High Yield Market is Hot

AMG data came out earlier today: High Yield mutual funds saw nearly $1B in inflows. This marks three weeks of very large inflows to the high yield market: $3.0B over the last three weeks. Here is a chart of the iBoxx $ High Yield Corporate Bond Fund (an ETF)

What I find interesting about this mini rally: It feels to me like the higher quality credits are outperforming the lower quality credits. And it looks (from the chart below) that the distressed ratio (number of issuers with bonds 1000 over treasuries) hasn't really budged over the past three weeks.

And empirically: Over the last two or three weeks, everyone is looking for "safe 8-9% paper" - feels like people are protecting their years. We have participated in this rally and sold a number of HY positions thinking things have gotten ahead of themselves. Time will tell.



Advanced Distressed Debt Lesson - Tribune (TRB)

Three days ago, the distressed bank debt of Tribune traded as such:

  • TLB (Initial): 61.5-62.5
  • Incremental: 59.75 - 60.75
  • TLB (Initial): 63.75-64.5
  • Incremental: 52.25-54.25

Going out today, here was the same market:
  • TLB (Initial): 64.25-64.75
  • Incremental: 56.25-57.25
Talk about volatile. Net/Net the TLB has gone up a couple and the incremental down a couple. I.E. the spread between the two securities has increased (quite dramatically I might add). In addition, the bonds were up a couple of points. What happened?

Well, unless you were living under a rock, you would know that Tribune examiner report was released. I have embedded it below (Warning: This document is highly technical, but an incredible read for the distressed debt professional)

Here is what Steven Church from Bloomberg news reported:

The biggest piece of Tribune Co.’s 2007 buyout is likely to survive a court challenge, even though managers used an improper solvency test to justify part of the $8.3 billion deal, an independent examiner said.

Creditors who blame the buyout for the newspaper publisher’s bankruptcy are “somewhat likely” to win a lawsuit based on the smaller piece of the two-part deal, attorney Kenneth N. Klee found in a report issued yesterday.

Unidentified Tribune managers required consulting company Valuation Research Corp. to use an ‘improper” method to calculate the Chicago-based company’s value, Klee said. When VRC issued its flawed solvency opinion favoring the buyout, Tribune managers claimed the opinion was supported by financial adviser Morgan Stanley.

The process of hiring VRC “was marred by dishonesty and lack of candor about the role played by Morgan Stanley in connection with VRC’s solvency opinion and on the question of Tribune’s solvency generally,” Klee wrote.

In a letter today, Tribune Chief Executive Officer Randy Michaels and Chief Operating Officer Gerald Spector urged the company’s employees, who include reporters, editors and television producers, “not to be distracted by the media attention.”

‘Disagree With Others’

“We agree with some of his assessments and disagree with others,” Michaels and Spector wrote of Klee’s report.

The judge overseeing Tribune’s bankruptcy case appointed Klee in April to evaluate allegations that the buyout violated bankruptcy law. A summary of Klee’s report provides support for both backers and critics of Tribune’s exit plan.

Tribune filed for bankruptcy in December 2008, a year after the buyout led by real-estate billionaire Sam Zell. Some lower- ranking creditors alleged the buyout was a fraudulent transfer because it added more than $8 billion in debt to the company while benefiting only Zell and shareholders.

Tribune’s buyout took place in two parts. The $8 billion in primary financing closed in June 2007 and is “reasonably likely” to withstand a court challenge, Klee wrote, a finding in favor of Tribune and lenders including JPMorgan Chase & Co.

By the time the second part closed in December, Tribune’s financial situation had changed, making VRC’s solvency opinion more important, Klee wrote. Tribune managers should have known that the second phase of the buyout would leave the publisher insolvent, he said.

Approval Opposed

“Fiduciaries charged with the responsibility for overseeing management’s actions and determining whether the Step Two Transactions would render Tribune insolvent did not adequately discharge their duties,” Klee wrote.

The lower-ranking creditors, who would be paid nothing under Tribune’s reorganization plan, have said they plan to oppose approval when it comes before U.S. Bankruptcy Judge Kevin J. Carey in Wilmington, Delaware, on Aug. 30.

Those creditors, who are owed $1.2 billion, have sued JPMorgan and the other lenders. They want the loans that funded the buyout to lose their payment priority.

In step two of the transaction, Tribune borrowed $3.6 billion and paid fees to its lenders, according to court documents.

Klee concluded that New York-based JPMorgan was likely to be exonerated from any allegations of bad faith for the first part of the buyout. The bank wasn’t likely to be cleared regarding the second part, he said.

