Notes from Invest for Kids Chicago 2011

Here is all the action from Invest for Kids Chicago 2011. Enjoy!

Michael Milken – The Milken Institute

• Milken noted that he would ot making specific predictions, but a thematic view of how he sees the world
• Thinks it’s valuable to understand history, and, unfortunately, we never learn from history
• Churchill said that when a solution to a problem is manageable it is always neglected
• It is no surprise why Germany is winning in the EU, their unit labor cost are much less than all the PIIGS
• Germany’s unemployment level is less than 6% vs 21% in Spain
• Northern Europe has routinely the least amount of problems, and Southern Europe has the most
• Valuable to look at 1) Perception vs Reality and 2) Capital Markets
• Perception: What came first the chicken or the egg? The correct answer is egg. Reptiles were laying eggs before chickens existed, and the birds that layed the egg to the first chicken were not chickens.
• You just need a different perspective on the problem to find the solution. Are we asking the right questions?
• The U.S. surprisingly has grown it’s oil production more than any other country in the past 3 years. Volatility created alternative production. North Dakota is the 4th largest producing state. ~ 6% of crude output
• Digital real estate is the important real estate. 6 billion digital phones in the world. Who is going to control the real estate?
• Brazil: Manaus Brazil use to be the rubber capital of the world. Now it is an electronic manufacturing powerhouse. Foxconn is investing 12 billion in Manuas.
• The world is moving east. Of the 50 largest GDP cities, 20 will be in Asia. Half of the European cities will drop of the list.
• Asia has 59% of their population that is 20-34 years old. This is where production and demand will be.
• The middle class is booming in China, Malasia, Thailand, Indonesia, Phillipines and India -This is where you need to invest.
• Milken then moved on to his view of the capital markets by beginning with: What is the American Dream?
• Access to capital is based on ability and not on social status.
• Profit is a function of Financial Capital * (Human Capital + Social Capital + Real Assets)
• Give capital to the productive people and employment booms. Figure out how to empower human capital. It is our largest asset as a nation.
• In the 1920’s the automobile was innovation. 60% of the cost was raw materials and energy. Now innovation is the microchip which is less than 2% materials and energy.
• It is too difficult to get into the U.S. which means we are losing the top minds. Other countries are getting the students that we will not let in. Australia and Canada, Singapore, and the U.K. are developing the best technology because they are talking more students from Asia.
• An example of this is Hollywood. All of the 6 largest film studios were started by someone from within 50 miles from Warsaw, Poland. Think if we would not have let them in the country.
• ½ of all growth is from medical research
• 70% of health is lifestyle, 30% hereditary
• The U.S. is the heaviest country on Earth 36.5% obese
• 1 trillion spent annually on obesity in this country. Think if we could save this just by eating less and changing lifestyle (Apparently we can deep fry butter and dip it in bacon fat. That is why we are fat)
• Education: U.S. spends 2% of income on Education (33% on housing), Asia spends 15% on education
• Moving on to Credit: Credit is what counts. Not leverage. Equity is too small a fraction of assets. This has all happened before. All banks in Texas were AAA, but when the energy cycle busts they all defaulted. We need to be extremely careful how we deleverage because it is a multiple factor on the economy.
• Loans to real estate: Real Estate does not always go up forever it never has. No one knows when interest rates will go up but they know that they will and the cost of homes will go up.
• 4 companies are rated AAA. However, S&P found away to rate 1600 leveraged securities AAA.
• Sovereign debt is by far the worst credit. They always default. Adam Smith noted that countries never pay their debts after they reach a certain point of leverage. Greece defaults 1 of every two years before they were in the euro zone.
• 1974 is important year to study. Interest rates doubled. The market feels like 74. The Nifty Fifty went from a P/E of 66 to 11. Investors lost half their money. Investors flocked to money managers to manage their money. (They could no longer just get by investing int the Nifty Fifty)

Barry Sternlicht (Starwood Capital Group)

