Approximately a year ago, we analyzed the debt of Six Flags. Our recommendation was to buy the bank debt at 72. Currently that debt trades at 101. In round numbers, about a 40% IRR. On an absolute basis a strong number, relative to where we could have played in the capital structure: Not so much...
A week or so ago, we laid out a few of the better quotes we found from Michael Burry's Silicon Valley Thread. Unfortunately for me, I was beaten to the punch by a number of other fantastic bloggers that also went through his old writings and pieced together some of the stronger, more illuminating "Michael Burry quotes" from the thread. Well - as one not to be beaten (and remember, I reference Michael Burry in July 2009), I plan on writing a few posts on Burry drawing from the Silicon Valley thread as well as some of the more "off-the-radar" pieces out there. For example, I bet a number of you haven't seen this document: Burry on his RMBS short
IMO everyone thinks of their IRA/tax-advantaged accounts as the "sit back and forget about it" accounts. I have harped on this irony for years. Given my type of investing, you'd think it would have hit me like a ton of bricks, and it did. I am an aggressive unapologetic value-based trader in all my non-taxable accounts. Everyone should be. As Jim said, it's a big, exploitable advantage. I think even Buffett more or less said so when he said he could make 50% a year if he was smaller (I am guessing he might agree that most chip shots are of the microcap, and hence ben graham, variety.) In my taxable ones, I'm a bit more apologetic. If it fits one's personality and stock-picking ability, then the advantages are obvious to a buy and hold strategy, though.
To recap, January saw a rapid run-up in the value of your investment in the Fund. One competitive advantage of mine has been taking advantage of the fast times to raise cash for the next slow time, to rotate into less-appreciated securities, and occasionally to short into speculative excess. This can result in my investment strategy producing higher profit, higher turnover, and, yes, higher taxes. In the past, it has done so. In the future, I expect it to do so.
It is Buffett, not Graham that espouses low turnover. Graham actually set targets: 50% gain or 2 years. That actually ensures rather high turnover.
When a stock is this misunderstood, and this many people have lost money on it, well, it's one of the better contrarian plays out there for the patient investor. And the patient investor should hope it goes lower, not curse the volatility.
- Post Properties (PPS) ... 1 buy, 2 holds, 12 sells
- YRCW Worldwide (YRCW) ... 1 buy, 4 holds, 8 sells
- Alon USA (ALJ) ...0 buys, 2 holds, 6 sells
- K-Sea Transport (KSP) ... 0 buys, 3 holds, 5 sells
- K-Swiss (KSWS) ... 0 buys, 2 holds, 3 sells
One of the first questions we ask about a possible investment is “Why is it mispriced?” If you don’t have a reason, there’s a good chance it isn’t really mispriced.
But who are you selling to? And what are they buying with?
May 18, 1999 (updated May 23, 1999): Silverleaf Resorts (NYSE: SVR) - Quick, first gestalt: time-share. Images of faded browns, unfashionably "retro" clothes and loud salesman fill my head. How about you? Well, now we have overtures of a growth industry. A pretty slick one too. Gone is "time-share." Now, we have "vacation ownership interest," or VOI. And forget those faded browns and past tenses. The story is much different, and it is happening right now. Big players such as Marriott and Disney have moved into the field, and the size of the VOI industry has more than doubled during the 1990's.In fact, open-minded investors wishing to ride the biggest demographic trend to ever hit the US - the aging babyboomers - may have already stumbled onto this industry. It appears a good time - an entire industry's worth of stocks are in the dumps, and consolidation is in the cards with many players selling for at or below net asset value.There is indeed value here, but the superficial numbers do not tell the whole story. One must dig a bit to understand.There are several different types of operators in this field, and they appear to be accorded different valuations.Despite the gross dissimilarities in returns, the general similarity in Price/Book ratios does suggest that the market is using current net asset valuations (note: book value is a decent proxy for net asset value, not its equivalent) to value these stocks rather than growth or return statistics. This makes sense, since the industry-standard way of accounting makes the growth and earnings numbers poor measures of value.Silverleaf looks the cheapest. Notably, it is also by far the smallest market cap. This proves rather artifactual. If Silverleaf were accorded an industry multiple, it too would sit among the Trendwests and Vistanas in terms of market cap. So it really is not a size issue