Creditors Divided

Creditors in similar bankruptcy cases filed since 2007 will look at the report carefully, said Harold Kaplan, an attorney in Chicago with Foley & Lardner. The findings may influence creditors of companies that went through leveraged buyouts when values peaked and were forced into bankruptcy by the recession, he said.

“Everyone is now asking, ‘Did the buyout overpay and saddle the entity with more debt than was justified?’” Kaplan, who isn’t involved in the Tribune case, said in an interview before the report was filed.

The buyout has divided creditors. The lenders behind the deal are split over whether to fight the allegations of lower- ranking creditors or settle with some of them, according to court documents.

Creditors have said that Klee’s conclusions may affect how they vote on Tribune’s reorganization plan. Carey must take that vote into consideration before he decides whether to approve the plan and allow the company to leave bankruptcy.

Right to Sue

Tribune’s plan asks creditors to give up their right to sue insiders, including Zell, and the lenders who financed the buyout over claims they left the company insolvent.

Tribune owns the Los Angeles Times, the Chicago Tribune and broadcasting stations in Los Angeles and other U.S. markets, as well as stakes in cable channels.

Tribune complained in court papers earlier yesterday about Klee’s decision to withhold certain details of the report from the company and other parties in the case until after an Aug. 9 court hearing.

The case is In re Tribune Co., 08-13141, U.S. Bankruptcy Court, District of Delaware (Wilmington).

I had always wondered why the market had put such a small spread between the incremental and TLB. Why risk the incremental's downside for 1/2-1 point. Many market participants did not expect this coming and it shows that even in bankruptcy's nearly 18 months old, new information can really swing the needle one way or the other.



Distressed Debt Conference

Last month we announced to readers that we were helping organize The Global Forum on Investing in Distressed Debt. In the coming weeks, we will be bringing you in depth interviews with a number of conference presenters talking about the major issues going on in the distressed debt market today. Before we get to that though, I wanted to take a little time out to discuss what I think the primary benefits are of attending a conference like this.

Distressed debt is, in my opinion, one of the most lucrative opportunities to intelligent investors because it requires a substantial amount of knowledge, both on the valuation as well as technical/legal side. 98% of investors out there will look at a distressed situation and say: "Too complicated - Pass" or "I don't understand this case - sell the paper." That is where the opportunities arise.

Today's distressed market is characterized by ever increasing complicated bankruptcy proceedings - In addition, the onset of a more and more pre-packs means the distressed investing professional needs two things: technical knowledge and as many contacts as possible.

The Global Forum on Distressed Debt Investing promises to provide attendees with both benefits. The current list of presenters is absolutely incredible - ranging from very experience bankruptcy attorneys to buy side professionals who can intelligently talk and extract certain nuances from today's distressed debt market. This is an invaluable resource to market participants. For example, soon we will have an interview on the site with one of the nation's leading experts on fraudulent conveyance - And given the vast amount of cases that are going that route (in one fashion or another), you have to be equipped with that knowledge to intelligently invest in this market.

Professional contacts are key in this market. Any distressed conference provides a fantastic avenue for meeting up with different players in this market, whether it be restructuring professionals, lawyers, the sell side, or buy side investors. In my opinion, this conference in particular, given its extensive schedule, will bolster these networking opportunities. In a market where forbearance agreements and pre-packs are the norm, the investor with the most contacts will surely have a better chance at being at the negotiating table, where IMO, the real money is made.

We hope you attend the Global Forum on Investing in Distressed Debt coming up in September. If you have any question, feel free to shoot me an email.



Most Post Re-Org Data

Coincidently, this week's Barron's has a great article on post re-org equities. You can find the article here: Post-Bankrupts: What Does the Next Chapter Hold?

One of my favorite pieces of the article:

In the coming months, Distressed Debt Investing will be covering each of these post re-org companies in depth. Stay tuned.



Investing in Post-Reorg Equities

We would like to welcome a new writer to Distressed Debt Investing - Julia Bykhovskaia, CFA will be joining us as we start discussing more post reorg equities on the site. Enjoy!


Post-reorg equities can often present compelling risk-reward opportunities for a value investor. However, even though stocks of the companies that recently emerged from Chapter 11 provide fertile ground for bargain hunting, blindly investing in post-reorg equities (as in any other securities) certainly does not guarantee investment success.

There were a few studies performed that focused on the price performance of the post-reorganization stocks. For example, in their 2004 study “A Chapter after Chapter 11”, Lee and Cunney of JP Morgan looked at 117 companies that came out of Chapter 11 between 1988 and 2003. They found that relative performance (to the S&P 500) of these companies’ stocks averaged 85% in the first year after emergence. However, the same study showed that volatility of these stocks had been very high, with only 50% of the equities outperforming during the period.