Idea: Housing. Homebuilders. Specifically Toll, NVR, Lowes, and HD

• The world is volatile so you have to look for themes.
• Residential real estate is where you want to be based on his view of the world.
• The average amount of house starts for the last decade was 1.1 million per annum. Currently at 300-400k.
• It could not be a better time to buy a house. Low interest rates. Low housing prices. It is cheaper to buy than rent for the first time.
• People are doubling up in rentals. Multi-generational families are growing which is causing housing formation to slow. Lots of pent of demand for houses.
• 3-3.5 million people enter the U.S. every year. This causes the need for 1 million to 1.5 million houses. We are only building 400k.
• Foreclosures and delinquencies are trending down. Prices are coming up and stabilizing. If you drop out distressed sales from banks they are up. Appraisals are hard to come by in distressed communities.
• Sees a rebound in housing starts. People will find a way to finance and buy homes given the demand.
• You could buy levered names but for a turbocharged return but he prefers: Toll, Lennar, DR Horton, and NVR. Specifically, he really likes Toll and NVR
• Toll: Caters to the haves (vs the have nots). Their world will recover first. 23% gross margins, and over a billion worth of inventory in favorable areas.
• Also likes Lowes: LOW owns 90% of their real estate. Earnings will be much higher in a bull market. Not only will P/E rise, but E will rise. You cannot be replaced by the internet. You have to have a lumber yard etc. They have lower margins than HD which they can improve. 71% remodeling exposure. Buying back shares. Have already bought back 13%. Trades at a reasonable multiple. TEV/EBITDA of 6.5x. Can buy back 70% of shares in 4 years. (Reminds him of Teledyne)

Richard Perry (Perry Capital):

Ideas: Fannie and Freddie Preferred Securities and RBS Tier 1 Securities.

• Fannie and Freddie are in conservatorship of the U.S. Government
• The U.S. has invested $107 billion in Fannie and Freddie
• The agencies have $34 billion in PFD, $19 raised in '07 and '08
• Not a litigation situation but it is interesting to look back and see what the government said when the agencies raised those preferreds. It makes you think they may be liable.
• The PFD trade at 8.5 cents on the dollar. This is an asymmetric risk/reward situation.
• The government needs to balance their budget. Could increase guaranteed fees slightly (10 BPS), reopen the mortgage market, and spur the economy
• A 10 BPS raise would result in a $30 billion dollar deficit reduction over 10 years. This helps the government
• Could also convert to common and monetize the government stake
• OMB could improve $65 billion to $150 billion by 2021
• House Financial Services recommended increasing the guaranteed fees
• Likes the asymmetric risk/reward return
• Moving on t RBS Tier 1: 10 billion in non cumulative Tier 1 Securities (preferred). EU directed RBS to stop paying dividends through 4/2012. Pari passu “must pay” trade at a 25% to 35% premium to “may pay”. RBS is a restructuring story. Recapped during 2008. Current Tier 1 is 11.3% vs 4% in crisis. 95% loan to deposit, peaked at 154% in 2008. Liquidity portfolio of £170 is 121% of short term wholesale maturities. Sovereign exposure is £772 or 1.6% of Tier 1. Tail risk is supported by the UK gov which owns 82%. £50 bn equity injection by UK was junior to Tier 1. Dividend on common is not payable unless Tier 1 is paid. Large banks perpetual securities trade at 7% yield. Restoring dividends could save money by making the bank more acceptable to investors lowering interest costs. The preferred coupon is deminimus relative to £48 billion in core Tier 1 capital

Tom Russo – Gardner, Russo, and Gardner

Ideas: Large multinational parent companies (Nestle, Pernod Ricard, SAB Miller)

• Thinking in terms of 10 year investments, not one year
• If people think the S&P could go down because of Europe (13% of S&P revenue from Europe) they would not like his fund which is 70% in non U.S. companies, 30% in emerging countries
• Europe is the place to be. Buy businesses that make their revenue away from Europe.
• Global value investing – “is not for girlie men”L
• Leading multinational firms benefit from: 1) Capacity to reinvest in high ROICS – corporate wide 2) No dividend burdens (opposed to subsidiaries which are in different companies) 3) Corp culture is knowable (ethics) 4) Corp governance 5) Global talent pool 6) Global best practices – SAB Miller uses their lessons learned in new markets 7) Low valuations are available (Europe is loathed) (revenues are not in Euros) 8) Reduce translation risk. (language barriers)
• Likes when you can buy the global parent for a lower multiple than subs: Nestle, Unilever, British Tobacco
• Value Strategy: Looking for 50 cent dollars, capacity to reinvest, capacity to suffer (in other words, a rock-solid balance sheet)
• Nestle: Investing in countries with growing incomes leads to higher value added product revenues. A large ability to suffer (balance sheet). Stayed in Russia during ruble crisis
• Pernod Ricard: Went to China. Large capacity to grow and invest. 15% of profits in China. Family controlled. Not thinking short term. India is a large opportunity in the spirit market
• SAB Miller: Africa: Local brewed beer to bottled beer is a large opportunity in their own back yard. EBITDA margin is down, sales are up. Volatility permits reinvestment. Just bought Fosters.
• Final thought: Money managers also need the capacity to suffer and stick with conviction in volatile markets.

