing services and offers clients creative talent, technical expertise, and global connectivity for features, episodic content, advertising and immersive content. The Creative business employs leading artists, color scientists and technologists who are recognized for their ability to realize the creative visions of the entertainment and advertising industries’ greatest creators."

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