Thus, while it is clear that opportunity for outsized returns exists, as with any kind of investing, investors are well-advised to conduct a thorough due-diligence and to be selective in their stock picking. Not all post-reorg equities are created equal; some companies emerge from Chapter 11 without accomplishing any substantial operational turnaround or debt restructuring – only to file for Chapter 22 not too long after original emergence (Bally Total Fitness, Foamex, Movie Gallery, Trump Entertainment are just some such examples).

Yet, there are a number of reasons for post-reorg equities to be inefficiently priced and such market inefficiency creates opportunities for investors hunting for bargains. Let’s look at some of the reasons why such mispricing can exist and why these stocks can have a potential for generating attractive returns.

Composition of the Equity Holders

The original holders of most post-reorg equities are former creditors (with some exceptions where former stockholders continue to own stock in the company post-bankruptcy; e.g. General Growth, Pilgrim’s Pride) – usually the holders of the company’s bank debt, bonds and trade claims and executory contract-rejection claims. Some of these newly minted equityholders are not in the business of managing money; they entered a distressed situation unintentionally and may not even be allowed to hold equities under their mandates. Banks and insurance companies, for instance, prefer to receive cash or cash-paying debt as a distribution in bankruptcy rather than common stock for regulatory and economic reasons. Landlords who received shares in the new company in exchange for their lease-rejection claims or vendors of the company who received their shares as a distribution for their trade claims may also be part of this category. High Yield funds may not be allowed to hold equities by their charters. All these holders can become “motivated sellers” and may be forced to sell the shares in the newly emerged company for noneconomic reasons and without giving consideration to valuation or potential returns – and thus creating mispricing.

Small Market Capitalization and Illiquidity

Many post-reorg equities are small cap names. Therefore, large institutional investors, which are often looking to place hundreds million dollar bets on each company, will not have these companies on their investment radar. Reorganized companies are simply too small for them to invest in. Similarly, post-reorg equities are often illiquid. Not only do they tend to be small cap names, but trading float can be small as well. Distressed control-type investors can be long-term holders of these equities and thus might be unwilling to trade their positions. Since liquidity and size are important considerations for many portfolio managers, these relatively illiquid small cap stocks are quite often simply ignored by many professional investors.

Lack of coverage by Wall Street equity analysts

As we mentioned before, the equities of formerly bankrupt companies often have small market capitalization and tend to be illiquid, at least at the beginning of trading. Since Wall Street generates more commissions from trading larger cap, very liquid names, Street analysts are not incentivized to spend time and resources to cover post-reorg equities given that the potential for generating substantial commissions or investment banking business is low. This is why post-reorg equities are often referred to as “orphan equities” – nobody cares to look at them. There are a handful of boutique sell-side firms which provide research on some post-reorg names; however their coverage is limited.

Information Access

Gathering information on post-reorg equities might be challenging as well. During the bankruptcy process, companies generally don’t host conference calls, rarely make public appearances at the conferences and sometimes do not file 10Ks and 10Qs with the SEC. To understand the company’s post-emergence capital structure and newly issued securities, it is imperative for an analyst to read the Disclosure Statement filed with the bankruptcy court which includes financial projections, the company’s new capital structure as well as liquidation and valuation analyses. Analysts can also look at the company’s Monthly Operating Reports, also filed with the court, for more detailed monthly financial data. All these documents are available to the public from the electronic court filing system PACER (http://www.pacer.gov/) for a small fee. However, even though the information is accessible, most non-distressed investors tend to be unfamiliar with PACER and bankruptcy documents, thus often neglecting post-reorg equities altogether.

Bankruptcy Stigma

One of the indirect bankruptcy costs is a stigma directed towards the companies which have gone through Chapter 11. Oftentimes there is a perception that a firm which is or was in bankruptcy has irreparable damage to its brand name and will have trouble retaining old customers and acquiring new ones, getting good payment terms from its vendors, and keeping its key personnel. While this view might be partially true in some situations, it is not rare to see a company do quite well after Chapter 11. It is especially true if the main reason for bankruptcy was overleverage and not underlying business problems. Moreover, bankruptcy process can often become a positive catalyst for a company – the company can use Chapter 11 to reject leases, renegotiate more favorable contracts with suppliers, rationalize workforce, sell underperforming assets, close unprofitable stores, install new management as well as substantially reduce debt load and in some instances get new capital injection. Many companies emerging from bankruptcy also have substantial NOLs which can be used to offset taxes due in the future. All these actions can allow the company to emerge as a healthier, more profitable firm with improved business model and reduced risk profile.