Leon Cooperman: (Omega)

Ideas: Charming Shops, E*trade, KKR Financial.

• Leon noted that Omega is normally a bottoms-up show but in this market you must address the macro environment to “set the table”
• Currently there is record stock and sector correlation
• Thinks the U.S. will avoid recession but will remain in a slow growth environment
• "We need 3% growth to dent unemployment, 9% unemployed, 10% more underemployed"
• All of the global unrest is a result is a result of the economic unrest, wealth disparity, and the uncertainty in government
• We could see riots in US like Arab Spring and UK.
• Europe: Expects ECB to execute bailout
• Obama wants to tax workers and punish savers: 50% of people are on the public dole, do not want a change
• 2012 will be a test. “If the president is in trouble, the market is in trouble”
• By the Fed Model, equities are cheap. Yields are higher than interest rates. Average P/E is 15, average treasury yields 6%. Yields today are 3% and P/E is 12x.
• Equities are cheap. They are the best house in the asset neighborhood.
• The ten year could jump to 4-6% which would be a big loss in the bond world. Not the place to be. Rather be in credit than bonds. Rather be in stocks than credit
• Charming Shops: Management needs to get out of Fashion Bug and sell Layne Bryant. No net debt. Lane Bryant alone worth 2x current stock price
• E*Trade: Great business but invested in mortgage bank. 13.8 billion invested in mortgages. 700 million rolls of every quarter. Earning 80 cents per share. 100 million loan loss provision. 1.5 billion in debt yielding 9%. Improved credit could add 40 cents per share to earnings. A strategic M&A asset in the brokerage
• KKR Financial: Dividend yield 9% covered 2x by earnings. 28% below book

Mark Lasry (Avenue Capital)

Ideas: GM and Hovnanian

• GM: Had the largest market cap at one point a number of years ago $12.2 billion. In 2000 revenue surpassed Wal-Mart. Trades at 1x EV/EBITDA. People forget Apple needed a $150mm investment from MSFT. Now it is the largest company. Apple trades at $370 billion, with EBITDA of $35.6 billion. Avenue bought the bonds to create GM at 2x EBITDA now he is pitching it at 1x. US government owns 1/3 of GM, people are trying to find the right time so that they don’t buy in front of the government sale. Now is actually the right time to buy, when everyone knows the government is going to sell. Comps trade at 4-6x (Except Ford trades at 3.1x). So GM could go up 4x. Ford 3.1x, Honda 4.4x, Toyota 5.6x, Hyundai 5.9x.
• Hovnanian: 7th largest home builder. Housing starts use to be 1.5 million, now 0.3-0.4 million. People will buy homes, the question is a matter of when. Interest rates are low, everyone wants to time it but they cannot. Buy the Senior Unsecured Bonds. Get paid to wait. HOV has a billion dollar NOL. Senior Notes trade at 35, current yield is 20%, (6.5 coupon). They have 350 million in cash on Balance Sheet. 1 billion dollars in land inventory. “Everyone knows this market will turn a question of when” You don’t need the economy to grow faster than 1% for this to work, their view is 1% is the most probable outcome. If Europe defaults this will go down, but you are getting paid to take that risk

Michael Elrad: (GEM Realty)

Idea: Class A malls, specifically Macerich

• Can you invest with conviction in a volatile market?
• GEM looks at investing in 3 stages: (Top down, bottom up, and hedging)
• Their top down analysis led them to Class A malls. Only way to buy Class A malls is through public companies (Simon, Westfield, GGP, Macerich, Taubman). 5 public companies control 80% of the Class A malls
• 15 years ago retailers were declining. In reality, the fittest retailers survived and now the standing retailers are stronger credits and tenants are more diversified.
• Today tenants pay more rent and have better credit
• Sales per square foot have rebounded from the 2008/2009 period
• NOI has been stable, even though retail sales have been volatile
• Lost very little occupancy during recession
• Currently stocks are 20% below their estimate of fair value
• Macerich is 10% discount to peers. Recommending a 3 year long in Macerich (MAC). Macerich has a 4.9% yield, NOI growth 3% in 2012. 84% of assets are class A. Debt is 45% of EV. 10% discount to big 5. Could be added to S&P. Destaggered board, could be a take out candidate. Approximate a 12% IRR over 3 years. 17% in upside case. To hedge short Class B properties and strip malls (50% hedge ratio)\
• Do not need to hedge internet risk, because strong internet companies need Class A space to enhance their brand (Apple).
• This is the future of retailing: "The show room for the online presence"

Barry Rosenstein (Jana Partners)

