FriendFinder’s 14% first-lien notes due September 2013 have been bid up to the 98 context on the expectation of a refinancing that would refinance the first-lien debt at par and include an equitization of the second-lien debt, according to sources.
A lot of options are still available, including whether or not the company decides to go private, according to sources, but communications are moving forward looking with the aim of coming to a suitable deal for all parties involved well in front of the May 6 deadline of the most recent forbearance agreement.
Last week a large odd lot transacted at about 97 and the bonds were immediately bid higher following the trade, according to sources, as the largest holders are still looking to be buyers of the paper at 96/97.5. That was an indication that first-liens expect to be refinanced out at par, which sources close to the situation say is of high likelihood. The movement was the first since the company announced that forbearance extension through May 6 and skip its excess cash flow payment to “take advantage of what management believes are current favorable market conditions to refinance.”
Even in a hot debt capital markets, a straight refinancing has for months has not been probable for the 2013 notes without some further restructuring, according to sources. The notes traded as low as 71 in August, but have steadily traded up since that time as the company started to work with bondholders on an amendment and refinancing.
The company had been unable to come to an agreement with the holders of second-lien notes, and already had to obtain an extension of a waiver from the second-lien PIK notes from certain covenants. The second-lien notes would be worthless in a bankruptcy scenario, according to sources, so much of the free cash flow has been used to pay down the first-liens. The company founder Andrew Conru, an early internet entrepreneur enriched by the partial sale of FriendFinder, through a trust owned 23.4% of the company as of April 20, according to the company’s most recent disclosures, as well as nearly all of the second-lien notes along with co-founder Lars Mapstead, according to sources. Conru also owns a portion of the first-lien debt and has largely been seen as driving the negotiations, according to sources.
FriendFinder was also notified early February that it again failed to meet Nasdaq’s $1 threshold and $15 million minimum market cap over the required 180 days and was subject to delisting. The company said it would appeal.
The company has $213 million in 14% first-lien notes outstanding as of Sept. 31; $9.6 million in 14% cash pay second lien notes due 2013 and $280.53 million in 11.5% second-lien PIK notes due 2014.
The company retained CRT Capital Group LLC as financial advisor to help explore opportunities to refinance the notes late last year, according to a disclosure in December. Previously Imperial Capital was the investment banker for the company during much of its financing changes, according to sources.
Holders of approximately 94% of the 14% notes and the holders of 100% cash pay notes due 2013 agreed to the forbearance.
The existing capital structure was put in place October 2010, followed by multiple adjustments to the company’s financial arrangements with lenders.
Calls and emails sent to the company and CRT requesting comment were not responded to by press time. - Max Frumes
FriendFinder’s 14% first-lien notes due September 2013 have been bid up to the 98 context on the expectation of a refinancing that would refinance the first-lien debt at par and include an equitization of the second-lien debt, according to sources.
Since the founding of the Distressed Debt Investors Club, Central European Distribution Corporation has been written up three times. Yesterday, CEDC launched exchange offers yesterday hoping to achieve an out-of-court resolution. The below article is not just a rehash of news reports and sell side commentary that has been put out today, but includes insights from a variety of sources that Distressed Debt Investing have spoken to over the past 24 hours.
While the offering memorandum, which was informed by analysis from financial advisor Houlihan Lokey, details a plan that would slash debt by $750 million, leaving it with just one $500 million issue of secured 6.5% notes, the reason to launch the exchange now was more to get the 20-day clock ticking to start elicit support for the final deal that will allow this to get done out of court, according to sources. Various options are on the table, sources said, while the whole process is backstopped by a plan to reorganize via Chapter 11 if necessary.
Important to the process has been the cooperation of Russian billionaire Roustam Tariko and his firm Roust Trading, Roust Trading, which owned approximately 19.47% of CEDC’s existing common stock as of Feb. 15, owns approximately $102.5 million aggregate 2013 converitble notes, according to the filing. Tariko doesn’t fully support the plan exactly the way it is, though through advice from advisors Blackstone and White & Case, he’s been communicating with the company to try and get this done out of court, or at least via a pre-negotiated or pre-arranged bankruptcy filing best for all concerned, according to sources – still short of a pre-packaged bankruptcy. The company, though Russian owned and the largest vodka producer in Poland, would file in Delaware.
Unfortunately for the convertible notes, Tariko’s negotiations appear to be aimed at retaining a large ownership stake and getting recovery through his other lending to the European spirits distributor, according to sources. Accordingly, neither the proposed or the alternative plan in the offering memorandum have positive outcomes for the converts or the equity compared with their levels yesterday before the news came out.
