Distressed Debt Comments

First of all, thank you to Eric for a gratious donation (see donation link on the right) to Distressed Debt Investing. If you enjoy the content here, why not contribute a little? =]

Now, before I start I want to talk about a few case studies I want to discuss over the coming months. They include:

Primus Telecom's Term Loan
Spanish Broadcasting's Term Loan
The situation going on at Trump
PCS and LEAP's equity which has gotten slaughtered recently
And finally, Thermadyne (bonds and equity)

In addition, I am working on a presentation to possibly DIP carveout at my place of work. Therefore, if you have extensive experience in DIP investing or syndication, please contact me ASAP: hunter [at] distressed-debt-investing.com ....

Now, I am absolutely horrendous at following up with comments. I am significantly better at following up on email. That being said, we here at Distressed Debt Investing want to take the time answer some comments throughout the blog. I am going to start with the most recent ones and work my way back a few weeks. Hopefully this is a help to all.

Anonymous writes: What kind of criteria are you using to identify the equity shorts? Are these shorts part of a broader hedging strategy (i.e. being long radio company secured debt and short the public common?)

Generally speaking, most of my shorting (Personal Account and the investment vehicle to which I call a career) will be specific to the individual company. For example, we wouldn't go long CCL and short RCL to hedge the exposure, we would just go short RCL. Going long bank debt and short the common is something that doesn't really make sense from a hedging perspective. Look at DTG as an example. Bank debt is up 75% and stock is up 2000%. A more likely capital structure trade (irrespective of DTG) would be something like long the bank debt short the bonds. Theoretically speaking neither bonds nor bank debt can move to infinity unlike an equity short.

I read an incredible article in this past Value Investor's Insight where Curtis Macnguyen of Ivory Capital says his fund identifies 40 characteristics of individual investments that he wants to hedge out. He mentions large caps, liquidity, leverage, exposure to China etc. For the better or worse, we do not necessarily do that. We do use common sense though and not just short companies with massive amouts of leverage and go long ones with little leverage.

Zack writes: Quick question: how often have you seen junior class bondholders in low-collateral situations hold out on tendering a restructuring offer in order to gain a sweetened restructuring offer? Is there an innate legal preference for senior debt beyond the rule of absolute priority, which goes out the window when a senior creditor is trying to maximize recovery on a low-collateral high cash flow firm that has a huge junior creditor base that needs to be convinced it should tender at 30 cents on the dollar?

Junior class bond holders will fight to the teeth if they think they have a case. Sometimes these sorts of things are hail mary's but it puts them in a position of better negotiating power. For example, in the Hawaiian Telecom deal, the junior creditors argued that the senior secured debt was not perfected to the extent the lenders though and therefore more collateral was available for the general unsecured class. When you buy bonds for 10 cents on the dollar, there is incredible leverage to get a few points here and there. The term "innate legal preference" means really nothing. Everything is in the documents. It is why I have stressed over and over that a key to investing in distressed debt is reading the documents. Do you know how underappreciated this is to the market? I have read countless sell side reports where the analyst lops in all bonds into one big basket for a recovery analysis; the problem is one of those bonds is guaranteed by all the money producing subs and the other bonds are guaranteed by shell companies. The bonds that is guaranteed by the money markets will prevail.

Ronagt says: While I have tremendous respect for Klarman and concur with you that his letters are a must read for any serious student of the markets, I think the Enron example you cite is not the best example of his wisdom. A 15% position in a single name is a tremendous risk. While the Kelly Rule has its place, I don't think any investor can ever get enough of an edge in a situation like Enron to make an outsized bets. Judges make mistakes and inconsistent decisions too often; not frequently, but too often for oversize bets, which makes big bets on litigation outcomes risky. The returns cited are hardly extraordinary for distressed. If the one position was the entire 15% of non performing and contributed 3.3% to NAV, then it generated just a 22% return; middling by distressed standards and not appropriate for what would have begun as a greater than 10% position. I don't mean to take anything away from Seth Klarman, his letters or his returns, but simply make the point that this particular investment isn't the examplar of why he is (rightly) held in such high regard.

Well, it depends on your investor base. The advantage Baupost and Seth Klarman have is that their capital has been locked up for over 15 years now. He can take these sorts of bets. The Enron situation, after you spent time on it, was actually very easy. The chance that you would lose money buying the bonds at 25 cents on the dollar (before any distributions) was essentially zero. Further, the bet had nothing to do with the market (other than the value of Portland General). But for most funds, volatility is the devil. If you can produce 12-15% annualized returns with half the volatility of the market, fund of funds will love you until the end of the earth. Yet they detest investors that return 20% annualized with market + volatility. They like smooth and steady. But for Klarman, he doesn't have to worry about that because the waiting list to get into the fund is probably 1000 deep.

Anonymous writes: I don't understand your calculation of the 1st lien recovery in the 4.0x EBITDA multiple case: why wouldn't the 1st lien get paid back at par (you have them getting 114) and the second lien get equity?

Well, I didn't do that write up, but let me just state a few facts of life in dealing with creditor negotiations. You have to look at incentives and the holder of certain instruments. CLO and CBO (or any other structured credit cash flow arbitrage vehicles) want back cash flowing paper. Hedge funds, more often that not want the equity. Insurance companies would rather have bonds back (equity is a big capital charge in certain insurance vehicles). Further, there is a bit of dance that goes on. Everyone wants a quick exit with the best valuation for their class. I say best and not biggest because if you want paper back at the first lien level you want a HUGE valuation versus wanting equity back and therefore wanting a tiny valuation. So to appease all parties, you start negotiating. Better yet, your creditor committee financial advisor starts negotiating. Even if a class has a full recovery using 4x EBITDA, it doesn't mean he is getting back cash. He is probably taking paper back. And even that might not be the case because the debtor wants very little debt so not to be a Chapter 22 or have to face the vices of leverage. Management wants as little debt as possible to avoid a re-filing and as much debt as possible to give the enterprise value a bit of a boost if thing go well - why? Because coming out of bankrupty they will have nice equity kickers (see: Lear case study).

That is enough for this lovely, yet terribly muggy Saturday in the city. Enjoy the weekend!


Anonymous,  8/17/2009  

I would love to see you address the PCS/LEAP situation. The business models seem very similar to the emerging market telecoms that were written up earlier on the blog.

Anonymous,  9/09/2009  

Margin of safety for PCS/Leap is very attractive, especially given the rest of equities have really run. Stocks both down based on weaker net adds and heightened fear of competition, but also consider revenues up were ~30% and EBITDA up ~11% yoy. If you take the time to model out all of their markets, you will see a strong fact pattern of being able to penetrate to the high single-digits. Both companies are in the midst of rolling out bigger and better cities so there is plenty of growth left, combine this with owned spectrum and ~$1bil of cash to spend. My sense is long-term Boost is not a credible threat given iDens inability to deliver data. Consumers will not want clunky Motorola iDen handsets limited to voice-only + texting. But the next quarter or two might be painful still. Tracfone could be a credible threat if VZ actually decides to turn the 6-month trial into a longer-term contract. This program makes very little sense to roll out on broadly given the threat of cannibalizing their higher ARPU postpaid subscriber base. Market is viewing prepaid wireless as a zero sum game. If there is room for everyone to grow, these companies will exhibit great growth and strong growing FCF in the coming quarters. Also, the real hidden option is PCS/Leap successful launching LTE next year. If this happens, their value proposition to customers will resonate loud and clear.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.