Idea: McGraw Hill

• This ideas reminds him of the 1980s. Companies with great assets that fail to create value. 3 reasons: Complacent boards, family CEO asleep at the wheel, Empire building. Or all 3.
• McGraw Hill: 4 groups: Ratings, Financial Data (CapIQ, Ratings Direct), Educational text Books, Platts
• Stock manages to under-perform year after year
• Capital allocation is inefficient
• Education needs the most capital but has the lowest returns on assets and growth
• Bloated cost structure because of conglomerate nature
• Impossible for analysts to value the sum of the parts
• Management has committed to buy back shares, and cut costs
• There is more to do: Education is better on it’s own, can take leverage to lower cost of capital (can’t get rated because of S&P currently); Private equity could buy it
• Platts could trade 5-6x turns higher than conglomerate value
• They can take out $200 million of costs per year, 6-7 dollars per share in value
• 15% of market cap buy back over 2 years
• Break off Platts, Financial. Suitors include Bloomberg, Reuters. Could get a high teen multiple
• Ratings business is not as bad as it seems. Regulation could make it harder for entry into the business. Real size of claims is smaller than people think. Small number of cases survive.
• Should trade at $60 per share or 40% upside.

John Keeley Jr.

Ideas: ITT, CFFN, ORIT, VPFG, RCKB, TBNK

• Focus on spin offs, below book value, distressed utilities, S&L conversions, and emerging bankrupt companies
• Spinoffs drift: not in an index, institutions sell, Individuals sell, no street coverage
• Case Study: Charles Tandy. Learned from all his spinoffs
• Average 33 spinoffs per year
• Idea is ITT: Jan 12 ITT separated into ITT, Xylem, and Exelis. Xylem is fairly valued, Exelis is undervalued. ITT has a good niche, is unlevered, can make bolt-on acquisition, and has room for multiple expansion.
• S&L conversions: CFFN, ORIT, VPFG, RCKB, TBNK
• S&Ls have to wait one year to pay dividends, 3 to be acquired
• TBNK and VPFG are coming up on their 3rd year
• Dodd-Frank is going to force all of these companies to look for an acquirer. These are the ones they like. Buy the package.

Sam Zell (Equity Group Investments)

• Globalization has already happened. GDP of Emerging economies equals GDP of developed. The trend is only beginning.
• Developed world has a Damacles sword hanging above it: Demographics
• If your population grows, productive investments will follow
• By 2050. Japan will be one to one. Retired vs. working. Sees no reason to invest in that environment
• The developed world is “hungry”. People have aspirations. They are confident
• Brazil: 25% of people in middle class. Going to 65%. Has 180 million people. Self Sufficient in food, energy, and water. Young and upwardly mobile population. Educated workforce. Brazil has pent up demand for products. 7 million houses under demand. Interest rates are high, inflation is high, expected returns are high. There is real demand for capital and that is why rates are high. Need to have a solid partner, cannot go in alone. Brazil reminds Zell of the U.S. in the 1950s. The people are extremely confident in themselves.
• Trade rule of law for growth in developing countries. He is not ignorant to the risks.
• Emerging markets are an extraordinary opportunity. Where do they need capital the most. Where are the highest returns?

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List of Pitches from Invest for Kids

Today, Distressed Debt Investing was in attendance at Invest for Kids Chicago, where top money managers pitched ideas to an audience of approximately 800 in attendance. While we are still in the process of cleaning up our notes (Edit: Notes have been posted here: Invest for Kids Notes), here is the list of stock picks from the conference:

• Leon Cooperman of Omega Advisors: Pitched KFN, ETFC, and CHRS as his top ideas, but also mentioned Apple, BSX, SLM, Energy XXI
• Michael Elrad of GEM Realty Capital: Pitched MAC
• John Keeley of Keeley Asset Management: Pitched ITT and a basket of S&Ls: CFFN, ORIT, VPFG, RCKB, TBNK
• Marc Lasry of Avenue Capital: Pitched GM as well as HOV bonds at 35
• Michael Milken from the Milken Institute: No specific tickers but pushed emerging markets as where to be (invest where middle class is growing)
• Richary Perry of Perry Partners: Pitched GSE Jr. Preferred Securities and RBS Tier 1 securities
• Barry Rosenstein from Jana Partners: Pitched McGraw Hill
• Thomas Russo of Gardner Russo & Gardner: Focus on companies with emerging market value growth plays like Nestle, Pernod Ricard, SAB Miller
• Berry Sternlicht of Starwood Capital Group: LOW was his top idea then TOL and NVR (home builders in general)
• Sam Zell of Equity Group Investments: Again no picks from the grave dancer, but talked about companies that cater to the Brazilian middle class

We should have our full notes up by the end of the week. Stay tuned.