The company's stock, trading under CEDC on the Nasdaq exchange, plummeted 60% to close at $0.62 yesterday (though the news of the exchange wasn’t publicly released until after market close, sources involved note that there was clearly a leak). The stock was up 3 cents today as of 3 p.m. EST. The 3% convertible bonds backing CEDC traded in two larger odd lots today at 10.5 and 11, quoted down at that level, compared with quotes yesterday at 15/23, according to sources, after trading at 24 and 24.5 last week.
The exchange offers are part of a financial restructuring prompted in part by the impending March 15 maturity of the converts. Specifically, it would give holders of the secured notes due 2016 65% of the common stock in CEDC. Those notes total $957 million, to be replaced with $500 million aggregate principal amount of new 6.5% secured notes due 2020. Holders of the $258 million in 3% converts, and Roust, which is owed $20 million in unsecured notes, together would share pro rata in 10% of CEDC's common stock. A separate $50 million secured credit facility provided by RTL would be converted into 20% of CEDC's common stock, according to the release.
The offer is conditioned upon the approval by the current stockholders of CEDC of a 64.51 to 1 reverse stock split and the issuance of new common stock.The offer expires 11:59 p.m. EST on March 22.
The alternative offer from a committee of holders of the 2016 notes and Tariko through his firm Roust Trading would give 2016 holders $172 million in cash and $450 million of new secured notes due 2018, bearing interest of 8%, increasing to 9% in year two and 10% after three years, and $200 million of new 10% convertible PIK notes due 2018, convertible after 18 months into 20% of CEDC’s equity, increasing to 25% if converted in 2015, 30% if converted in 2016 and then 35% if converted in 2016 or thereafter. The 2013 converts and Roust’s notes would be exchanged for as much as 15% of the total common stock. Roust would own approximately 85% of the equity of CEDC in this scenario on account of the new equity investment and the conversion of the $50 million facility into equity. The proposal has not been formally presented to the board yet.
Skadden, Arps is counsel for CEDC; Houlihan Lokey was the investment banker; and Alvarez & Marsal was financial advisor in connection with the plan.
Also, the way the memorandum was written renders Roust’s previous issue with the $30 million put option moot, as there’s a 90-day waiver between Roust and CEDC. Tariko was trying to extend out the exercise date of his put options for 5.7 million shares of commons stock but CEDC didn’t agree, so Roust sent a put notice that it planned on exercising the put at above the market price.
Tariko had been in dispute with the company, claiming it was no longer required to complete an acquisition of 28% of CEDC because the company’s restatements last year breached the agreement. Since then, CEDC and Russian Standard have been in negotiations, resulting in revised terms designed to turn the spirits distributor around.
A CEDC spokesman declined to comment. - Max Frumes
Aurelius Capital Management has joined the motion to allow JP Morgan to prosecute in order to resolve a claim over a portion of MF Global's $1.2 billion revolver, according to a filing today. According to court documents, Aurelius is a lender under the ~$1.2 billion Liquidity Facility.
On Feb. 13, JPMorgan (JPM), as administrative agent and as a lender to MF Global motioned to prosecute or settle an issue regarding at least $928 million of the revolver facility that was transferred to a unit of the company referred to as MF Global Finance, or Finco, just before the bankruptcy of MF Global in October 2011.
In the Feb 13. motion, JPM points out by avoiding the $928 million of the HoldCo's intercompany claims (and subordinating the claim of Holdco vs Finco), recoveries to Finco could increase substantially. The current proposed plan allows the intercompany claim in full against Finco (a double dip) but language on whether an offsetting claim from Finco to Holdco is uncertain at best. As background, Finco drew down on the Amended Liquidity Facility in the two weeks prior to MF Global's bankruptcy.
The plan currently proposed was signed by co-proponents including Silver Point Capital, Knighthead Capital and Cyrus Capital Partners, along with Caspian Capital, Citigroup, Deutsche Bank, BlueMountain Capital, P Schoenfeld Asset Management, Scogging Capital, Serengeti Asset management and RBS, Waterstone Capital in conjunction with trustee Louis Freeh, according to the filing.
These creditors asked the court to postpone the hearing on the motion. Aurelius' counsel submitted that such request should be denied because the group represents competing interests, as they have claims in the company's other notes in addition to the revolver, according to the motion
Unlike the creditor co-proponents, Aurelius only holds claims in these Chapter 11 cases under the Liquidity Facility, according to Aurelius' counsel's statement.