but rather a valuation issue.And this is where it gets interesting. Silverleaf is an operator of "drive-to" VOI's. In other words, Silverleaf positions its resorts within reasonable driving distance from major metropolitan areas. The targets are middle-income customers, outside the targets of the Disney's and Marriott's. This greatly increases its potential customer base, and is a decent economic model that helps set Silverleaf apart from the crowd.But the valuation is far from straightforward. Silverleaf is the cheapest of the bunch on both a price/earnings ratio and a price/book ratio basis. Its revenue gains are the greatest, but that is mainly due to a capital infusion in the form of $75 million in long-term debt last year. And the revenue gains are not sustainable without further capital infusions.This is because Silverleaf, like other reputable VOI operators, typically books revenue at the time of sale of the interest, and matches expenses/costs of revenue generation to the period in which they are generated. However, most customers finance their purchase after a down payment, so Silverleaf is booking revenue that it has not yet received in cash. This is aggressive, and very important for intelligent investors to understand.For instance, when a VOI is sold, the customer pays 10% down, and finances the rest over 7-10 years. However, for a given period, Silverleaf - using accrual accounting - books the entire purchase price as revenues. In addition, Silverleaf collects and books the interest received from customer notes receivable. There are also additional revenues from management fees for operating the resorts. But the key is that the principal payments - which will be received as installments over the next 7-10 years - have already been booked as revenue up front. This is aggressive accounting no doubt.Because the remaining 90% of the principal has not been yet collected as cash, it goes into Silverleaf's accounts receivable. Silverleaf then uses the accounts receivable (the stream of future installment payments against principal) to secure up to 85% loan advances which it can use to help finance additional construction and development. These loans are the primary source of capital for Silverleaf. Other VOI operators use similar accounting. For instance, Fairfield regularly securitizes its accounts receivables to generate cash.Because these loans are secured, the interest rates for such borrowings are lower, at a few percentage points over LIBOR, than they otherwise would have been. In fact, the weighted cost of Silverleaf's total borrowings including more expensive senior debt was just 9.1%, and interest income typical exceeds interest expense in any given period.But in the most recent period, interest expenses amounted to a historically high 57.8% of the interest income received (via the steady stream of notes receivable). Blame the new, expensive long-term debt. Silverleaf cannot dip into that well repeatedly.Now, there's the issue of inventories as well. What are they? The company's inventories are the VOI's it has either acquired, reacquired, or built but not yet sold. The inventories are on the books at the lower of cost or market price. The company did have a large amount of inventories acquired several years back at a low cost basis. It has depleted those, and is now selling out of inventory that it built at a higher cost. This is squeezing margins on VOI sales.As well, management anticipates higher marketing expenses associated with several new ventures. The company may have miscalculated a bit and is being forced into stepping up marketing efforts more than it planned in order to sell interests in certain slower markets.Future inventory will come from current inventory and VOI's not yet built. The wisdom of further long-term debt to finance this is questionable. So what happens when the company sells through its inventory and has maxed out its borrowing of 85% against accounts receivable at some reasonable level? The company's sales will basically crash. The lone recurring revenue will be net interest income (expiring over 10 years) and management fees.The sum result is apparent in the company's cash statements, which show deepening negative free cash flow despite the record sales and earnings. Indeed, a risk factor listed in the firm's annual 10-K is "negative cash flow."In an intended vote of confidence, the chairman, CEO, and majority shareholder Robert E. Mead has announced he will purchase up to half a million shares on the open market. The company's own share buyback plan has been stymied by covenants of its senior debt. So this is indeed a nice gesture, although he already owns over 50% of the outstanding stock.Which brings us to a point that must be mentioned with regard to this inudstry - takeover valuations. As insinuated before, large players in the leisure industry such as Disney and Marriott