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Distressed Debt Research - Dynegy

Yesterday, Dynegy Holdings, LLC and four affiliated entities filed for Chapter 11 bankruptcy protection in SDNY.

For those looking to play along, you can find the Dynegy docket here:

Dynegy Holdings Docket

Before we dive into the filing, I first want to lay out the Dynegy organization chart as it is imperative to understand the case:

Dynegy Corp Structure Chart

The Chapter 11 filing comes with Restructuring Support Agreement, and associated Term Sheet, signed by Dynegy as well as prominent distressed investors (that hold $1.4 billion of Dynegy senior notes) including:

• AEGON USA Investment Management
• Avenue Capital
• Caspian Capital
• Franklin Advisors
• Venor Capital Management

As was reported in the press, Dynegy, Inc (the public company) is not filing for bankruptcy. The bankruptcy filing really relates to the leases on the Roseton & Danskammer facilities and the associated 7.67% Pass Through Certificates.

The plan contemplates unsecured noteholders of Dynegy Holdings receiving a package of cash and securities:

• $400M in cash
• $1B of 11% Secured Notes issued out of Dynegy, Inc (the public holding company) backed by equity in GasCo and CoalCo (more on this later) - this amount if fungible based on lease rejection claims coming from the Roseton-Danskammer leases
• $2.1B of Convertible PIK Notes again issued out of Dynegy, Inc due 12/31/2015. If the notes are still outstanding at maturity, they will convert into 97% of DYN equity
• Specifically to the holders of the subordinate 8.316%: The plan contemplates, a 25 cent on the dollar treatment in lieu of contractual subordination ($200M outstanding for a total claim consideration of $50M)

We will attempt to value this package shortly.

A bit of background: Earlier in the year, Dynegy announced a restructuring and refinancing that moved and ring-fenced the majority of the company's assets to two entities known in the credit markets as GasCo and CoalCo. These entities secured bank debt financing which was used to refinance debt, extend the maturity profile, and bolster liquidity at Dynegy Inc. Legacy bondholders though still benefited from significant equity value in both of these entities. In a second step though, contested by other prominent distressed funds (now stayed), CoalCo's equity was transferred from Dynegy Gas Investments to the ultimate parent company, which sets above the bondholders, and thus out of their reach.

You can read more about that transaction here:

Avenue Capital Et Al Complaint 9-21-2011 (2)

It is important to note that the Delaware Chancery Court did not view this transaction as constituting fraudulent conveyance.

Moving on to Roseton-Danskammer: In his declaration in support of the Chapter 11 filing, Kent Stephenson, EVP and General Counsel of the Debtor stated:

"It is my understanding that, before the commencement of these chapter 11 cases, the Debtors engaged in discussions with representatives of both the PSEG Entities and certain of the Pass-Through Certificate Holders seeking to consensually restructure their obligations under the Lease Documents. These discussions ultimately proved unsuccessful. During those discussions, the Debtors indicated that, absent a consensual resolution, a bankruptcy filing by the Debtors was likely and that, in such case, rejection of the Lease Documents was probable. Upon information and belief, representatives of both the Pass-Through Certificate Holders and the

PSEG Entities have analyzed and prepared substantially for the relief requested in the Motion to Reject. In fact, the Owner Lessors have had several months’ notice of the Debtors’ precarious financial situation and the likelihood that the Debtors would be forced to seek the relief sought herein if an acceptable out-of-court restructuring could not be accomplished. Public filings issued by the Debtors’ affiliates were clear on this point."

According to the filing, there is $550.4M of the 7.67% Pass Throughs outstanding (Series B). In fact, on November 8th (i.e. today), there was a ~$82.5M lease payment due for the two facilities.

This pass through relates to a sale-lease back transaction on the Roseton-Danskhammer plants in May 2001. The plants were sold to Public Service Enterprise Group, where PSEG contributed $138M of equity to fund the purchase with the balance secured from the two series of pass through notes. To note, these are old plants, and specifically on the Danskhammer side, the declaration notes that the facility will require $375M of capex by 2014 to meet EPA regulation.