Conservative Projections in the Plan of Reorganization

Since management is often getting stock options (as well as warrants and some percentage of the new equity) in the reorganized company, they can be enticed to provide conservative projections in the Plan of Reorganization so they could price their stock options at a lower price and also outperform their own projections in the future to equity analysts applause. Another reason for preference of a low valuation by management is that it allows the firm to emerge with less debt on its balance sheet. While not always the case, the practice of providing overly conservative financial projections is not uncommon and analysts should be on a look out for such situations.

To conclude, post-reorg equities are often ignored and misunderstood by investors. Every year, 20-30 firms usually emerge from Chapter 11 as publicly traded companies (to name just a few examples, such companies as Tronox, Chemtura, Lyondell Chemical, W R Grace are expected to come out of bankruptcy in the next 12 months). Because many investors are unwilling or unable to invest in these stocks, equities of formerly bankrupt companies can provide attractive value-investment opportunities. Outsized returns may be achieved by wisely investing in select post-reorg equities and we hope that this blog will provide our readers with some guidance and advice on post-bankruptcy investing and help better understand and value these situations.



Thoughts from Third Avenue's Special Situations Fund

At Distressed Debt Investing we have discussed (in detail) Third Avenue Credit Focused Fund, a group I very much respect. What a lot of people don't know though, is that Third Avenue also has a special situations fund (fund name = Third Avenue Special Situations Fund) run by Michael Fineman. While I will not post the entire letter, I will grab snippets which I think are particularly insightful.

On Chrysler Financial (a favorite among many distressed funds)
"During the quarter we greatly expanded our interest in a private company (“FinCo”) that indirectly owns 100% of Chrysler Financial. At our purchase price we believe we are buying a well-seasoned portfolio of automotive loans and leases at roughly two-thirds of run-off value. Importantly, the underlying portfolio has a very short duration, as the overwhelming majority of the book is expected to be liquidated in approximately two years.

By way of background, before the April 2009 bankruptcy filing of automotive manufacturer Chrysler LLC (“CarCo”), FinCo was the captive finance provider for CarCo. During the peak of the crisis and rumors of bankruptcy, FinCo equity was marked in the low to mid 20s. However, since CarCo’s bankruptcy and emergence in later summer 2009, Ally/GMAC has assumed FinCo’s previous duties as the primary provider of retail, lease, and wholesale financing for CarCo-manufactured vehicles. As such, FinCo is currently in run-off, with assets turning into cash on an accelerated basis.

Given the seasoning of FinCo’s book, consumer/wholesale default stabilization, and a remarkable turnaround in used vehicle prices, we are confident FinCo’s reported balance sheet is conservatively marked and we have a large margin of safety when you consider the significance of our purchase price discount. The primary uncertainty associated with this investment is the timing of when capital will be returned, which may be dictated by how the managing partner of this private equity interest seeks to re-deploy these funds. Given what we perceive to be an acceptable alignment of interests, we view the downside to this investment to be a mediocre IRR and the upside to be a holding period return in excess of 60% from current levels after already experiencing material appreciation."
Another distressed debt special: GMAC Preferred's
Ally 7% Cumulative Perpetual Preferred Stock (“PS”) pricing was volatile during the quarter, and we added to our position (while still leaving substantial room to buy more) as prices have fallen. Regular readers of our letters will recall in 2008 and 2009 that we successfully invested in the unsecured bonds of GMAC on multiple occasions. Now, with the prospect of an Ally Financial IPO over a one-to-two year horizon we believe our preferred shares are well situated in the capital stack: Preferred share pricing results in a 9%+ current yield to us, with upside on an early par takeout if Ally management and the majority common shareholder (United States Treasury) look to facilitate a smooth S-1 filing by redeeming us and removing our common dividend blocker.

Of course, we do not hold a contractual right to early redemption, and it is entirely possible Ally could execute a successful IPO with our preferred share common dividend restriction in place. However, even in this downside case we believe we are likely to be credit-enhanced in advance of an IPO when the Treasury converts some or all of its $11.4 billion of mandatorily convertible preferred stock (currently pari passu with our $2.7 billion of PS) into common stock to thicken the common layer and increase Tier 1 common levels to a more acceptable range.
And on their general outlook:
The Fund remains focused on both distressed performing credit and debt-for-equity investments. Since the start of the year we’ve been telling investors that the middle market (companies with total debt less than $3 billion, but less than $1 billion the real sweet spot) is the most attractive environment for debt-for-equity investments. These companies have typically relied on leveraged loans provided by collateralized loan obligations (CLOs) and regional banks for their financing needs, rather than the high yield markets, which serves larger companies who issue larger amounts of debt. The continued shortage of capital available from CLOs and regional banks has made it difficult for middle market companies to refinance or extend the maturities of their existing debt, even as their larger competitors go to the high yield markets to take advantage of still low interest rates. When so many leveraged companies are facing real hard maturities in the near term it creates opportunities for distressed investors.