By the same logic, Aurelius feels JPMorgan is the "best and most appropriate party to prosecute these claims and defenses because" it is not a fiduciary for multiple estates or creditors.
Attorneys representing JP Morgan at Simpson Thacher and Aurelius at Stutman Trester & Glatt declined to comment further than on what was in the filing. - Max Frumes
A more topical issue in the distressed debt market that arose after a controversial ruling in the Washington Mutual bankruptcy case is the issue of insider trading, getting restricted, and the cleansing of material non-public information. With a significant number of cases going the pre-pack route, funds involved in these restructurings may be unable to trade due to their knowledge (material, non-public) in the case. But what happens when a fund has multiple departments that might not know what the other group knows (or is doing)? The Restructuring and Bankruptcy Team at Proskauer Rose, led by Martin Bienenstock, frequent contributors to Distressed Debt Investing, has penned a fantastic post for the site below on these exact issues. Enjoy!
MNPI and NDAs: The Alphabet Soup of Getting Restricted
Investors wanting to equip and position themselves to negotiate a debtor’s restructuring may temporarily relinquish their ability to buy and sell securities in exchange for access to material nonpublic information (“MNPI”). This delicate balance between the need for investment liquidity and the desire for informational transparency often leads to increasingly fierce negotiation between a company and its creditors over the terms of a confidentiality or non-disclosure agreement (the “NDA”).
When a company is ready to negotiate a restructuring of its public debt, it will typically direct its attorneys to negotiate an NDA with holders of substantial indebtedness. An NDA will typically require the creditor to acknowledge that it may receive MNPI. In accordance with federal securities laws, the receipt of MNPI immediately “restricts” the ability of the creditor to trade unless the creditor has executed a “big boy” letter with its counterparty. While a “big boy” puts the buyer on notice of the creditor/seller’s possession of MNPI, many sellers will refrain from trading with “big boy” letters because the efficacy of the “big boy” remains uncertain, subjecting the seller to potential civil and criminal liability notwithstanding their execution.
In addition to these trading restrictions, the NDA will also impose contractual restrictions on the ability of the creditor to share or discuss confidential information or MNPI with parties who have not executed a confidentiality agreement with the company. Some NDAs include a “standstill” provision prohibiting any discussions with other creditors or parties in interest for a certain term, whether those parties execute a similar NDA with the company or not.
Indeed, if the company wishes to accelerate negotiations to achieve resolution of impending liquidity challenges, an NDA may very well facilitate, rather than impede, dialogue among its key stakeholders. Investors will want all these contractual restrictions to terminate on the same date as the trading restrictions (i.e., the date upon which the company “blows out” or “cleanses” the MNPI, see further discussion below) to avoid the undesirable scenario where the investor can trade again for purposes of federal securities laws, but still remains subject to the contractual prohibitions in the NDA.
MNPI can range from a transaction proposal or term sheet to more detailed nonpublic financial and operational information, such as cash flow projections. Even mere knowledge of the existence of nonpublic restructuring discussions and negotiations between the company and certain creditors may constitute MNPI. The level of informational visibility the investor wants will often determine the length of the restrictions in the NDA. For the investor to become “unrestricted” after its receipt of MNPI, the MNPI must either become (i) immaterial/stale or (ii) public. Accordingly, investors will require the company to publicly disclose the MNPI at the earliest possible cleansing or “blow out” date through a press release or SEC filing. The company will then weigh these considerations against its own external disclosure timeline (i.e., a company may not wish to preview year-end numbers before it files its Form 10-K) and the reality that it must try to accommodate the liquidity concerns of its largest creditors if it wishes to achieve a consensual deal with their participation and imprimatur. Regardless, if the investor determines the company has failed to sufficiently cleanse all MNPI, after prompt written notice to the company, the investor frequently has the self-help remedy entitling it to disclose the information on its own.
Some investors try to avoid these issues altogether by retaining a financial advisor or law firm to get “restricted” on its behalf. The advisor, however, cannot reveal the nonpublic content to the investor until the investor is willing to be restricted. Thus, the investors effectively allow their advisors to negotiate for them to some extent until the investors are willing to restrict themselves and complete the deal. This strategy also affords the investors more time to trade and accumulate their position.
