Distressed Debt Recommendations from Citigroup

This past Tuesday, Citigroup’s distressed analysts presented their respective top picks to a large audience at the company’s high yield conference. As one would expect from a “flow shop” most of the names discussed were very high profile companies with large capital structures. While there were no “hidden gems” unearthed, their team did a great job of elucidating their points. The presentations opened my eyes (wider) to a couple of situations I had previously written off as not worth the trouble. The following is a list of their top picks with a brief synopsis of their thoughts.

AMERICAN GENERAL

• Positive on the entire cap structure (bank debt YTM = 14.5%; bonds 13-14%)
• Not just a sub-prime portfolio – had a different business than most because they knew they were keeping the loans being made
• Thinks they are able to handle the July 2010 bank debt maturity through internal liquidity, bank group extension, or a loan/cash from AIG given the ILFC precedent

CIT GROUP

• Like the steering committee loans because they have ‘B’ yields for ‘BB’ risk
• Thinks the Series B Notes go to par upon emergence
• Estimates $6 bln of book equity, which implies 18 points of additional bond value
• New notes should return 20+% over next 6 months

CHEMTURA

• Bonds trade at 107 area, downside is your claim
• 2016 Notes are structurally senior to other notes
• IF EV > 1.2 bln then you get par on the 2016s
• Upside comes from equity value
• Risk is that you are taken out for cash or reinstated somehow

GM / MOTORS LIQUIDATION

• (Note that GM bonds were marching up to 23 from 17 throughout this day)
• Base case recovery is 29.5
• Q3 #’s show they are ahead of plan
• GM bonds cheaper than Ford equity
• Macro bet on the economy

LEHMAN

• (Citi’s analyst did an amazing job with this presentation. He gave out a 30 page slide deck that I would highly recommend for those with Citi coverage. The bullets below are from the first page alone!)
• Resolution of Lehman’s many estates will be very difficult and there is no way to determine assets and claims with precision
• However, there is enough information to set reliable ranges for many variables
• Estimate base case recoveries of 25-32
• Recovery is most sensitive to changes in asset value assumption, setoff and collection
• Time to distribution and discount rate are next most important drivers

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Distressed Debt Example - Accuride

The applications for the Distressed Debt Investors Club continue to roll in. As noted in previous posts, I am trying to stagger the number of people I admit so people that are just learning about the club get a fair chance to apply through the end of the year and into early 2010. That being said, if you have not heard from me one way or the other regarding your membership status, please give me a few more weeks to wade through all the applications.

Currently 40 members have been admitted from a wide range of hedge funds and buy and sell side shops. You would know most of these funds. The strength of the site is the community that is developing - that and the amount and quality of ideas presented to members. I have already learned of three or four situations that I had never even heard of that look to be quite lucrative.

Here is an example of an idea from one of the members of the site:

Accuride

Synopsis:

Accuride filed for a pre-negotiated bankruptcy on October 8, 2009. The proposed plan gives 95% of the re-org equity to the Sub Note holders. The company's operating assets are conservatively worth $715 mln ($130 mln EBITDA x 5.5x EV multiple). As planned by the POR, a $715 mln EV implies an equity value of ~$537 mln. As such, 95% of the new equity would be worth approximately ~$510 mln, providing a 42% return (on all capital invested). The investment's IRR would be materially higher than 42% as the rights offering purchase of the convertible notes would take place at emergence

Investment Thesis:

COMPANY DESCRIPTION:

Accuride is a North American manufacturer and supplier of commercial vehicle components. The company’s products include commercial vehicle wheels, wheel-end components and assemblies, truck body and chassis parts, seating assemblies and other commercial vehicle components. Accuride management believes the company has #1 or #2 market shares in nearly all of its major product lines. The company’s primary customers are commercial vehicle OEMs, namely Daimler Truck, PACCAR, International Truck and Volvo/Mack. Accuride operates 19 facilities in the U.S., Canada and Mexico and employs nearly 3,000 people. (Source: 2008 10k)

PATH TO BANKRUPTCY:

The commercial vehicle industry, already well-known as a “deep cyclical”, is suffering from its lowest demand levels in recent history. Class 8 truck production is expected to be ~116k vehicles in 2009, down nearly 50% from the past two years. As a commercial vehicle parts supplier, Accuride’s top line has suffered accordingly. For example, the company’s second quarter sales were down 45% y/y. As a result, the company was in violation of its financial covenants under its credit agreement at the end of the second quarter. On July 8, Accuride entered into the first of what would later become five temporary waivers with its credit facility lenders. Additionally, Accuride missed the August 3 coupon payment to its subordinated note holders. On August 31 the company entered into the first of a series of forbearance agreements with its bondholders. Accuride filed for bankruptcy (Delaware) on October 8. The pre-negotiated filing includes a support agreement with 57% (principal amt) of the credit agreement lenders and 70% (principal amt) of the noteholders.

PRE-NEGOTIATED PLAN:

The proposed plan has six key components:

a) $50 mln of a two-tranche new money DIP

b) The pre-petition credit agreement loans will be amended and re-instated

c) The pre-petition notes will be cancelled in exchange for 98% of post re-org equity (subj. to dilution)

d) A $140 mln rights offering of new senior unsecured notes convertible into 60% of the post re-org equity. The rights offering is available to the Sub Note holders and backstopped by the plan supporters

e) The proceeds from the rights offering will be used, in part, to repay the $70 mln “Last-out Loans” made by Sun Capital

f) The pre-petition equity holders will receive 2% of the new equity warrants for up to 15% of the company, subject to further dilution

VALUATION:

Accuride’s enterprise value is conservatively worth $715 mln based on a $130 mln (mid-cycle) EBITDA and a 5.5x enterprise value multiple. I estimate that the new company will have $110 mln of cash at emergence, reducing net debt and increasing equity value.

