Distressed Debt Analysis - TRX

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

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

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

Next we need to pull, again from the disclosure statement, the estimated total enterprise value, as determined by the financial advisor, which is Rothschild in this case:

As a result of such analyses, review, discussions, considerations and assumptions, Rothschild estimates the total enterprise value (“TEV”) of Reorganized Tronox at approximately $975 million to $1,150 million, with a midpoint of $1,063 million. Rothschild reduced such TEV estimates by the estimated pro forma net debt levels of Reorganized Tronox (approximately $510-$517 million) to estimate the implied reorganized equity value of Reorganized Tronox. Rothschild estimates that Reorganized Tronox’s implied total reorganized equity value will

range from $458 million to $640 million.

So let's also throw that bit of data into the spreadsheet:

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

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

The current government offer (July 5th, 2010) asks for:

• $165M in cash
• $130M in 15% Preferred Stock Convertible to an equity value 10% greater than plan value
• 7 year warrants convertible into 16.7% of reorganized Tronox at an implied equity value of $1.05B
• Certain Nevada assets

I will note of that $165M in cash, the company had already earmarked $145M in cash:

"Up to $145 million in Cash in the form of the Funded Environmental Amount (subject to decrease if total funded debt under the Exit Credit Facility on the Effective Date is less than $510 million, provided that in no event will the Funded Environmental Amount be less than $115 million in Cash as contemplated by the current committed exit financing)"

So using the Enterprise Values above, here is what we get to (no one really has any idea what Nevada is worth so I skipped that part:

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

What about the current disclosure statement?

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

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

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

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

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

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

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Current On the Run Distressed Debt Credits

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

"Hunter, I intend to apply to the DDIC, but want to make sure I write about an idea not yet covered on the site. Could you send me a list of credit that would suffice?"

And because I get that question often, I thought it would be a good idea to turn it into a post.

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

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

Ok, back to the issue at hand: Just by eyeballing it, and combined with current entries to the Distressed Debt Investors Club, here are a few of the more live items that I think would be good additions to the site (and I will probably analyze here at some point)

• AIG, Amgen
• Fairpoint Term Loan
• Sorensen
• CIT
• MBIA
• Mortgage Insurers
• Gateway Bank Debt
• Insight Health
• Majestic Star
• Foxwoods (MASHTU)
• Stations
• Sallie Mae
• GGP (an update at least)
• Nortel
• Neff
• Greektown
• Wamu
• Lehman (no one has braved it yet!)
• Capmark
• Nuveen

I think that is a decent list to get people started. I'll try to tackle one of these a month on the DDIC myself - always good to get comments from other distressed debt investors!

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Tronox: Distressed Debt Re-Visited

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

And the original underlying thesis of the post:

Investment Idea Synopsis

• Recommend purchase of 9.5% Senior Unsecured Notes (Ticker: TRX) at 75 and subscribing to rights offering at $10.40 per share a 40% discount to implied market value.
• Recommend purchase of L+700 bp (2% LIBOR Floor) DIP/Exit Facility at approximately 96(W/OID) at syndication.

As of today, the Tronox bonds are trading 77/79. On July 7th, they were trading in the upper 90s. What gives?

Like most bankruptcies, Tronox's plan of reorganization has gone through a number of revisions. Here is the press release of the most recent change:

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

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

and tort liability to certain trusts to be funded upon Tronox's emergence from

bankruptcy.

Under the Plan:

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

property, insurance and financial assurance assets.

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

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

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

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

interest."

Wanlass stated: "We are pleased to be able to propose a fair and comprehensive package to the government while still achieving substantial recoveries for all of our other creditor groups. While there is much work ahead, the end of this complex bankruptcy is in sight and we will continue to work closely with our stakeholders in an effort to garner their support for the plan before voting

begins. We thank our customers, suppliers, business partners and employees for their ongoing commitment to the company through this process, which has helped us to build a stronger Tronox."

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

Copies of the Plan and Disclosure Statement can be found under the "Reorganization" section of Tronox's website at www.tronox.com . The Plan is subject to receiving the requisite votes from stakeholders, receiving approval from the Bankruptcy Court and satisfying closing conditions. The Plan is subject to change.

Let's parse this. They are creating a trust. This trust will deal with environmental and tort liability, as well as remediation. And this trust will be funded with recoveries that were intended to go to bond holders. The initial plan had these same litigation trusts funded with a $105M rights offering and $10M of cash on hand. As can be seen above, they are getting a lot more than that. Research reports indicate that the delta between the initial plan and the most recent plan was that a number of cities and states were not "in" on the first round of negotiations and thus as these guys became party to the discussion, more stakeholders wanted a larger piece of the pie.

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

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

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Distressed Debt Opportunities

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

Distressed debt funds queue for opportunities

Phil Craig

12 Jul 2010

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

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

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

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

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

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

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

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

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

Investors have been placing money with distressed debt managers in recent months.

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

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

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

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

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

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

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

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

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Money Manager Interview

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

RRHCap Final (1)

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