are moving into VOI's. A confirmation of the demographic trends from some expert marketers, to be sure.The greater meaning is obvious for players like Silverleaf which are trading well below book and up to a 50% discount from current net asset value. These are tantalizing numbers to would-be acquirers. In a takeover, just a fair price would be a big bump from current levels.So given the inability to value this sector in terms of growth or simple ratios, the next step in the analysis is to figure out the current net asset value. We'll assume all liabilities are real, per Graham's instructions, and adjust the asset side of the balance sheet to reflect reality.The inventories are recorded at cost. If we use recent history as a guide, those inventories are actually undervalued, as the company's cost of building VOI's is only about 1/7th of the amount received on sale. First, assuming conservatively that only 50% of the inventory is saleable, we get $40 million in saleable inventories. Allowing for the higher cost basis on more recent inventories, these will amount to nearly $200 million in sales. The present value of these sales would sit at about $160 million conservatively, or twice the recorded value.According to industry standard the notes receivable have a securitizable value of about 15% more than their recorded value. This is due to the high 14+% interest rates charged to buyers. So the $198 million in accounts receivable could be adjusted to about $227 million. I'll stick with the $198 million figure to remain conservative.The fixed assets are assumed worth 25% of stated value, cash is given full value, and minimal other assets are given 50% of stated value.Using these adjustments, the adjusted total assets are actually about $400 million. Less total liabilities of $208 million, the net asset value sits around $192 million, or about $15 per share.The market currently values the shares at about $97 million, or $7 1/2. Credit the huge disparity to the concentrated majority ownership - the market is betting that CEO and majority ownder Mr. Mead will not sell out. Still, the fact remains we have a dollar selling for about 50 cents. Makes one wonder when Mr. Mead himself will consider taking the company private rather than just buying a few shares.
- Throughout the archives, I have found Dr. Burry to weigh heavily on relative valuation. For example, he would put up four or five companies in the same industry and gauge them on things like Price/Sales, EV multiples etc. Generally speaking - we all do this. But what he liked to do was to dig in and try to figure out WHY the market was pricing these companies where it was relative to the industry.
- Burry also dug into the numbers of the companies he analyzed and tried to get a sense if the stated GAAP numbers were overstating or understating the true economic performance of a company.
- Burry gives a reason for the market selling a dollar at fifty cents.
Over the past few days, I read a number of stories about high yield debt issuance for March 2010 being an all-time record. From Bloomberg:
March 29 (Bloomberg) -- Junk bond sales reached a record this month as rising profits and record low Federal Reserve interest rates foster lending and investment to the lowest-rated borrowers.Companies worldwide issued $38.3 billion of junk bonds in March, passing the previous high of $36 billion in November 2006, according to data compiled by Bloomberg. Yields fell 0.95 percentage point to within 5.96 percentage points of government debt, the narrowest gap since January 2008, Bank of America Merrill Lynch index data show.This is “an almost ‘Goldilocks’ environment for leveraged credit markets,” JPMorgan Chase & Co. analysts led by Peter Acciavatti, the top-ranked high-yield strategist in Institutional Investor magazine’s annual survey for the past seven years, said in a March 26 report to the bank’s clients.Sales soared as investors plowed a record $33.6 billion into speculative-grade funds this quarter, according to Cambridge, Massachusetts-based research firm EPFR Global. Bonds of Stamford, Connecticut-based Frontier Communications Corp. and Consol Energy Inc. of Pittsburgh, which sold a combined $5.95 billion of debt last week, rose about 2 cents on the dollar to 102 cents.That’s a turnaround from February, when companies canceled sales at the fastest pace since credit markets began to freeze in 2007 amid concern that the inability of European governments to trim their budget deficits will threaten a global recovery.
A few weeks ago, we discussed a letter the ad-hoc equity committee of Visteon sent to Visteon's Board of Directors. Late last week, the ad-hoc committee sent yet another letter. This in response to a new plan submitted by Visteon earlier in the week. I find this letter fascinating as the equity holders basically spell out how they went about valuing Visteon's equity...