The second quarter saw increased volatility in both the credit and equity markets as investors absorbed news of the Eurozone’s sovereign debt problems and China’s attempts to manage and slow its economic growth. Third Avenue’s “Safe and Cheap” approach to investing serves us well in times like these by providing strong risk adjusted returns. We analyze many companies and attempt to determine the optimum security within the capital structure and at the appropriate pricing level that limits our downside. Such volatility as the markets experienced recently has helped to create those buying opportunities for the fund.

We continue to size our positions based on our risk analysis of each issue which has provided for several high-conviction, highly concentrated positions that we believe have limited downside. Fund management has also implemented certain inexpensive hedges to hopefully mitigate the tail risk associated with specific companies as well as macro hedges. Finally, we have initiated and increased certain positions that have hard scheduled events and therefore are capable of generating strong returns no matter how the market behaves.

The macro backdrop supporting this middle market thesis remains the same as we had written about in our First Quarter 2010 letter; but recent events noted below seem to further support our thesis:
  • Sovereign default risk has expanded from one EU country to several, not to mention austerity measures being taken by many other countries;
  • The FDIC list of problem banks has grown from 702 to 775;
  • Unemployment rates continue to remain just under 10%;
  • Some $1 trillion dollars of maturities come due over 5 years, albeit back end loaded; and
  • Many balance sheets remain highly leveraged as earnings are first fighting to return to the levels of 2005-2007; let alone grow into those balance sheets.
We could not agree more. The Unwinding of the CLO bubble, is going to make it a very interesting couple of years for distressed debt investors.



Perry Capital 2Q 2010 Letter

Thanks to Jay at MarketFolly for posting Perry Capital's most recent quarterly letter. As always, a fascinating read:



Distressed Debt Analysis - TRX

Earlier in the week, we started looking at the distressed debt of Tronox. What I want to do today is to show readers today in a step by step fashion how to create a valuation recovery model in Excel.

I will note that the bonds have moved up since our last post and are currently quoted 81.5-83.5

The first thing we need to do is pull the plan projections. These can be found from the Tronox disclosure statement on page 97. I have thrown them into an Excel spreadsheet (maybe some rounding errors here)

Next we need to pull, again from the disclosure statement, the estimated total enterprise value, as determined by the financial advisor, which is Rothschild in this case:
As a result of such analyses, review, discussions, considerations and assumptions, Rothschild estimates the total enterprise value (“TEV”) of Reorganized Tronox at approximately $975 million to $1,150 million, with a midpoint of $1,063 million. Rothschild reduced such TEV estimates by the estimated pro forma net debt levels of Reorganized Tronox (approximately $510-$517 million) to estimate the implied reorganized equity value of Reorganized Tronox. Rothschild estimates that Reorganized Tronox’s implied total reorganized equity value will
range from $458 million to $640 million.
So let's also throw that bit of data into the spreadsheet:

As you can see, using the 2010 plan, TRX is being valued at 5.1x-6.0x.

From here we need to figure out how that enterprise value and equity valuation residuals gets parsed down by the various claimants in the case. And this is where Tronox gets complicated because the company is in negotiations with the government to try to get this case out of bankruptcy as soon as possible.

The current government offer (July 5th, 2010) asks for:
  • $165M in cash
  • $130M in 15% Preferred Stock Convertible to an equity value 10% greater than plan value
  • 7 year warrants convertible into 16.7% of reorganized Tronox at an implied equity value of $1.05B
  • Certain Nevada assets
I will note of that $165M in cash, the company had already earmarked $145M in cash:
"Up to $145 million in Cash in the form of the Funded Environmental Amount (subject to decrease if total funded debt under the Exit Credit Facility on the Effective Date is less than $510 million, provided that in no event will the Funded Environmental Amount be less than $115 million in Cash as contemplated by the current committed exit financing)"
So using the Enterprise Values above, here is what we get to (no one really has any idea what Nevada is worth so I skipped that part:

How did I get the GUC (general unsecured claim?): The disclosure statement of course: $470.6. And how did I get the warrant value? It was a conditional statement - the warrant only has value when enterprise value is over a certain threshold, in this case $1.05B, and thats why it kicks in in the mid and upper case. I will note, if the government plan gets confirmed and either Tronox's multiple or EBITDA is substantially higher (or lower) the valuation changes dramatically.