As a rejected lease claims, Dynegy expects the maximum claim from these leases to be $300M as governed by section 502(b)(6). This stipulates that the maximum lease rejection claims can be the greater of 1 year's rent or 15% of the remaining term (not to exceed 3 years). With that said, holders of the Pass-Throughs as well as PSEG has commenced litigation a number of times over the aforementioned restructuring transactions:

The litigation commenced by the Indenture Trustee is currently pending in the New York Supreme Court. The PSEG Entities sought injunctive relief in a lawsuit filed in the Delaware Chancery Court in July. The Delaware court denied plaintiffs’ request and both the Chancery court and the Delaware Supreme Court denied plaintiffs’ requests for interlocutory appeal. Plaintiffs' then voluntarily dismissed the Delaware action in August, 2011. The same PSEG entities filed another lawsuit in New York Supreme Court on November 4, 2011 asserting many of the same claims which the Delaware court found unlikely to succeed. That lawsuit remains pending. The Pass-Through Certificate Holders’ case was voluntarily dismissed in favor of the Delaware action.

Moving on, from the DYN 8K today: "It is a condition precedent to the consummation of the Restructuring that the rejection damage claims arising therefrom do not exceed $300 million." with Dynegy being able to waive this is rejection claims come in between $300-$400M (and needing approval if more than this).

Throughout the day today, there were many many markets being made on both the cash bonds and the triggered CDS of Dynegy. It felt like the 8.375% senior unsecured notes due May 1, 2016 were the most liquid cash bonds of the day which went out 75.75-76.25 Here is a chart:

Quick note: This bond will trade slightly higher than the rest of the complex due to the larger claim as a result of accrued interest.

As you can see, bond prices rallied very hard today and over the past two-three weeks.

The question then becomes: What is this thing worth. It really hinges on three things:

1. What you believe the price of the new 11% Secured Notes will trade to
2. What you believe the price of the new Convert notes will trade to
3. And to a lesser extent - the probability / chance that Roseton-Danskhammer rejection claims are significantly more than $300M and the whole plan has to be re-worked

Stepping back a bit: There is $3,570M face value of bonds outstanding at Dynegy including the aforementioned sub notes. I then gross up this value based on accrued pre-petition interest. For instance, the 8.375% notes have $1,046,834,000 outstanding. Each bond has about 4.4 points of accrued interest meaning the total claim is $1,046,834,000 * 1.044 ~ $1,093,000,000.

Each bond is grossed up by the accrued interest. Then I adjust the sub notes to 25% of claim as discussed in the restructuring support plan agreement. I then assume $300M of rejection claims from Roseton-Danskhammer.

This is somewhat important because according to the restructuring support agreement:

"If the aggregate claims arising from the rejection of the Roseton / Danskammer leases are allowed by the bankruptcy court in an amount that is less than $300 million, the aggregate principal amount of New Secured Notes shall be reduced by an amount to be agreed for every dollar such claims are less than $300 million. If the allowed claims exceed $300 million and the condition to consummation of the chapter 11 plan requiring such claims to be capped at $300 million is waived as set forth below, the aggregate principal amount of New Secured Notes shall be increased by an amount to be agreed for every dollar such claims exceed $300 million. The adjustment amount to be agreed for increases in the New Secured Notes shall be the same as the amount for decreases in the New Secured Notes."

Bringing this all together, I see approximately $3,850M claims. Of this, each bond will have a different percentage of % claim based on the size of the bond and its accrued interest. Our 8.375% notes for instance have 28.3% of the claims.

We must then apply this 28.3% to the value of the package being received:

• 28.3% * $400M of cash = $113.2M
• 28.3% * $1 Billion of Notes = $280.3M * Assumed Trading Price of Bonds. I actually am more bullish on this piece of paper than the market given how much equity I think there is at GasCo and CoalCo (which secures the new notes). I assume that they trade at par+ (whereas many people are saying in the low to mid 90s). So $280.3 * 100 = $280.3
• 28.3% * $2.1 Billion of Convertible PIK Notes = $594.3M * Assumed Trading Price of Bonds. This is where things get real messy, and truly believe the swing factor here given the size and uncertainty of what will happen with this security.

With the market trading price of the existing 8.375% senior note at 76, the market is implying (assuming par on the secured notes), that the convert will trade to ~74 cents on the dollar. (To check math: $113.2 + $280.3 + (74% * $594.3) = $833.3 /$1,093 = ~76.

To me, that feels right (mostly based on the PIK, and subordinated nature of the security), but I think there is upside there for 2.5 reasons:

1. Aforementioned equity value of GasCo and CoalCo flows through to the Converts after deducting for 11% Notes. I would expect an IPO of one or both entities after litigation is resolved.
2. The incentive factor here: If the converts are not called prior to 12/31/2015, they are then convertible into 97% of DYN's equity. It is imperative for equity holders to deal with this security prior to that. Of course, when you got Carl Icahn calling the shots, you never know what you are going to get as a bond holder

And reason 2.5 -> If you are bullish on the power market, this is a very (VERY) levered way to play recoveries in the power market (where demand, in theory, eventually should increase in a time when no new supply is coming to the market.