Dear Members of the Board of Directors:As you know, we represent an ad hoc committee of equityholders (the “Ad Hoc Equity Committee”), the members of which collectively hold 7.87% of the outstanding common stock of Visteon Corporation (the “Company” or “Visteon”). The Company’s most recently proposed chapter 11 plan, dated March 15, 2010 (the “Plan”), completely ignores the true value of the Company and, accordingly, wrongfully extinguishes shareholders and must be revised. Delaware corporate law requires a shareholder vote to sell substantially all Visteon’s assets, but the Company is undertaking to effectuate the same result as a transfer of virtually all of Visteon’s assets to certain creditors without a shareholder vote.As with the initial chapter 11 plan proposed by the Company, the recent Plan is based on an unrealistically low valuation of the Company and its assets and a suboptimal capital structure, which together provide an indefensible windfall to the Company’s secured lenders at the expense of the Company’s other creditors and shareholders. The Ad Hoc Equity Committee’s analysis shows the Company is worth significantly more than the Plan and Disclosure Statement would lead the Court, creditors, and equityholders to believe for the following reasons, among others:First, as pointed out in our letter dated March 8, 2010, the Company’s prior projections must be viewed with a healthy dose of skepticism.2 Relative to the improving macroeconomic picture, consensus assumptions for worldwide production volume growth in the industry and the improving market positions of the Company’s largest customers, the Company’s top line projections appear to present an unreasonably low revenue forecast.Second, given the Company’s successful cost cutting (including exiting all of the Company’s US manufacturing operations, which will have the effect of lowering manufacturing costs significantly) and general margin improvement illustrated in Q3 and Q4 of 2009, it appears the projections do not reflect the operational improvements the Company has achieved.Third, the Company’s valuation of its equity in its non-consolidated joint ventures is far below their fair market value. The Company values all these joint ventures at $195 million or about 5 times 2009 dividends, 2.5 times 2009 net income and 65% of 2009 book value. Our financial advisors are willing to provide you with numerous examples of comparable Asian automotive suppliers, which currently trade at forward net income multiples in the teens. If the Company truly considers $195 million to be a fair value for its non-consolidated joint ventures, the Ad Hoc Equity Committee recommends the Company offer these assets to the Ad Hoc Equity Committee at that price.Fourth, the Company inappropriately values its 70% stake in Halla Climate Control Corporation (“Halla”) on a consolidated basis (using a market multiple in-line with US comparables, not the higher multiples afforded to Halla’s Asian competitors), and then subtracts out the market value of the 30% of Halla not owned by the Company. This creates an artificial, negative multiple arbitrage that results in a lower valuation. Halla’s value should not be up for debate or manipulation, as shares of Halla trade publicly; at the most recent closing price of Halla shares at current exchange rates, Visteon’s stake in Halla is worth $915 million before any premium for Visteon’s control position. A proper valuation of Halla would assign a premium to the current trading price for Visteon’s controlling interest in this valuable enterprise. The Company’s position that its 70% stake is worth ratably less than the 30% minority stake is not only incorrect but is also troubling.Put simply, the sum of the Company’s $1.1 billion of cash on its balance sheet as of December 31, 2009, its $915 million stake in Halla (before including a control premium) and the Company’s overly-conservative valuation of the non-consolidated joint ventures is in excess of the Company’s estimated valuation in the Plan, before including any value for Visteon’s core business, which the Ad Hoc Equity Committee, Ford and the Company’s other customers firmly believe has value. Furthermore, using a reasonable valuation of both the Company’s non-consolidated joint ventures and Visteon’s core business (ex-Halla) together with the Company’s cash and the public market value of Halla would result in a total valuation well in excess of the $3.1 billion of total claims against the Company, leaving significant value for shareholders.The Ad Hoc Equity Committee is eager to learn more about the Company’s motivations and processes by which it arrived at its valuations and reserves all rights to seek discovery on this issue and all issues.Additionally, there are more optimal capital structures which preserve, create, and distribute value more fairly to all of the Company’s stakeholders. Any such structure should reinstate the existing