Investors at hedge funds or financial institutions having one department that trades debt for itself or clients and another department that holds debt for their own proprietary accounts, may erect internal information barriers or trading walls to enable the department trading debt for clients to continue to do so, while the other department is restricted and negotiates a restructuring. These entities often designate one or a small number of individuals as “restricted personnel” with access to MNPI while non-designated employees on the other side of the wall continue to trade the company’s securities. The erection of walls must be done with much care. Large institutions, of necessity, must know and understand their total exposure to each credit for risk and financial reporting purposes. The individuals who know this information are effectively operating above the walls and looking down at each department, creating a situation of walls without ceilings. These individuals must be identified in advance and instructed not to share any information they learn with people trading or holding the debt for which there is an NDA.
Most importantly, investors must understand the determination of what constitutes MNPI remains an inherently subjective one. Accordingly, investors must always evaluate the aforementioned considerations in consultation with internal compliance officers and experienced securities law counsel before trading.
As some of you know, there are a number of big changes in store for Distressed Debt Investing. I'll be posting some more specifics on the upcoming changes early next week, but in the meantime, I wanted to post this as soon as possible: I am hiring for my new company. This is a full-time, paid position. See below for details.
Position: Distressed Debt Research Analyst
Location: New York City
I am seeking an experienced, hard-working, and highly motivated distressed debt analyst that will cover a variety of distressed situations (pre-bankruptcy, during bankruptcy and post re-org). The analyst will provide fundamental published trade and investment recommendations (utilizing a value investing philosophy), write notes on bankruptcy proceeding, and maintain and update written research reports/database for names under their coverage. The analyst will work closely with me and have the opportunity to take on increasing responsibility over time.
The ideal candidate will have 1-2 years of experience working in restructuring or as a desk analyst at a broker/dealer covering distressed situations. Those with buy side experience in distressed debt investing, along with candidates from legal backgrounds (1st-3rd year bankruptcy associates), are also encourage to apply. I am looking for someone with a combination of strong analytical skills (valuation and restructuring waterfall models) as well as excellent communication abilities. And finally: tenacity, intellectual curiousity, and a strong work ethic are all requirements of the position.
Contact: To apply please send your resume to hunter [at] distressed-debt-investing [dot] com
Note: In addition, I am looking for interns this summer (starting in May). While I do not have a formal posting yet, if you are interested (we had a fantastic intern working for me the past 3 months), please reach out to me with your resume.
A few weeks ago we alerted readers to the upcoming Global Distressed Debt Investing Summit put on by iGlobal Forum. The event is next Wednesday February 20th - I will be there and looking forward to seeing those that attend (shoot me an email if you'll be there to meet up).
This year, like years past there is a great great list of panels/panelists with speakers from funds including
- WL Ross
A few years ago, Distressed Debt Investing interviewed the team from Aegis Financial as part of our Emerging Manager Series. In mid 2012, I spoke with Evan Vanderveer and David Shapiro who let me know they had raised capital for a new fund. Not only that, but the backing comes from one of the best value investors out there: Tom Gayner on behalf of Markel - a firm people often describe as a mini, and possible the next Berkshire Hathaway. That in itself is a massive ringing endorsement and I think, as the interview below will testify, will demonstrate the skill of this emerging manager team. For more information, you can find their website here: http://vanshapcapital.com/ Enjoy!
1. Give us a background on Vanshap Capital. How did the firm come to be? Describe the firm’s approach to investing.
We were previously members of the investment team at Aegis Financial, a highly regarded deep value manager also here in Arlington. We had both been drawn to Aegis because of our interest in—and the firm’s strict adherence to—investing in mostly smaller, undervalued companies. Over the period that we worked side by side, we both began to recognize that some foreign markets were priced less efficiently than the domestic markets we were primarily analyzing at the time. Our interest in global deep value equities evolved into the idea of building a firm solely focused on that strategy.
After pondering how best to raise capital, we decided to reach out to a handful of other value oriented institutions that could be in a position to assist with forming a new firm. The idea was to find someone who really appreciated our strategy and took a truly long-term view. One of the value investors we contacted was Tom Gayner of Markel Corporation. After a series of discussions with Tom and other potential investors, we concluded that partnering with Markel would be a terrific fit, and that has indeed been the case.
Our investment approach is fairly straightforward. The description is “focused global deep value investing.” We own stakes in 15 to 30 public companies located around the world. These companies broadly have low levels of debt, generate high returns on capital, and have strong management teams at the helm. Most importantly, they trade at low multiples of tangible book value or cash earnings. The philosophy is driven by the fundamental belief that a carefully selected portfolio of financially sound, well-run companies selling at discounted valuations should generate above average returns over time.
