The Deal: PIK Interest Mounts at Pulse Electronics

NEW YORK (The Deal) -- In the wake of Pulse Electronics' (PULS) CFO disclosing that pay-in-kind interest is piling up at the computer and telecom components company as its revenues stagnate, one hedge fund investor who used to own the stock is glad he bailed, especially since Oaktree Capital Partners LP's holding and influence has grown.

"It's a disaster," the former shareholder, who sold his shares within the past 12 months, said by phone Wednesday. "It's one of the worst positions I've had as a hedge fund. Management did a horrible job, and Oaktree took over."

Pulse CFO Drew Moyer explained in an Aug. 6 earnings call that the principal of the company's term loans from Oaktree has increased to $110.9 million due to the addition of PIK interest, up from $103.5 million when the loans were issued in November.

Meanwhile, Pulse's revenues are languishing, coming in at $88.3 million, down from $100.4 million for the same period a year ago.

The company also has other debt concerns, as Moyer noted that it's in discussions with Oaktree regarding $22.3 million in principal of 7% convertible notes due Dec. 15, 2014.

"We are still in discussions with Oaktree regarding the possible terms of a convertible bond exchange offer as part of our investment agreement with Oaktree," he said. "Though we have not yet reached an agreement to move forward with an offer, we believe we have a number of other options regarding the retirements of the convertible bonds either before or after maturity."

Pulse's stock price has slid steadily since the beginning of 2011, when The Deal Pipeline estimated it had a market capitalization of $220 million or so before getting a takeover offer from Bel Fuse ( BELFB). That market cap is now $35.84 million even after the company enacted a 10-for-1 reverse stock split in May in order to regain compliance with the New York Stock Exchange's listing requirements. The shares closed at $4.51 on Wednesday.

Now that $249 million takeover offer that fellow electronics manufacturer Bel Fuse made in February 2011 looks great in the rearview mirror.

At the time, however, San Diego-based Pulse convinced shareholders that it would get a better deal through a recapitalization, the former shareholder explained.

" Pulse CEO Ralph Faison pitched the offer as wildly undervalued," the hedgie said.

More than a year and a half after Bel Fuse's offer, looming debt maturities forced Pulse to take action, and Oaktree Capital recapitalized the firm with a $102.7 million debt and equity offer that gave the Los Angeles investment firm a 49% stake.

Oaktree gave Pulse a $75 million senior secured term A loan with a 12% annual interest rate, and exchanged $28.5 million of principal and unpaid interest on its 7% senior convertible notes for a new $28.5 million secured term B loan. Pulse started out with $50 million of 7% notes. The term loans mature on Nov. 20, 2017.

"Nothing has played out the way management promised for years," the former investor said. "When we bought in, Pulse had relatively low debt compared to earnings."

Moyer didn't respond to requests for a comment on Pulse's debt service strategy and its potential exchange offer.

The company reported $23.2 million in cash and cash equivalents at June 28, and $88.3 million of net sales for the second quarter. According to data from Bloomberg Financial, Pulse has Ebitda of $7.4 million and a debt-to-assets ratio of 51.3%.

The earnings call touted a cost-cutting program that is designed to cut $6 million annually.

Colin Dunn, the vice president of finance at Jersey City, N.J.-based Bel Fuse, was wistful about a missed opportunity for greater synergies between the two electronic components makers in an Aug. 7 phone interview.

"We would have created more value, there's no doubt about that," he said. "There's overcapacity in this industry, and no one was really making money at the time of the takeover offer."

Pulse's rejection of the offer "just seemed illogical to us," Dunn said, explaining that a combination would have cut overhead costs by eliminating duplication in areas such as corporate staff and sales staff. "There were a lot of low-hanging overheads that could have been squeezed out. It becomes a volume proposition -- you've got to manage fixed overheads."

Although Bel Fuse is currently looking for acquisitions -- the commercial aerospace sector, particularly fibers, is of interest -- Pulse is not on its wishlist any more.

"I wouldn't say we'd never look, but I think it'd be very difficult in today's market," Dunn said. "There is not dramatic growth potential there. They're in three difficult market segments."

Indeed, off Pulse's three business divisions -- network products, power products, and wireless products -- Dunn said the wireless business is the weakest link.

When it comes to the future shape of the industry, Dunn expects some Darwinian action.

"I'm not too sure if we'll see consolidation or if we'll just see people drop out of the market," he said. "The returns are very low. I don't see anyone else coming into the business in any significant way."

Pulse has a tough row to hoe after missing out on the consolidation wave in its industry, but Dunn thought Oaktree may find a way to reap some value. "Oaktree is a very smart outfit and I admire the work they've done in the past," he said.

Oaktree declined to comment.

Current Pulse investors Royce & Associates, Schneider Capital Management, LSV Asset Management, and ICM Asset Management didn't respond to requests for comment.

-- Written by Lisa Allen in New York

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