bank debt or provide the bank debtholders with a new note at the lowest interest rate the law allows, and we urge the Company to do so.Based on the Ad Hoc Equity Committee’s projected cash flows (and even using the Company’s onerously conservative projections), Visteon has ample cash flows to support both this interest expense as well as annual contributions to its domestic pension plans. Furthermore, the Company will generate significant cash over the projection period to address future maturities. Therefore, the notion that Visteon must be free of long-term debt is an unreasonable view that directly robs equityholders of value resulting from the preservation of the Company’s bank debt at an attractive interest rate. There are many comparable companies in the automotive sector, domestically and internationally, that have debt. Indeed, several of these comparable companies have emerged from bankruptcy with leverage and yet continue as important suppliers to Ford as well as to other Visteon customers.The Company should also consider distributing shares of Halla to its guaranteed note holders. While the Ad Hoc Equity Committee believes there is great value to the Company’s majority ownership in and control of Halla, the Ad Hoc Equity Committee also believes there is very little incremental value or strategic benefit from owning 70% of Halla, as opposed to owning 51%.Finally, the Company should satisfy remaining unsecured bonds with a combination of cash and convertible preferred securities. Cash can come from either excess balance sheet cash, or a $200 million rights offering.4 The convertible preferred securities should contain a mandatory dividend payable in securities at the Company’s option at an appropriate rate, be callable at the Company’s option, and be convertible into common equity in certain circumstances. Such a structure would enable Visteon to reinstate its existing equity (subject, of course, to dilution for the rights offering, if necessary, a management incentive plan, and the convertible preferred securities described above). Designed properly, such a structure ought to preserve the value of the Company’s significant net operating losses.The Ad Hoc Equity Committee reserves its rights to seek termination of exclusivity to propose a plan and/or seek the appointment of an examiner to protect its interests, as well as all other rights granted by the Bankruptcy Code. The appointment of an examiner may be particularly appropriate given the wide gulf between the Company’s prior projections and actual results, the limited changes made in the Plan, and the issues the Company’s Plan raises as to whether the Company and its Board are carrying out their fiduciary duties.Of course, the Ad Hoc Equity Committee’s preference is to work collaboratively with the Board, management, and the Company’s other stakeholders to ensure a consensual chapter 11 plan that treats all stakeholders fairly, and rewards management for improved performance. The shareholders are the Company’s owners, and we trust the Board and management will act in accordance with the shareholders’ best interests consistent with their fiduciary duty.We look forward to your response.Sincerely,/s/ Martin J. BienenstockMartin J. Bienenstock
On Friday, I picked up Michael Lewis' new book "The Big Short: Inside the Doomsday Machine" which chronicles the sub-prime short through the eyes of four different characters: Cornwall Capital, Steve Eisman, Michael Burry, and Greg Lippmann. To give you a sense of how much I enjoyed it, and how quick a read it was, I successfully finished the book last night. Despite the somewhat lukewarm review on Amazon and in the press, I really enjoyed this book and recommend it to readers.
..."But we're sitting there," recalls Vinny, "and he says to us, like he actually means it, 'I truly believe that our ratings will prove accurate.'" And Steve shoots up in his chair and asks, 'What did you just say?' - as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him. "With all due respect, sir," said Vinny deferentially, as they left, "you're delusional."
I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind.
Last week, we wrote a quick post on Michael Burry of Scion Capital. Because of that post I received about 50 requests to share any information I had on Dr. Burry. A few years ago, a friend told me about Michael Burry's archive on Silicon Investor. To all those interested, you can find the various threads and messages here (Michael Burry's Archive). It is amazing to me that he wrote 3304 posts in the span of 5 years. Over the next few months, I will try to add some commentary here and there from what I've learned from Dr. Burry. In the meantime though, I'd like to speak of two quotes I found from his archives that I think are particular provoking. (As an aside, I have no idea if Dr. Burry would agree with his own commentary 12 or so years after he wrote these in the last 90s).