2. In the current market environment, where are you seeing the most opportunities?
We are seeing opportunities where we typically find them—in smaller, orphaned, out-of-favor securities. In many developed markets, companies with market caps of less than $250 million have very little or no analyst coverage. Specifically, last year, we found the U.K. to be fertile hunting ground. Many of the brokerage firms there have dropped coverage of small caps during or in the few years after the crash. One of our holdings, Dart Group, had a market cap of just £20 million in mid-2008. Today, the market cap is £220 million, but fewer analysts cover the company now than did back then; another well-known broker just dropped coverage. Dart is far from a one off example; we see the same phenomenon time and again when scouring the globe.
We are fond of the John Templeton quote “People are always asking me where the outlook is good, but that is the wrong question. The right question is: Where is the outlook most miserable?” Not coincidentally, we find many of our investments in countries, industries, or specific businesses that are experiencing some kind of ‘misery.’ Often the confluence of small size, lack of attention, and misery create the investment opportunities we find attractive.
3. What influences have most shaped your investment philosophy?
Our driving influence is the overwhelming amount of data that supports the effectiveness of a small cap deep value strategy. According to our analysis derived from the Kenneth French data set, equities in the cheapest decile of the market on a price-to-book and price-to-earnings basis outperformed the most expensive decile by 14% and 10% annually since 1952. Many other studies draw similar conclusions. The data also matches our personalities; we enjoy searching for bargains and are inherently contrarian by nature.
The other influence, on a more personal level, is Scott Barbee, who is the owner and portfolio manager at Aegis Financial, our prior firm. As we mentioned, Scott was our deep value investing mentor, and is similarly driven by data that suggests buying stocks trading at a discount to tangible book value outperform the market over time. Scott is one of the more disciplined investors we know; he refuses to wander from his time-tested strategy no matter what is in vogue. He is highly skeptical of consensus opinion and searches for investments in the most out-of-favor areas of the market. We are forever indebted to Scott for providing a strong foundation to our investment philosophy.
4. What advantages, if any, does your background in high yield investing give you in the world of small-cap value equity?
We would argue our background in high yield investing has provided two advantages. First, we believe debt investors tend to be more focused on the downside scenario or the “margin of safety,” and are inherently less optimistic about potential outcomes. Relatedly, we have trained to closely examine the asset backing of the business and what might be left over if something did go wrong. The second advantage would be strong analytical experience when studying debt structures, covenants, and other more technical aspects of the balance sheet. We believe these skills are important even when investing in relatively unlevered companies to ensure there are no peculiarities when performing due diligence.
5. Coming up on one year since Vanshap was founded, what has been the most difficult aspect of starting your own firm? What advice would you give to others who may be considering taking the leap?
As an analyst, the focus is simply on the investment side of the business. When you launch a firm, there is an entire other role that develops; actually managing the organization. This hasn’t been so much difficult as it has been a change from our previous roles. Thankfully, we really enjoy both aspects. We have purposely structured the business to have as many functions outsourced as possible so we can concentrate on investments and the broader strategy of the firm, while keeping a close eye on our service providers.
Our advice would be to find a high-quality partner, an organization or person that you admire, and build the firm with their support. In today’s environment, we would argue that scale and a proper back office is required to sustain the business over the long term and attract capital from institutions. This is not to say one cannot go at it alone, but we think the partnership route is the more conservative and potentially rewarding model.
6. What type of personality does it take for a person to be comfortable with your investment style?
To answer the question in one word: contrarian. Individuals who want large exposure to the hot stock of the day—the one everyone is suggesting should be bought—will be disappointed with our style. We invest in companies that people are selling or that no one is discussing.
We seek to attract individuals who understand our fidelity to deep value investing, have a long-term focus, and are more prone to add capital in a declining rather than a rising market. As Seth Klarman has discussed, you can have everyone in the country attend the Berkshire Hathaway Annual Shareholders Meeting and only a small percentage of attendees will become ‘value investors.’ We fit best with the few who do.
7. Why do you believe deep-value equities represent a better opportunity relative to other asset classes going forward?
We don’t frankly know if deep-value equities will outperform other asset classes, but we do believe the strategy will outperform other equity strategies over the long term. As mentioned before, we believe the data supports this view. That being said, we think predicting the performance of individual asset classes is a tough game and that reversion to the mean plays a large role. Instead we believe that owning a stake in a handful of undervalued, high-quality, well-managed businesses will produce acceptable returns over time regardless of how other asset classes perform.
