Distressed Debt: What I Will Remember About 2012 and a look to 2013

As investors, we are bombarded with information. Whether it be macro news, political turmoil, or earnings releases (just to name a few), its oftentimes hard for investors to filter out the noise from things that actually change the intrinsic value of securities. With so many things happening through the year, the one thing I'll remember about 2012: equity recoveries in bankruptcy.

Do not get me wrong. When I tell friends or family about what stocks I am invested in, most of them think I am speculating on some pump and dump scheme of a failing company. Maybe I monitor Twitter or Yahoo message boards for the next stock that's going to EXPLODE. Look at most of the stock message boards for companies entering the Chapter 11 process and you may go blind and/or cry.

2012 was different. In 2012, there were huge returns to be made by diligent investors invested in the bankrupcies of certain equities. During 2012, I was invested in (and in many case still invested in via the liquidation trust)

Of those five, I am currently still involved in 3 via the liquidation trusts as well as being invested in the HEARQ liquidation trust which was a 2011/2012 event.

If Europe imploded, or China went into a deep deep recession, maybe my returns would have been lower than what they printed at for the year. But probably not terribly different because at the end of the day, the macro news (noise) had little effect on the intrinsic value of these securities.

I do not remember a year when there was so much money to be made in bankrupt equities and seriously doubt 2013 will come close to the sort of opportunities that were presented. There have definitely been years prior (2009) where buying incredibly stressed, levered equities was the most profitable trade out there (Dollar Thrifty anyone?).

Comically, there are a number of trades I still missed despite being deeply knowledgeable about the players, docket, and companies that had filed. In fact, one of the most profitable trade I've seen in my life is right in front of me but I haven't been able to buy the stock for 3 months. Frustrating to say the least.

The distressed cyle in general in 2012 was in line with what people had expected. I am hearing numbers all over the place for fund returns for 2012 with some eye popping numbers barbelled with some generally poor numbers and a number of funds in the mid single digits - low teens. This relative to a low double digit return for high yield is frustrating to funds that hedged rate and only picked up spread tightening which would contribute a far less return. If you were long housing (via homebuilders, subprime mortgages, Ambac etc) you did very well. Some on and off the run situations that I spoke about in the blog were all over the place (Petroplus dropping to 10 then quickly doubling, MF Global grinding to 60+, etc).

2013 inevitably will be a harder year for funds to generate absolute returns but probably an easier year to generate better returns than their benchmarks. If you were long S&P vs short funds in 2012 you are now counting your money. I don't think that will be the case this year for a variety of reasons. I really do think this year will be a stock pickers market where money will be made in catalyst driven opportunities on the long side (when financing is cheap, event driven things pick up...think M&A, spin offs, IPO of business units) and on the short side simply because valuations are stretched for a number of industries especially if you consider a sub optimal growth tragectory for the U.S. and abroad. Commodities are interesting from the short perspective given the supply outlook for a number of materials in the 2014-2015 time frame.

The stars were definitely aligned for distressed equities in 2012. Here's to hoping a few more come down the pipe in 2013.


Anonymous,  1/03/2013  

"can't buy the stock for 3 months" bc of liquidity/float, etc or bc it is on you firm's restricted list?

Anonymous,  1/08/2013  

What are your thoughts on CAGAQ and it's liquidation value?

Anonymous,  1/14/2013  

"the one thing I'll remember about 2012: equity recoveries in bankruptcy."
W/o having historical experience to fall back on (currently finishing the DDI course 201 recommended reading), any comments on if there was a general trend driving the equity recoveries?
Were there less complex investors on the funding side, a result from issuance during the crisis, thus increasing the equity recoveries? Liquidity driven BKs, maybe from tighter credit to SME's, instead of insolvency?
All were just case-by-case and nothing consistent overall?


TboneSam 1/15/2013  

I was thinking about this too and here's what I teased out from my own reading:


- 95% of pre-file equity recoveries occur in scenarios where one or more assets were sold to strategic parties. This makes intuitive sense because it is difficult to see a full par recovery for the liabilities without some kind of synergies that turn a negative operating environment around.

- Re-orgs without asset sales usually result in such massive dilution that it may as well be a zero

- Obviously exceptions abound, but this seems to be a good rule-of-thumb


- Refinancing need during broader credit crunch forces bankruptcy for orderly sale/refi process (GGP)

- Lawsuit / fraud / other sudden event (non-core business related) creates sudden liquidity crunch. Orderly sale/refi process needed (classic Texaco / Pennzoil case)


- A major non-management shareholder who has a lot to lose from being zero'd out and will fight for value in front of a judge

- <10% management shareholders have perverse incentives vis a vis pre-file equityholders in selling assets or otherwise maximizing value. They are likely to buddy up with creditors and argue for low valuations in order to secure post re-org positions and 5-10% equity stakes.

Anything to add?

Hunter, I think this would make for an interesting post


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.