"Wow, this is getting really interesting. People (read: more than one) are taking time out of their day to come the value investing thread and tell us how irrelevant value investing is. At about the same time, friends and acquaintances are losing all patience with my talk about value but perk up when someone says "this one will double by December." These are the same ones that say, "I'm making 40%" and expect it to continue. Recently two people approached me about helping them do commodities for even bigger gains - 30-40% in stocks isn't enough. One of them thinks commodities aren't enough, he wants options on S&P futures.As I run a value investing web site, I can also tell you that I approach 200 hits/day when the market shakes out like in October and January, but am down to 60-70 hits/day now. People don't need ideas - they know to just pile into the stocks everyone talks about, a strategy that has worked well the last 15 years.I tell my editor that Dell at 140 is an albatross that has just been shot, and he says no way, the money flow is just too strong. That money flow brought it to around 122 pre-split within a few days.Certainly is interesting...last year I was bearish on valuation, but never before have I had so many people slap me in the face with their impatience with value investing."
Last year I told you that we would also promptly complete a succession plan for the investment job at Berkshire, and we have indeed now identified four candidates who could succeed me in managing investments. All manage substantial sums currently, and all have indicated a strong interest in coming to Berkshire if called. The board knows the strengths of the four and would expect to hire one or more if the need arises. The candidates are young to middle-aged, well-to-do to rich, and all wish to work for Berkshire for reasons that go beyond compensation.
"IMO, the biggest impediment to investing in the spirit of Buffett is the idea that somehow we can be a 100% imitator of him and see the same success. That anyone could be a perfect imitator of his approach strikes me as ridiculous. Try compounding the 10% difference between even your best imitator and Buffett over 30 years.I don't have it down yet. But in terms of investing in the spirit of Buffett (rather than in his mirror image), neither does anyone else here that I can see. I'm young. I'm reading a lot and continuously reviewing and updating my approach as new revelations occur. Remember I said "Buffett-like stock for me," not you. If it was that easy for you to see, I'd be disappointed. I'm certainly glad I can't find anyone to agree with me on this. If anything, it indicates I'm headed in the right direction."
Every few months, I like to put up an example of the quality work the members of the Distressed Debt Investors Club are sharing with other users of the site. The DDIC now has over 100 members and as many ideas ranging from distressed bankrupt companies to equity shorts. Our forum has over 350 posts where users are sharing commentaries on the market, ideas, job discussions etc. It really has exceeded all my wildest expectations. Without further ado, here is an idea on Tembec.
One of the additions we have made to the Distressed Debt Investors Club is a job forum for members. Currently I am receiving one or two job postings every few weeks from members of the site. We would like to get more opportunities in front of our members; to that end, if any distressed / credit / high yield recruiters would like to get their job postings in front of a very high caliber group of traders, analysts, and portfolio managers, please contact me at hunter [at] distressed-debt-investing [dot] com.
Wanted to send a quick note out about the Chicago Distressed Investing & Restructuring Conference coming up on April 16th, 2010. Looks to be a very solid conference - professionals from distressed debt hedge funds, creditor and debtor restructuring advisors, a bankruptcy judge(Chris Sontchi - one of the more prominent judges in the Delaware bankruptcy court), and other bankruptcy professionals will be speaking on a number of different topics.
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.
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. BienenstockMartin J. BienenstockMJB/dsCC:Marc Kieselstein, Esq.
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.
"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."
The Valuation Analysis is dated as of December 15, 2009 and is based on data and information as of that date.
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...
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.
Certain of the Debtors' management and directors wil be entitled to participate in theManagement 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.
Chapter 11 Plan of ReorganizationThe 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.
- Sales came in at $6.69B vs 2009 plan projections of $6.45B
- Adjusted EBITDA of $454M vs plan projections of $302M
"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.
- Management on board - how to incentive them? With a big check.
- 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.
Dan Loeb of Third Point has always been one of my favorite investors. Here is his 4th quarter 2009 letter.
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.
A feature of the last credit cycle was the growth of 2nd lien financing. While structures involving bank debt, high yield bonds, and/or mezzanine loans also involve inter-creditor considerations, many 1stlien/2nd lien agreements exhibit less standardization than for more traditional structures. Especially when considering rights, recoveries and remedies in a bankruptcy scenario for 1st or 2nd lien instruments where both senior and junior liens exist, developing a view of how the bankruptcy court will likely interpret and enforce the provisions of an inter-creditor agreement can be critical.