8. Vanshap invests in deep value equities on a global scale. Which countries do you find most attractive from a valuation standpoint?
Our answer to the question is driven by what countries appear on our worldwide screens, and those countries are often undergoing some kind of misery. To give you a sense, we have a few investments in Australia, which is currently experiencing a sour economic climate and some industries there are being impacted by “Dutch disease.” We have one investment in South Africa where there are major labor problems and a stagnate consumer environment. Although U.K. small caps have appreciated recently, we believe the austerity and negative sentiment there is creating opportunity. Additionally, we have been looking in the troubled Eurozone countries, including Greece where we have an investment in a large retailer. There are many Korean, Hong Kong, and Japan-based companies on the list. We have looked closely there, but frequently have trouble with the corporate governance.
9. What is your approach to understanding geopolitical risk? Can you describe a specific situation where you have passed on a compelling idea because you couldn’t get comfortable with the geopolitical risks?
When analyzing a potential investment, we pay particular attention to what risks from the political sphere could damage our investment thesis. Have there been recent government seizures of personal property, or is there a strong rule of law in this regard? We ask management about political risk, and they tend to be quite candid when discussing the topic. We additionally search widely in the media for any indication of positive or negative change in the country’s rule of law. However, we believe predicting a political event is just as tough as predicting stock market performance, so we tend to have investments in a variety of countries and regions across the world in case an event does occur.
We looked briefly at a company based in a fast-growing Southeast Asian country. The company makes a lubricant product and has a roughly 63% market share because of a near-monopoly position protected by government tariffs. The business was exceptionally well run and arguably undervalued at the time. However, the company admitted that if the rules governing the industry were changed and foreign competitors were allowed to enter, the profitability of the business would be severely impacted. While there was no real threat at the time, we were concerned that trade protectionism could change at some point, so we decided to pass. The stock has performed quite well and there may well be no shift in the industry.
Conversely, political events can create opportunity and cause stocks to become highly discounted. We have a stake in a Canadian energy company that owns a large acreage position in a prospective shale gas play in Quebec. The government there placed a moratorium on fracking for a few years and the stock has declined by 80% from the highs. Interestingly, we think the company’s other assets are worth significantly more than the enterprise value today, even if fracking in Quebec is permanently banned. So in this case, the political event created the opportunity.
10. What is Vanshap’s approach to hedging macroeconomic risk?
We don’t hedge economic risk in the normal sense of the term with exotic derivatives or anything along those lines. Instead, we attempt to ‘hedge’ by owning a basket of undervalued, high-quality companies from around the world that operate in a variety of industries. Our thinking is “invest from the bottom up, but worry from the top down,” so we try to consider what could go wrong on the macroeconomic front. For instance, how would a Chinese crash impact our investments? We are constantly considering questions like this to try and ensure no one event could unduly harm the portfolio.
11. Tell us about your favorite investment idea.
Our largest investment is the company we mentioned previously, Dart Group. Though the stock has appreciated recently, the business still appears to be materially undervalued. Dart is a U.K. based holding company with three different businesses, although two are intertwined and one is wholly unrelated. Jet2.com is a leisure airline and Jet2 Holidays is a packaged tour business that utilizes the airline. The other subsidiary is Fowler Welch Coolchain, a distribution business that works with many of the large supermarket chains, including Tesco.
Philip Meeson, the Chairman and CEO who owns about 40% of the group, has done a fantastic job since joining in 1983. Over the last decade, he has compounded tangible book value at 19% annually, a remarkable achievement in our view. The record over the entire period is not much different. The business is run extremely efficiently, with a non-unionized workforce and a flexible, largely owned aircraft fleet.
Dart is currently valued at roughly 7x earnings, or 6x earnings net of excess cash, and just slightly over tangible book value. Another way of looking at the valuation is to subtract the value of the distribution business, £50 million which we think is conservative, and excess cash of £40 million. That implies a value of less than 3x EBIT for the airline and holidays businesses, while comparable tour businesses also with internal airlines, Thomas Cook and TUI trade at 6x EBIT. The company reported first-half profit before tax grew 37% over the prior year and the packaged holidays business, Jet2 Holidays, has yet to reach even half of management’s market share goal. We think the group’s brightest days are ahead.