What about the current disclosure statement?

In that case there is $50M of convertible preferred stock, and three different warrants, to different claimants based on enterprise value. They are struck at EVs of $1B, $1.2B, and $1.2B effectively. Why two at a valuation at $1.2B? Because the C warrants go to old equity holders and the B warrants go to the environmental claimants.

Because our EV above maxes at $1,150, we will only consider the A warrants:

I will note that these recoveries are in essence recoveries to the unsecured class. And because some part of that class claim is accrued interest, the recoveries I note above will be lower than the equivalent trading bond price. I.E. 97% * $370 = $359 / $350M face value = 103 dollar price.

As you can see the different plans come up with significantly different valuations. The recovery to the class as a whole is 65%-115% translating into bond prices of 69 to 122. Pretty big range.

Now this gets even more complicated when you start to consider that if the current plan is not agreed to by the torts, they also become unsecured creditors. As noted in the previous post, this number approximates $2B. Those claimants were supposed to get 12% of the Anadarko litigation $7M in cash and insurance claims.

Given the fact that comps in the space are trading at 5.5x-6.0x, I would lean to the higher end of the valuation spectrum...call it 75-120. And I think some arrangement gets made so that the tort claimants come onboard - but for that I would have to discount the recovery call it 10%. With that, the bonds at these levels are probably fair value - if they got back to the high 60s I would be buyer of these distressed bonds.



Current On the Run Distressed Debt Credits

Before I continue my distressed debt analysis of Tronox, I wanted to answer a question I received from a reader:

"Hunter, I intend to apply to the DDIC, but want to make sure I write about an idea not yet covered on the site. Could you send me a list of credit that would suffice?"
And because I get that question often, I thought it would be a good idea to turn it into a post.

I just popped open my Bloomberg, went to MSGS and clicked to Distressed ... here is a screenshot:

Most people in distressed land know Alex Bea, and as you see he is dominating the JPM Distressed Trading desk...

Ok, back to the issue at hand: Just by eyeballing it, and combined with current entries to the Distressed Debt Investors Club, here are a few of the more live items that I think would be good additions to the site (and I will probably analyze here at some point)
  • AIG, Amgen
  • Fairpoint Term Loan
  • Sorensen
  • CIT
  • MBIA
  • Mortgage Insurers
  • Gateway Bank Debt
  • Insight Health
  • Majestic Star
  • Foxwoods (MASHTU)
  • Stations
  • Sallie Mae
  • GGP (an update at least)
  • Nortel
  • Neff
  • Greektown
  • Wamu
  • Lehman (no one has braved it yet!)
  • Capmark
  • Nuveen
I think that is a decent list to get people started. I'll try to tackle one of these a month on the DDIC myself - always good to get comments from other distressed debt investors!



Tronox: Distressed Debt Re-Visited

In January, Distressed Debt Investing did a post on the distressed debt of Tronox. For a reference, here is the trading chart of the Tronox 9.5% due 2012.

And the original underlying thesis of the post:
Investment Idea Synopsis
  • Recommend purchase of 9.5% Senior Unsecured Notes (Ticker: TRX) at 75 and subscribing to rights offering at $10.40 per share a 40% discount to implied market value.
  • Recommend purchase of L+700 bp (2% LIBOR Floor) DIP/Exit Facility at approximately 96(W/OID) at syndication.
As of today, the Tronox bonds are trading 77/79. On July 7th, they were trading in the upper 90s. What gives?

Like most bankruptcies, Tronox's plan of reorganization has gone through a number of revisions. Here is the press release of the most recent change:
OKLAHOMA CITY, July 8 /PRNewswire-FirstCall/ -- Tronox Incorporated (Pink Sheets: TRXAQ, TRXBQ), on behalf of itself and its affiliated debtors and debtors in possession (collectively, "Tronox") announced today that it has filed a Plan of Reorganization and the accompanying Disclosure Statement with the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"), where Tronox's Chapter 11 cases are currently pending.