In a 2nd lien financing, the 1st lien lender and the 2nd lien lender share in the same collateral, with the latter receiving liens junior to the former. The inter-creditor agreement covers (1) subordination of claims and liens and (2) certain waivers of rights by the 2nd lien lender both inside and outside bankruptcy. While the focus of this post shall be specific to bankruptcy waivers, waivers under non-bankruptcy law are also extremely important and can have serious implications within as well as outside of bankruptcy. See Buena Vista Home Entertainment, Inc. v. Wachovia Bank, N.A. (In re Musicland Holding Corp.),374 B.R. 113 (S.D.N.Y. 2007) for a particularly serious example of a 2nd lien creditor suffering from a bankruptcy court’s interpretation of a general consent granted by the 2nd lien lenders in an inter-creditor agreement.
The bankruptcy courts have not always enforced bankruptcy waivers as consistently as many creditors perhaps would have liked: BRC§510(a) states “a subordination agreement is enforceable in a case [in bankruptcy] to the same extent that such agreement is enforceable under non-bankruptcy law.” However, some courts have held that the Bankruptcy Code mandates subordination is distinct from certain statutory rights creditors receive through the bankruptcy process that cannot be altered through pre-bankruptcy negotiations and waivers. Some important bankruptcy waivers include:
- Adequate protection
- 2nd lien lender waives right to oppose adequate protection for 1st lien lender.
- 2nd lien lender waives right to seek adequate protection for itself.
Issue: BRC§361 provides three methods to provide adequate protection of a secured party’s interest in property to compensate for declines in the value of collateral: 1) cash payments, 2) replacement liens, or 3) the “indubitable equivalent” of the collateral. With a junior lien, declines in the value of the collateral will impair the 2nd lien instrument’s value first. Especially for collateral that declines rapidly in value, these waivers can constitute a significant risk for the 2nd lien holders, especially in longer-duration bankruptcy cases. Strict enforcement of this waiver could leave the 2nd lien holder severely under-secured, with only a general unsecured deficiency claim for the remaining balance of the loan.
- Use of cash collateral
- 2nd lien lender consents in advance to, and/or waives objection to, use of cash collateral if 1st lien lender approves.
Issue: Cash collateral is money earned from the sale of assets against which a lender has a lien, and the lender retains liens against these cash proceeds unless the bankruptcy court approves their use by the debtor. Particularly for asset-based loans secured by floating liens against receivables and inventory, the debtor will likely generate significant cash collateral as it collects pre-petition accounts receivable and sells pre-petition inventories. An over-secured 1st lien lender has little incentive to protect a 2nd lien lender’s lien in cash collateral and may support, or decline to object to, the debtor’s use of cash collateral. That action, especially when combined with a waiver of adequate protection, again would leave the 2nd lien lender unsecured with only a general unsecured claim for the deficiency.
- DIP financing
- 2nd lien lender consents in advance to, and waives right to object to, DIP financing approved by 1st lien lender and priming liens granted in favor of DIP lender.
Issue: DIP financing can be authorized by the bankruptcy court, which will grant a priming lien senior to existing pre-petition liens if (1) the debtor is otherwise unable to obtain such credit and (2) the existing lien holder remains adequately protected. Consider a scenario where there is a 1st lien claim for $50M, a 2nd lien claim for $40M, and the collateral is worth $80M. Without a priming lien, there is 100% recovery to the 1st lien creditor and 75% recovery to the 2nd lien creditor. Now consider a $30M DIP facility combined with an enforceable waiver against the 2nd lien creditor causing such creditor to lose the right to oppose the DIP loan. The 1st lien creditor still enjoys 100% recovery, while the 2nd lien creditor’s recovery drops from 75% to 0%. Often, the 1st lien pre-petition lender is also the DIP financing provider, so will have an incentive to prime the 2nd lien holder, especially if the 1st lien lender is receiving large fees from providing the DIP facility and/or other benefits afforded to DIP lenders such as a roll-up of pre-petition debt.
- Lien release
- 2nd liens release during bankruptcy.
Issue: Would turn the entire secured claim secured by a junior lien into a general unsecured claim if strictly enforced by the court.
