Shareholder Activism and Distressed Debt

Earlier in the week, I discussed some interesting details and facets about the bankruptcy of Visteon. Well today, Davidson Kempner, Brigade, and Plainfield Asset Management (all places I thoroughly respect and where I know analysts) filed a 13D on Visteon. According to the document, shares were bought between 2/26/2010 and 3/8/2010 meaning some of the lots were purchased in mid 20 cent range.

Along with the 13D, the ad hoc committee of shareholders filed a letter to Visteon's board of directors. It is a great read. Enjoy.

Dear Members of the Board of Directors:

We represent an ad hoc committee of equityholders (the "Ad Hoc Equity Committee"), the members of which collectively hold 7.3% of the outstanding common stock of Visteon Corporation (the "Company"). In light of the significant and ongoing improvement in the Company's financial performance and outlook, we believe it is imperative that the Board consult the Company's owners and their advisors to help develop a revised chapter 11 plan. Given that the Company is in the final phase of its chapter 11 case with a hearing pending shortly to approve its existing disclosure statement, we submit time is of the essence and the Board should consult with our clients immediately.

On December 17, 2009, the Debtors filed their Joint Plan of Reorganization and related Disclosure Statement. In general, the plan provides for recovery for the Debtors' secured debt in the form of new secured debt and more than 95% of the equity in the reorganized Debtors. The plan provides no recovery for general unsecured claimholders and, thus, no recovery for holders of the Company's equity securities.

The projections in the Debtors' Disclosure Statement, issued in support of its proposed plan just two weeks before the end of the 2009 fiscal year, present a portrait of the Company's fiscal health which appears increasingly inaccurate with each passing month of improved financial performance. On February 26, 2010, the Company filed its quarterly earnings and Annual Report which revealed that the Company produced sales, gross margin, EBITDA and net income for 2009 materially higher than that forecast in the Disclosure Statement. The Company's January Monthly Operating Report provides evidence that the financial performance continues to improve. Likewise, cash on hand, which had been projected on December 17th to be $777 million actually totaled $1.095 billion at December 31, 2009. The Company's Chairman and CEO, Donald J. Stebbins, underscored this improved financial outlook in a press release that coincided with the release of the Annual Report:

"As vehicle volumes increase and the macro- economic environment improves, we are well- positioned to win and retain business from customers around the world who recognize the benefits of Visteon's product quality, innovative technologies, and strong global engineering and manufacturing footprint."

Considering that the financial projections in the Disclosure Statement were prepared with the benefit of having actual results for the first three quarters of 2009, the magnitude of the difference between actual 4th quarter results and those implied by the December 17th forecast is all the more striking. Given current trading prices of the Company's debt and equity securities, which have increased sharply since February 26th, it appears that our clients are not the only ones who view your proposed Disclosure Statement's bearish financial projections used to justify a low valuation of the Company with an understandable dose of skepticism. As such, there is no meritorious basis for the Company to exclude its shareholders from significant distributions under a revised chapter 11 plan and the necessary discussions to overhaul the Debtors' proposed restructuring.

There is a practical incentive for creditors to argue for a low valuation of the Company in order to receive securities that will actually provide them a windfall well above payment in full of their claims, all at the expense of existing equity. Accordingly, the Board's fiduciary duty to its shareholders compels it to take immediate action to ensure that your proposed plan and disclosure statement are revised to reflect the new reality of the Company's financial picture and these chapter 11 cases.

We hope to work collaboratively with the Board and management to ensure that this happens. The shareholders are the Company's owners, and we trust the Board and management will act in accordance with the shareholders' best interests.

To that end, we request a meeting with the Board, financial advisors, counsel, and the Company's management no later than March 12, 2010 to discuss appropriate modifications to the Plan. Because time is of the essence, we ask that you please respond to our request for a meeting by 5:00 p.m. (New York Time) on Tuesday, March 9, 2010.

We look forward to your response.

Sincerely,

/s/ Martin J. Bienenstock

Martin J. Bienenstock

MJB/ds

CC:

Marc Kieselstein, Esq.