With that said, at today's prices there is not enough pessimism priced into the bonds to get me overly excited. I would play in small size and then wait for some sort of scare on the litigation front or the power markets to add to my position. This will be a fascinating bankruptcy to follow after what happened with Mirant 5 years ago. We will keep you updated as the trial (s) proceed.

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Third Annual "Invest For Kids" Conference

This coming Wednesday (November 9th), the third annual "Invest For Kids" Conference will be held in Chicago. Inspired by the Ira Sohn Conference, Invest for Kids supports organizations in the greater Chicago area that serve children and youth. 100% of money raised (you heard that right) will go directly to local Chicago children's charities.

This year the list of speakers is simply amazing:

• Leon Cooperman of Omega Advisors
• Michael Elrad of GEM Realty Capital
• John Keeley of Keeley Asset Management
• Marc Lasry of Avenue Capital
• Michael Milken from the Milken Institute
• Richary Perry of Perry Partners
• Barry Rosenstein from Jana Partners
• Thomas Russo of Gardner Russo & Gardner
• Berry Sternlicht of Starwood Capital Group
• Sam Zell of Equity Group Investments

I think this is going to be a simply fantastic event with market moving presentations from this elite group of speakers. I hope everyone able to attend can make it this year.

You can find more information, or purchase tickets here: 2011 Invest for Kids Conference

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"A View from the Buyside"

Last week, the LSTA hosted its 16th Annual Conference. The LSTA does a fantastic job at these conferences, and in fact puts up every slide deck from the various presentations on their website. You can see them all here: LSTA's Annual Conference Slide Deck

One panel in particular I enjoyed and took detailed notes on was entitled: "A View from the Buyside." They have a similar panel every year and it gives an interesting and detailed look at some of the current trends in the leveraged loan market. The lineup of panelists, as usual, was a really great group of buyside practitioners that offered an inside look on what's going on in the market today.

The panelists included (with associated abbreviations for the notes below):

• Beth McLean (BM) – Executive Vice President and bank loan portfolio manager at PIMCO

• Leland Hart (LH) – Managing Director and Head of the Bank Loan Team at BlackRock

• Greg Stover (GS) – Partner and Head of Fixed Income at Stone Tower

• Dan Norman (DN) – Senior Vice President and Group Head of the ING Investment Management Senior Loan Group

  
  

Note: I've organized the below into a question / answer format, with the associated responder notes by the above abbreviations.

Question: What is the outlook and current situation in regards to retail funds flow (LH):

• Relatively optimistic on flows, though earlier in the year when it became clear that rates wouldn't move up in any way you lost a lot of lows.
• The amount of liquidity being provided by the dealer community is tremendously low so moves were fast to the downside.
• Going forward as vol goes down, what's paying a lot in fixed income is high yield and loans and we will see flows coming back into the space

Question: We have seen a number ETFs focused on the bank loan / floating rate space. What is your outlook for these sorts of products (DN):

• These ETFs are essentially income products that benefit towards the overall move of the global investment community towards income orientation
• Typically these products come to market 6-12 months after positive total returns. Four closed end funds in first half of 2011 where very opportunistic at that time.
• Year to date, 19 fund filings for additional CEF, ETF into the asset class. - but all were before the July / August volatility
• A product like this will thrive when there is very little volatility in returns. Loans don't have the returns to weather another 4^th quarter of 2008.
• Fed Policy has not done any favors. Retail, who this product is really marketed to, doesn't understand LIBOR floors.

Question: What is the current situation in terms of capital raising on the institutional side (BC):

• A saying at Pimco is “Practice safe spread.”
• If you are looking for a sleeve of fixed income with strong fundamentals, maturity schedule pushed out, low default rates, recovery rates higher, seems like a good time to invest in asset place.
• New issue premiums are attractive now to total return investors.

Question: Can you discuss the product innovation from sell side (GS):

• This is really an evolution more than revolution. In other words, you have to ask yourself in the product better bought or better sold?
• Amend-extend attractive to CLO b/c if vehicle is entering non reinvestment period can still extend duration of portfolio.
• For example, the recent Kinectic Concept loan: Lead arranger Bofa went to a large audience (largest LBO since sell off), and one thing they did was carve out a 5 year tranche being sold into vehicles that couldn't invest in the longer piece due to indenture restraints.
• Growing amount of reinvestment period CLOS – by end of 2012, ½ of CLOs will be passed reinvestment period. Lots of buying supply coming out of the market.
• More market driven things: Some movements towards consolidation of loan and high yield (drive-by loan deals). Also seeing a shortening of launch to commit date.
• Rolling incremental or add-on loans: makes loans look a lot more like high yield.