The Plan contains the framework of agreements Tronox is formulating with its principal creditors — the United States government, several states, its unsecured creditors' committee, various tort claimants and its equity committee — and is premised upon the transfer of Tronox's legacy environmental
and tort liability to certain trusts to be funded upon Tronox's emergence from

Under the Plan:

* Newly created government trusts responsible for environmental remediation at properties located throughout the United States will be funded with a package of consideration that includes (i) up to $145 million in cash, (ii) 88% of Tronox's interest in pending litigation against Anadarko Petroleum Corporation and Kerr-McGee Corporation (the "Anadarko Litigation"), (iii) preferred stock and warrants convertible to common equity of Reorganized Tronox, allowing the trusts to share the benefit of improvements in Tronox's enterprise value, and (iv) certain other real
property, insurance and financial assurance assets.

* Tort claims will be satisfied through separate trusts funded with 12% of the Anadarko Litigation proceeds, $7 million in cash and certain insurance assets. If tort claimants vote to reject the Plan, they will share in the general unsecured pool and Tronox will retain 12% of the Anadarko Litigation and the $7 million in cash.

* General Unsecured Claims (including claims held by the company's prepetition noteholders) are slated to receive all of the primary common equity of Reorganized Tronox. Tronox expects general unsecured creditors will recover between 80 and 100% of their claims based on plan valuation.

* Existing equity holders will recover warrants to purchase up to 5% of the common equity (subject to certain terms and conditions) if they vote to accept the Plan.

"The filing of the Plan is a key milestone for Tronox as it focuses on emerging from Chapter 11. We believe the plan contains the elements necessary to achieve a consensual settlement of our environmental and other legacy liabilities," said Tronox Chairman and Chief Executive Officer Dennis Wanlass. "Importantly, the Plan would enable Tronox to emerge from Chapter 11 as a going concern, responsibly capitalized and well positioned to ensure its long-term viability for the benefit of all stakeholders — including the environmental trusts and agencies responsible for serving the public

Wanlass stated: "We are pleased to be able to propose a fair and comprehensive package to the government while still achieving substantial recoveries for all of our other creditor groups. While there is much work ahead, the end of this complex bankruptcy is in sight and we will continue to work closely with our stakeholders in an effort to garner their support for the plan before voting
begins. We thank our customers, suppliers, business partners and employees for their ongoing commitment to the company through this process, which has helped us to build a stronger Tronox."

The hearing to consider approval of the Disclosure Statement that explains Tronox's plan is scheduled for August 5, 2010.

Copies of the Plan and Disclosure Statement can be found under the "Reorganization" section of Tronox's website at www.tronox.com . The Plan is subject to receiving the requisite votes from stakeholders, receiving approval from the Bankruptcy Court and satisfying closing conditions. The Plan is subject to change.
Let's parse this. They are creating a trust. This trust will deal with environmental and tort liability, as well as remediation. And this trust will be funded with recoveries that were intended to go to bond holders. The initial plan had these same litigation trusts funded with a $105M rights offering and $10M of cash on hand. As can be seen above, they are getting a lot more than that. Research reports indicate that the delta between the initial plan and the most recent plan was that a number of cities and states were not "in" on the first round of negotiations and thus as these guys became party to the discussion, more stakeholders wanted a larger piece of the pie.

To top all this off, the company has noted that if the Tort Claimants reject the plan, recoveries may be materially lower. Why? Ff the Class 4 tort claims reject the plan, they could be included in the general unsecured claim basket. This is bad for the bonds. Terribly bad for the bonds. Why? Current unsecured claims number about $475M. But from the various bankruptcy filings we know that the tort claims amount to over $2 billion! Of course some of these will be rejected, and worked down, but this creates even more uncertainty.

It is getting late, but tomorrow I will lay out a bearish and a bullish case for the bonds. If you can't wait that long, the still like the DIP facility, which, in our opinion is well covered in all scenarios, trades in the 101 context, boasts a decently fat coupon, and will collect exit fees ALONG with possible amendment / extension fees if this bankruptcy drags on.


Distressed Debt Opportunities

Good article on distressed debt opportunities in Financial News. I have pasted the article below...

Distressed debt funds queue for opportunities

Phil Craig

12 Jul 2010

Jumping in near the top of the market goes against almost every rule in the book. But distressed debt managers are expecting investors to do just that. They are preparing for substantial inflows even though hints of another recession suggest asset prices could be set to fall.

Weak economic data, such as the US non-farm payroll data released this month, which showed a 125,000 decline in jobs in June, the largest fall since October, suggests a “double-dip” recession is growing more likely, say investors and companies. A survey published last week by accountancy firm Deloitte found that chief financial officers at 125 UK companies believe there is a 38% chance of a double-dip recession.