Sounds similar. In light of the credit markets simply being on fire, more marginal issuers can do high levered deals which means junior creditors and equity holders have a higher likelihood of being in the money. I know of a number of company in bankruptcy right now where they could surely get a deal done and give a larger slice of the buy to sub bond holders or equity. Keep turning over those stones and you will find some interesting distressed debt situations as well.

Read more...

Distressed Debt Equity Example - Visteon (VSTNQ)

In the past, I have pointed readers to the concept of understanding incentives in a distressed debt analysis when it comes to evaluating disclosure statement, plans of reorganization, and financial projections. In my opinion, management teams will side with the creditor class in which they will benefit most financially. I do not mean to admonish management teams for this action - they are acting in their own best self-interest (read: incentives) which, as I have reiterated in the past, is one of the keys to understanding how a certain bankruptcy case will unfold.

Below, you can see a 1 year chart of Visteon's equity (VSTNQ):

And also below, you can see a 1 year chart of Visteon's 8.25% notes due 2010:

I doubt I need to point out to the reader that if you had invested in either of these securities at the beginning of 2010, you would have a proverbial "home run."

So what happened? How can a bond nearly quadruple in a matter of two months, or for that matter an equity increase exponentially in a few trading days.

On December 17th, 2009, Visteon filed its disclosure statement in the Delaware bankruptcy court. Here are is the salient passages from the document:

"Based on the valuation analysis prepared by the Debtors and their advisors (the "Valuation Analysis") and the Term Loan Lenders' secured position in the debtors' capital and corporate structure, the Plan contemplates that the Term Loan Lenders wil receive a 100% recovery on their Claims, which equates to an approximate 96.2% implied equity ownership interest in Reorganized Visteon and that the PBGC wil receive a 12% recovery on its Claims, which equates to an approximate 3.8% implied equity ownership interest in Reorganized Visteon."

96.2% + 3.8% = 100% = Nothing left for anyone else, i.e. the aforementioned bond holder and equity holders. But this all based on this Valuation Analysis. Let's take at what I view as important quotes / line items:

The Valuation Analysis is dated as of December 15, 2009 and is based on data and information as of that date.

Meaning they don't have full year numbers...(emphasis added below)

In preparing the Valuation Analysis, Rothschild has, among other thngs: (1) reviewed certain recent available financial results of the debtors; (2) reviewed certain internal financial and operating data of the debtors, including the business projections prepared and provided by the Debtors' management to Rothschild on December 15, 2009 relating to their businesses and their prospects; (3) discussed with certain senior executives the current operations and prospects of the debtors; (4) reviewed certain operating and financial forecasts prepared by the debtors, including the Financial Projections; (5) discussed with certain senior executives of the debtors key assumptions related to the Financial Projections; (6) prepared discounted cash flow analyses based on the Financial Projections, utilizing varous discount rates; (7) considered the market value of certain publicly-traded companies in businesses reasonably comparable to the operating business of the debtors; (8) considered the value assigned to certain precedent change-in-control transactions for businesses similar to the debtors; (9) conducted such other analyses as Rothschild deemed necessary and/or appropriate under the circumstances; and (10) considered a range of potential risk factors.

Rothschild assumed, without independent verification, the accuracy, completeness, and fairness of all of the financial and other information available to it from public sources or as provided to Rothschild by the Debtors or their representatives. Rothschild also assumed that the Financial Projections have been reasonably prepared on a basis reflecting the debtors' best estimates and good faith judgment as to future operating and financial performance. To the extent the valuation is dependent upon the Reorganized debtors' achievement of the Financial Projections, the Valuation Analysis must be considered speculative...

You will notice the sections I have bolded all have one thing in common: Management was driving the ship...

Then this:

Rothschild estimates the Reorganized debtors' implied reorganized common equity value to be $1.505 bilion based on the midpoint of the DEV range. The common equity value is subject to dilution as a result of the implementation of the Management and Director Equity Incentive Plans.

Management and Director Equity Incentive Plans...Let's take a quick look and see what that means...