- Post-petition interest
- 2nd lien lender waives rights to seek post-petition interest, fees, and expenses.
Issue: When a secured lender is over-secured, BRC§506(b) and case law provide for that lender to collect post-petition interest; and reasonable, contractually-determined fees and expenses, up to the amount which the secured lender is over-secured. In estimating returns to a 2nd lien instrument that appears over-secured, inability to collect post-petition interest, fees and expenses could have a material impact on return calculations, particularly in longer bankruptcy cases.
- Sale of collateral
- 2nd lien lender waives right to object to sale of collateral if 1st lien lender consents.
Issue: A numerical example illustrates the implications of this waiver. Using the same example as in (3) above, again assume 1st lien debt of $50M, 2nd lien debt of $40M, collateral worth $80M. Sale at $80M would yield 100% recovery to 1st lien creditor, 75% recovery to 2nd lien creditor. Now assume a “fire sale” of the collateral for $50M to which the 2nd lien creditor cannot object: The result is a 100% recovery to the 1st lien creditor, who is indifferent to whether sale occurs at $50M or any value above that amount, but a 0% recovery to the 2nd lien holder.
- BRC§1111(b) elections
- 2nd lien lender waives rights to make BRC§1111(b) election without consent of the 1st lien lender.
Issue: The BRC§1111(b) election allows a secured claimant to have its entire claim, to the extent allowed, treated as a secured claim instead of having it bifurcated into a secured and an unsecured portion, provided the secured party waives any deficiency claim against the estate for the amount which the secured party is under-secured (see BRC§1129(b) for details on the “cram-down” of secured parties). Without getting into extensive detail, this waiver would significantly affect recoveries for a 2nd lien creditor which is (1) under-secured and (2) expects recoveries for unsecured creditors to be low.
- Voting rights:
- 2nd lien lender waives voting rights on a plan of reorganization, or assigns rights to 1st lien lender.
- 2nd lien lender waives right to vote for or on the appointment of a trustee.
Issue: The 2nd lien lender could be forced to vote for a plan that would provide a recovery significantly inferior to the amount to which the lender would be entitled even if “crammed down” in accordance with the provisions of BRC§1129(b).
To reiterate, there are doubts regarding the bankruptcy courts’ enforcement of bankruptcy waivers. One school of thought holds that 1st lien lenders and 2nd lien lenders are sophisticated parties, and that the 2nd lien lender waives rights, including bankruptcy rights, in exchange for a higher yield. However, some courts have held that the US Constitution vests in Congress the right to set uniform laws on the subject of bankruptcies, and that had the “Founding Fathers” intended private parties to pre-determine provisions of bankruptcy law between and among themselves, the Constitution would not have vested such authority in Congress exclusively. This tension has led to case precedents that can seem in conflict with one another. For example, in Bank of America v. North LaSalle Street Ltd. P’ship (In re 203 North LaSalle Street Ltd. P’ship), 246 B.R. 325 (Bankr. N.D. Ill. 2000) and in In re Curtis Ctr. Ltd. P’ship, 192 B.R. 648 (Bankr. E.D. Pa. 1996), bankruptcy courts reached seemingly differing conclusions regarding whether the 2nd lien lender’s waiver of the right to vote to confirm a plan of reorganization was valid. Other precedents that, on their face, may appear to contradict one another, exist for other bankruptcy waivers.
Furthermore, recent growth of 1st lien/2nd lien structure and the attendant proliferation of agreements and disputes regarding such agreements, some issues have not yet been fully adjudicated by the bankruptcy courts. While the “ABA Model Intercreditor Agreement” is a welcome development that may reduce uncertainty for new issues, many distressed analysts are currently considering secondary purchases of the issues that took place during the last decade’s credit expansion that lack standardized clauses and, accordingly, standard interpretations.
For a complete analysis of returns for a security significantly affected by inter-creditor issues, the lack of certainty regarding enforcement of certain clauses means that, while reading the inter-creditor agreement is a necessary first step, making educated guesses, almost certainly assisted by counsel, on how certain of its provisions could be enforced by the bankruptcy court may also become necessary.