Question: What is your outlook for the amend extend. We saw a significant amount in the 4th quarter of last year running into the 1st quarter of this year (BM / DN):

• You will see a lot of amend-extends coming down the market, especially those due 2014.
• Beth told all corporate treasurers if they hadn't extended their loan, they should do it now
• Hopeful that buyside will be disciplined in working with arrangers to get good terms - she mentioned specifically true call protection
• The new pricing has to meet current levels of secondary market to play the amend-extend as well as trying to add in covenants.
• One interesting technical issue companies have had to deal with is when only a small portion of loans extend. The non-extended piece knows the company has to roll that more recent maturity sometime in the near future, and are probably waiting for a bigger pick up in spread and / or terms...Community Health is a great example

Question: What is the chance that new CLO's pick up the slack where older vintages are leaving the market because of reinvestment windows closing (LH):

• Prospects change week to week because of the volatility and the arbitrage (both liability and asset side spread volatility are high.
• Real drivers will be who can raise new equity. If you can find equity dollars, the structure (either CLO or TRS) will fall behind.
• Market will exist but will be smaller. Until further equity comes into the asset class, it will be slow going
• Liabilities haven't come back as fast as the asset side of the equation – makes arbitrage difficult.
• The arb is very difficult, especially if you haven't been warehousing

Question: What about other products to pick up the power power (DN):

• Asset and liability prices are changing on different variables.
• June was a great time to close but if you waited 2 weeks it would have been impossible.
• Who is the marginally buyer of loans? It was structured buyers. It was a rating arb.
• Now, its institutional buyers and they are saying why not just own the outright asset. This leads the panelist to believe the market see simpler structures
• At beginning of year, equity investors were more comfortable taking the first loss piece, since June and especially August very difficult to find first loss risk

Question: Another question on loan innovation and growing the base of institutional buyers: (BM)

• Need to be paid for that volatility. The assets spreads need to stay up where they are today.
• What is happening in Greece shouldn't affect the loan class but it does because it affects those making markets.
• Call protection is good but soft call isn't really good enough (bond take out).
• Need to also improve settlement funds (15% pf trades settling at T+30).
• Structural changes, for example borrower approval of assignment. That just needs to be taken out of the market immediately

Question: Pension Funds have always been the holy grail of loan investment managers. What's the likelihood pension money flows into the asset class (DN):

• They are the holy grail. If Pensions go from 0 to 2% or even 2-3%, it will be a massive number.
• They want capital gains and income. Entry point today for loans: high yield like returns with senior securities.
• Though, pensions are long term strategic allocators. They have many meetings and then will dip their toe in.
• Allocations started to pick up in 2010, escalating in the first half of the year, but given the events of July/August, flows have been neutral (not not interested, but want the right price).
• Will loan prices go down? Loans seem to be 100% correlated with risk assets meaning given everything going on, loan prices will go down.
• Pensions like the investment thesis, and the panelist would love to see them pick up where the CLOs will drop off.
• Though again structural changes are needed: CUSIPs on every loan. Automation. Improving trade price and market clearing clarity. Structure → call protection, want senior secured structure with price protections like HY bonds
• Insurance companies, more-so than most, want covenants

Question: What is the future of the covenant light structure (GS):

• Will get back to 20% on covenant lite.
• Seeing reasonably better call protection that the past (NC structures).
• When market heats up, that will go by way-side. Right now, there is a deal in market with 6 month call protection.
• We will continue to see LIBOR floors in the market. Only way for this asset class to compete is LIBOR foors and high credit spreads.

Question: Outlook for returns in the marketplace relative to other asset classes (LH):

• 80% of returns in fixed income in last 20 years has been duration driven.
• What the panelists thinks you are going to see is not investors running from duration, but more questioning it.
• You'll see high yield and loans become more fundamental driven by credit spreads versus investors guessing on duration.

Question: Outlook for default rates (all panelists):

• (GS): Think 2011 will represent a trough in default rates, depending on economy, big worry is lower quality high yield and those from the 2007 LBO boom. As you get further out in 2013/2014, you will be subjecting default risk to the capital markets (i.e. can you kick the can down the road further)
• (DN) Default rates being macro path dependent, 2-3% next year but with component of tail risk. Further out, completely path depending on economy, 3-4% default rates
• (BM): 2-3% in 2012 and 2013, big jump in 2014 (TXU is 2% of index, people will start reporting defaults ex TXU): 2014 will be 6-8% in the big LBOs
• (LH): In 2014, those that can't amend-extend, will hit a wall.

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