Mid-cycle EBITDA estimate = $130 mln

- During Accuride’s last trough-to-peak cycle (2002-2006) the company’s EBITDA averaged nearly $120 mln (source: company financials)

- Based on management projections the 2009-2013 trough-to-peak cycle will see average EBITDA of $139 mln (source: 8k filed 10/15/2009)

- Also note that free cash flow should be stronger than in the past as management projects lower than historical capital expenditures (obviously cash interest will be much lower given the new capital structure)

Enterprise value multiple = 5.5x

- Accuride only has a handful of semi-relevant peers. In descending order of relevance I believe the best comps are ArvinMeritor (5.6x 2011E), Allison Transmission (> 6.5x), and Navistar (6.0x). Purchasing AURD 8.5s at $80 “creates the company” at just over 4.0x my mid-cycle EBITDA estimate. Also note that the exit multiple of 5.5x is below that of each peer. Further, I believe new Accuride should trade at a premium to a company such as ArvinMeritor.

RISKS:

- I think there is very limited “plan risk” in this situation, however, if the pre-negotiated plan were to fall apart significant delays could occur, which would negatively affect the estate as a prolonged bankruptcy could cause the OEMs to seek out replacement suppliers.

- Valuation risk should be limited given the conservatism built into my valuation. That said, a lack of confidence in the prospects for the commercial vehicle industry could reduce multiples for Accuride and its peers.

RECOMMENDATION:

Buy Accuride Subs and participate fully in the rights offering. Accuride is a textbook example of a good business with a bad balance sheet. The company has leading market shares in its core products and has delivered low-single-digit operating margins over the past ten years. The model below shows my recovery estimates more explicitly. Note that I am assuming the New Converts are indeed converted on issuance, as is allowed according to the term sheet.

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100th Distressed Debt Investing Post

The most recent post marks the 100th post at Distressed Debt Investing. We could not do have done it without the wonderful support, commentary, and (sometimes) criticism of our readers. We hope to continue to bring you the best commentary and learning tool in relation to Distressed Debt out there.

If you do not mind, please take a quick second to answer our poll below (you can select up to two choices). This will help us to continue tailoring our content to suit reader's needs.

Thanks again,

Hunter

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Interesting Thoughts from a Credit Trader

A friend sent me this commentary from a credit trader at Deutsche Bank. Quite interesting commentary, especially given where credit spreads have moved in from:

In the past month we have been traveling a lot visiting clients and co-workers across the globe. The purpose of this was twofold, first we wanted to sell the New DB to the world. In our opinion we have built the best trading desk on the street and we have made great progress in converting ourself into a flow desk selling idea's and providing liquidity. Second we wanted to get a first hand snapshot of the new buy-side landscape, clearly the world has changed in the past year and we wanted see and talk to some of the new and old players that make up the new mkt. Although we have many more clients to see we would like to provide you with some interesting take aways from my trips.

1) CASH The cash on the sidelines is real and building, there is still billions of dollars on the sidelines and the number is growing everyday. Coupons and bonds rolling off are creating 100mm's a day at individual insurance companies on top fo the billions they already had, this cash may or may not be invested into the credit mkt's but its there and praying for a back up in spreads to deploy into credit. Many accounts are still seeing new mandates flow into the credit space including pension money being allocated to credit from equities thus the buying of 30yrs. There is no indication that the cash on the sidelines and the cash still coming into credit will change any time in 2010.

2) The dollar, rates and spreads We found it interesting that outside the US they are much more bullish on the dollar than many accounts we saw in the US. The dollar and its potential negative impact on rates was given by many US accounts as one the main risks to a continued recovery. We spoke to several European accounts about dollar mandates they either had or were close to getting, if you look at US spreads vs Euro or Sterling mkts its clear why they are interested in dollar debt. Almost everyone expected rates to be much higher at the end of 2010 than today, and that is why the new issue books for front end bonds is out of control. We did not find many accounts that thought spreads would be wider, almost everyone thought that IGs could get to the 60-70 area. That being said most accounts were looking at HY for performance next year, and many spoke about having compression trades on.

3) Basis and leverage We found more basis buyers and we were told by many that they expect basis to go from negative to positive in 2010, and we now have more accounts looking for HY basis than in the past few months. More than a few mkt participants spoke of having more leverage at their disposal now than they have had for some time. Very few thought that the correlation mkt would come back in the form it had but most thought the need for yield in the second half of the year would produce some bespokes with small amounts of leverage. Just a few weeks ago we got hit on some 8yr cds vs a new deal being done, the mkt was split on if that was a one of or if we will see more deals.

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Distressed Debt Investing Loves the LSTA

The LSTA (Loan Syndication and Trading Association) is a group that I really adore. From their website, "The LSTA undertakes a wide variety of activities to foster the development of policies and market practices designed to promote just and equitable marketplace principles and to encourage cooperation and coordination with firms facilitating transactions in loans and related claims."

And why do we adore them? Because, they put their presentations on the web, for all to see. Please follow links to see presentations from their 14th Annual Conference: The Future of the Leveraged Loan Market. I will have commentary on these over the next few weeks.

The Future of the Leveraged Loan Market

Secondary Trading, Pricing and Liquidity

Restructuring: Then & Now

Loan Defaults and Credit Quality

The Future of CLO?

Life After CLO - Where is the Loan Demand Coming From?

Current Legal Themes Affecting the Loan Market Today

Navigating FAS 157

Closing and Settling Loans Today

Recent Legal Developments in the Secondary Loan Market

Investment Grade Loan Update

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