Certain of the Debtors' management and directors wil be entitled to participate in the

Management and Director Equity Incentive Program, which shall be set forth in the Plan Supplement. The Management and Director Equity Incentive Program shall have an aggregate share reserve of up to 10% of New Visteon Common Stock issued in accordance with the Plan, on a fully diluted basis. The Management and Director Equity Incentive Program shall be deemed approved and authorized without further action by the New Board.

10% is a big slug of ~$1.5B of equity value. How much equity did management own before the bankruptcy? From their Visteon's recently filed 10K:

Hopefully you see the little asterisk represents less than 1%. So in aggregate management owned less than 1% and now they are getting 10% of the company?

Wait - hold on - Management and the board are getting 10%, but the PBGC is only getting 3.8% of the new company. What kind of stake did the pension have in the game? Again from Visteon's 10K:

Chapter 11 Plan of Reorganization

The Plan, as filed with the Court on December 17, 2009, contemplates that the Debtors may pursue the termination of certain of the Debtors' pension plans. The Plan provides for the Pension Benefit Guaranty Corporation ("PBGC") to receive a 4% equity interest in the Company upon emergence from the Chapter 11 Proceedings in exchange for any termination- related claims it may have against the Debtors and their "controlled group members." As of December 2009, the Company estimated that this claim could total approximately $460 million.

So in exchange for terminating their $460M claim, the PBGC gets 3.8% of the equity ... whereas management / directors are getting 10% of the equity when they collectively owned less than 1% of the company as of Feb 2010...

So back to the original question: Why did the bonds and stock rally so hard?

The company reported results well ahead of the aforementioned plan projections in which the valuation was based on:

• Sales came in at $6.69B vs 2009 plan projections of $6.45B
• Adjusted EBITDA of $454M vs plan projections of $302M

Weren't the projections completed in December? And you were off my $150M in EBITDA? Explanation?

"Our restructuring, ongoing cost-reduction initiatives and ability to keep overhead costs aligned with reduced sales helped drive significant year-over-year improvements in cash flow and earnings, despite significantly lower vehicle production volumes and challenging industry conditions," said Visteon Chairman and CEO Donald J. Stebbins.

Man - I never realized costs can be ratcheted down that dramatically in the last 2 weeks of the year. Color me surprised!

More recently, if you have been following the docket, you would have also know that a lot of action is going on behind the scenes - specifically those related to alternative plan structures which was really the catalyst for the initial bump in the bonds in the first month of the year. Lots of people want to own the equity of this company obviously - And to get the equity of this company, within the exclusivity period, you need two things:

1. Management on board - how to incentive them? With a big check.
2. A valuation assessment where your class consequently becomes the fulcrum security ... i.e. low enough that no one behind you gets equity, but large enough to be plausible.

Could one have predicted prior to the recent earnings announcement that Visteon was going to show a huge EBITDA number? I think so - with the right amount of due diligence combined with a bar being set low (for whatever reasons) can create for some interesting distressed debt investment opportunities.

Read more...

Third Point 4th Quarter Investor Letter

Dan Loeb of Third Point has always been one of my favorite investors. Here is his 4th quarter 2009 letter.

Third Point Q4 Letter

Read more...

Michael Burry: Hedge Fund Star

If you have not already seen the article on hedge fund manager Michael Burry from Vanity Fair, you can find it here: Michael Burry in Vanity Fair. This is from Michael Lewis' new book "The Big Short: Inside the Doomsday Machine" which I am very excited about reading.

In 2005, a friend of mine pointed me to an article about Burry and Scion Capital. Every since then I have followed his moves closely, read a significant chunk of his Silicon Valley Investor archive, and scoured the web for his old MSN Articles (he wrote a column a long long time ago for MSN Money), as well as his old websites (www.sealpoint.com and www.valuestocks.net). In fact, what is interesting about the article above, specifically about Greenblatt seeding him, Michael Burry actually interviewed Joel Greenblatt for one of his MSN pieces in the the late 90s.

Unfortunately, Michael Lewis beat me to the punch, as I had quite a long piece on Burry queued up for the blog - Now with him back in the limelight, will try to write some more select pieces on Mike Burry and Scion. The earlist investor letters from Scion can be found at Scion Capital Investor's Letters

Read more...