Over the past few years, Distressed Debt Investing has attended the annual Wharton Restructuring and Distressed Investing Conference (here our notes from last year: Notes from the 2012 Wharton Restructuring Conference). The conference is always full of incredible insight (and networking opportunities) for distressed debt and restructuring professionals. This year's keynote speakers is one of the best lists I've seen in some time:
- Golden Tree's Managing Partner Steve Tananbaum
- CEO of SunCoke (high yield issuer) and former CEO of GM Frederick Henderson
- Euro distressed guru Lee Buchheit, Partner at Cleary Gottlieb
- No introduction needed: Ed Altman - the dean of distress.
Distressed Debt Investing will be there as a Media Sponsor. We truly hope to see you there.
For more information, please visit the conference home page here: Wharton Restructuring and Distressed Investing Conference
In the past, Distressed Debt Investing has taken snippets from Baupost's year end letters, which are always a treasure trove of information from possibly the greatest investor living: Seth Klarman. This year's letter is, as usual, simply amazing and below I've stripped out my three favorite quotes from the letter with some commentary. Enjoy!
"As investors have become accustomed to sputtering economies and massive government intervention, episodic "risk-on" and "risk-off" behaviors drive the capital markets. Unexpected bad news means risk off. A stopgap solution to the crisis du jour is offered -- i.e., a bailout, a rescue, a Band-Aid deal, QE(n) -- and risk on resumes. We have been on a roller-coaster ride for the last four years and counting, with no meaningful recovery, no feasible solutions, and ineffectual leadership. Investors conditioned to the short-term trading mentality are increasingly ill prepared for policy changes. What will happen when the Fed declares, as it someday must, that the era of low interest rates is at an end? What if governments holding trillions of dollars of sovereign debt and other securities stop buying and begin to sell? Or if another serious crisis -- economic, political, international -- materializes and governments have insufficient ammunition to intervene? The content, though not the timing, of the next chapter in market history is quite predictable. Few will say they saw it coming, though, in fact, everyone could have seen it if they had only chosen to look."I have often written about hope not being an investment strategy - especially when that hope stems from a central bank put. The fiscal and monetary situation / climate we find ourselves in today would look like Mars ten or twenty years ago. What scares me is that the climate is starting to be regarded as status quo or a background noise in the environment in which we are asked to generate returns of and on our capital base. In the long run, short term pain is always better to push excesses out of the system. Managing volatility (Klarman discusses this later in the letter) conditions investors to environments that, once the rug is pulled out, could be very painful.
"We pursue opportunity largely off the beaten path, sifting through the debris of financial wreckage, out of favor securities and asset classes in which there is limited competition. We specialize in the highly complex while mostly avoiding the plain vanilla, which is typically more fully priced. We happily incur illiquidity but only when we get paid well for it, which is usually when others rapidly seek liquidity and rush to sell.This is the first time I have ever heard the term "compounding multiple conservative assumptions." It really is a beautiful concept. If I use two very conservative assumptions in my calculation of valuation, which estimate of intrinsic value will be substantial (exponentially) lower than someone using a bullish or even for that matter fair assumptions. Oftentimes I've read Klarman using the term "conservative assumptions" and by adding conservative assumption to others in the same estimate for securities one can be comfortable that risk of permanent capital loss is low.
We make no heroic assumptions in our analysis, hoping, instead, that by compounding multiple conservative assumptions, we will crease such a substantial margin of safety that a lot can go wrong without impairing our capital much or even at all..."
In terms of complex securities: Its a place where Baupost shines. Later in the letter, tere is disclosure that Lehman entities make up more than 20% of Baupost's NAV. Lehman (they discuss LBIE) is an inordinately complex situation that few across the street have an understanding (some may understand the valuation, but adding in process and cross border issues makes the situation very complex). The Lehman trade has been a home run for many funds that got involved shortly after the following with capital distributions already ahead of initial purchase price with significant distributions coming over the next 2-3 years.