Distressed debt funds made 30% last year, according to data provider HedgeFund.net, and rose a further 7% in the first half of this year. Managers of distressed debt funds already took hundreds of millions of dollars into their strategies in 2010.

An economic downturn would cause the prices of distressed assets to fall, implying losses for distressed debt funds. Losses can be substantial. In 2008, this class of fund lost 27%, according to HedgeFund.net. Investors might be expected to pull money away from the funds and avoid the sector until they feel sure that any recession has passed its lowest point.

But fears of an economic downturn are making managers more optimistic, not less. Distressed debt funds typically have extended lock-in periods, minimising risks of substantial short-term withdrawals. Moreover, they believe that slowing growth will spur investors to place even more money in the asset class, as more distressed opportunities come to the fore.

Iain Burnett, head of distressed debt at BlueBay Asset Management, which manages $1.6bn (€1.3bn) of such assets, said: “Over the last 12 months, maybe $2bn or $3bn have flowed into distressed debt as a whole, but I would expect a much higher figure over the next year. It will be a combination of investors understanding that we are in a stage of the cycle where there will be very good returns, and that the outlook is not so good for other asset classes.

“The opportunity is defined largely by the leverage pumped in during 2007. There are hundreds of billions of potentially distressed situations out there. This is the distressed debt opportunity of a lifetime.”

Paul Taylor, head of restructuring at M&G Investments, said: “Our view is that there will be an abundance of opportunities in the coming years, and we are putting the work in now.”

He highlighted four reasons for expecting an oversupply of distressed debt: a persistently weak economic backdrop; limited credit available for refinancing; “sticking plaster” refinancings enacted in 2008 that need to be restructured; and a wave of approaching maturities over the next few years. He said real estate debt provided particularly good opportunities, as few debt investors specialise in the area.
Investors have been placing money with distressed debt managers in recent months.

BlueBay launched its second distressed debt fund, focused on Europe, last December. Alchemy Partners has taken commitments of more than £280m (€335m) for its latest distressed debt fund focused on Europe and is targeting £500m, and OakTree Capital Management is preparing to raise its third fund focused on Europe this year, according to sources familiar with the two companies. Other managers that have closed European distressed debt funds this year include Intermediate Capital Group and Apollo, according to data provider Preqin.

Why not delay an investment until any second economic dip has begun? Andrew Kirton, global head of investment consulting at Mercer, highlighted distressed debt as a good opportunity for investors in early 2009 and said Mercer’s view had not changed. He said: “There’s a danger of catching the falling knife. Clearly, there is risk involved. But if you are building a diversified portfolio of distressed debt, you will be able to withstand a certain default rate. I remember back in the early 1990s when some managers were buying property debt at 40 cents in the dollar. It took five years, but they made a lot of money for investors.”

Damien Miller, global head of special situations at distressed debt specialist Alcentra, said: “It is possible that less sophisticated investors will retrench due to fear, as many did during 2009. The more sophisticated investors will increase allocations to distressed funds on the back of the inevitable increase in the size of the opportunity that a double dip brings. We have already started to see this.”

Miller said a pull-back in flows should, on balance, be a net positive for the overall return opportunity in the asset class. He said: “Any interruption to supply and demand for an asset class will serve to create assets or investment opportunities which are mispriced – there is no better example of this than leveraged loans during 2009. We like to pursue actively investments in assets which we believe are mispriced because we think we are able to value them better than other market participants.”

Ken Kinsey-Quick, head of multi-manager alternative investments at London boutique Thames River, which runs a fund of funds investing in distressed assets, said: “I think most investors are committed to this space. If anything, we have seen people thinking about adding assets.”

There is a fly in the ointment. A weakening economic backdrop could lead banks, which still hold substantial loans on their balance sheets, to avoid selling them, according to BlueBay’s Burnett. He said: “One of the key drivers for distressed debt is that we need banks to start selling their problem corporate loans.

“They haven’t done it yet on any significant scale, and we would like to see the banks making big profits, which would give them cover to sell bad loans at a loss. But a double dip would be bad for banks’ earnings, meaning they might put off selling bad loans.”

However, a senior executive at a rival asset manager, who declined to be named, said other factors could offset such worries: “It is possible that a bigger driver for banks’ behaviour will be a liquidity crisis. If the European Central Bank stops providing short-term liquidity, the banks will have to shed their assets to avoid the refinancing risk.”



Money Manager Interview

Ankit Gupta has posted a fantastic interview with money managers Roark, Rearden, & Hamot Capital Management on his blog Selected Financials. I have always enjoyed Ankit's pieces and I am sure my readers will as well. You can see the interview below.



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.