And finally from Jim Mooney's section on Baupost Public Investment Group:
"Looking ahead, it is quite difficult, as always, to predict what 2013 will bring in the public markets. On some level, much of the landscape appears to be relatively benign, with a seemingly insatiable investor appetite for corporate credit, a broadly held view that Europe is 'fixed' or a least on long-term life support, and many forecasters predicating continued strong performance in equity markets. However, we continue to see many potential cracks in the facade. As anyone with a passing view of credit markets knows, we have entered uncharted territory for flows into the leveraged-loan and high-yield space, and, with that, new lows in yields and default rates. While some would argue that because credit spreads remain near historical averages, the market isn't that overheated, we remain of the view that, at best, the level of absolute yields is yet another manifestation of the overall interest rate bubble and, at worst, is evidence that investors are accepting insufficient returns for the risk they are taking. Whatever the case, we are optimistic that there will be many opportunities for distressed investments in the future."Since the dawn of credit and lending, borrowers have over extended themselves. When the cycle turns, and it will definitely turn (its just a question of when), distressed opportunities and forced selling will abound. It's going to be fantastic.
Hot off the docket: In Penson, a rule 2019 just hit the docket. Here's the listing of funds and holders:
- Pine River
See below for the filing:
On May 29th, 1969, Warren Buffett wrote to the limited partners of the Buffett Partnership, stating:
"The investing environment I discussed at that time (and on which I have commented in various other letters) has generally become more negative and frustrating as time has passed. Maybe I am merely suffering from a lack of mental flexibility...He then goes on to note that he is retiring from running the partnership and alerting partners to the option of maintaining proportionate interests in two controlled companies - one being Berkshire Hathaway.
However, it seems to me that: (1) opportunities for investment that are open to the analyst that stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years; (2) our $100M of assets further eliminates a larger portion of this seemingly barren investment world, since commitments of less than about $3 million cannot have a real impact on our overall performance, and this virtually rules out companies with less than about $100 million of common stock at market value; and (3) a swelling interest in investment performance has created an increasingly-short term oriented and (in my opinion) more speculative market."
Full text here: http://www.rbcpa.com/WEB_letters/1969.05.29.pdf
By exiting the market (he sold most of his marketable positions) he relieved himself and his limited partners the anguish that followed in the early seventies (monetarily and emotionally). He was putting up a ridiculous track record:
And he just hung it up.
Of course, he wasn't just sitting around. He was making the best out of the declining business that was Berkshire Hathaway and harvesting the cash flows of that entity and other entities that he had purchased. And when the market really took a snag and plummeted in the following years, he was ready.
One of the more interesting behavioral finance biases out there is the heuristic of believing what just happened will happen again. Some people call it recency bias. If you saw the world nearly coming to an end in 2009, you probably thought the world was coming to an end again in 2010 despite that fact that world was a completely difference place.
If Warren had kept investing during the years of 1969-1972 his results would have surely been better than the market as a whole given his investment prowess. The question I ask myself: Would the tumultuous period of those three years had a long term impact on his investment psyche and consequently his ability to generate returns well in excess of the market for the following 40+ years?
To be honest - I don't know the answer to that question. The alternative (i.e. hanging it up) obviously worked well for him.
More and more managers have done the sort of ride off into the sunset thing the last few years, hanging off the reigns of their money management empires to #2s or kin. Frankly, I'm surprised we haven't seen more of it in the credit markets.
Simply put: The returns on the high yield asset class are in no way compensating investors for the various risks they are assuming (duration, spread, etc).
Here's what scares me: If 2009 was year when things really started getting better in credit, we could similarly compare that to 2003. The returns in HY were very impressive both years. Let's take that a step further.
A few questions I get often:
- Are the level of excess in the credit markets comparable to that in 2007? I would say not yet, but we are getting there.
- Is credit overvalued? ABSOLUTELY
- Are there things still to do? Of course - THQ bonds are a triple from the lows. But for larger funds its getting harder and harder (to note - its interesting in the quote above from WEB that Warren wanted a 3% position as a minimum size). With that said EVERY single basis point of alpha is valuable to a fund these days
- What about Europe? 2013 might be a bit early. But its going to happen when banks do not have spigots of liquidity flowing into them
Some of the best distressed funds out there also have a mandate to run long only money - buying par bonds because in essence, they have to. It's in essence a game of "Buy the best of the worst possible opportunities out there." And many of those bonds will return in excess of the market for the foreseeable future as these analyst are very good at what they do. The problem of course is that when an asset class is down 20%, and you are down 10%, LPs are still going to be angry.
The duration of the asset class scares me. The spreads scare me. The ferocity of inflows scare me. The terms are downright obnoxious. I can legitimately paint a scenario where with a little rate pick up combined with widening of spreads (it absolutely could happen), on the run high yield will trade in the low to mid 80s. And if you start really seeing stress appear in spreads the new par for high yield could be in the 50s.
Things have felt a shade weaker the past few days. And rightly so. Proceed with caution.