Over the weekend, a reader sent me a question on how I go about finding this to look at in distressed debt land. I may have covered this on the blog tangentially over the past few years, so I thought I would take a stab at it with a summary post.
More often than not, and maybe I am alone in this, ideas kind of fall into my lap. Thinking over the past few months I've spent an inordinate amount of time on MF Global, American Airlines, Jefferies, etc. More specifically, in the past week, all I've really been working on is Petroplus (I have no position one way or the other at this point and will do a post on it later this week). So here is essentially how it went:
- Petroplus bonds down 35% to the high 30s
- Start looking at the bonds
That might sound amazing simple, but really, that is exactly how it happened. I know about 4 or 5 analysts that started looking at the bonds when they dropped in November. I never got a chance to so now I am playing catch up.
With that said, when times are more sanguine than they have been in the past few months, I will use that time to sharpen my pencil on names that had little sponsorship or no hard catalyst but was trading at a juicy yield. I've been looking at Ahern for over a year now flying in the dark as they had not released financials for some time (we got our first glimpse from the bankruptcy filing). I've looked at ATPG for nearly a year now. I've looked at Eastman Kodak (and still really don't have much opinion) for three years now.
In that, I want to know who the players are in a particular situation. On both the investing side and the financial advisor side. If a group of investors are getting together to provide a DIP for XYZ debtor, and I have a position in the name, I want to be part of that group to protect my original investment. "FAs" take a ton of calls from the buyside trying to better understand the dynamics of a situation.
One of the greatest aspects of distressed debt investing is that complexity creates opportunity. Lehman Brother and American Airlines have such rich capital structures, with so many avenues to allocate capital, that an analyst could spend an entire year working on one or the other. Seth Klarman once noted in a speak to Columbia Business School students that Baupost had an "Enron Analyst" - the analyst's sole job was to understand everything Enron and help Baupost make money anywhere in that structure. Because of this dynamic, capital structures themselves present opportunities for me. While this is more than likely in more complex bankruptcies, the fact remains that capital structures are indeed getting more complex with 1st / 2nd lien structure, varying guarantors, etc.
I talk to a lot of other investors. One of the reasons for me starting the
Distressed Debt Investors Club is so I could have an avenue to write to other investors during the day (I have about 500 posts on the member's message board). This inevitable creates a two-way conversation offline where me and another intelligent investor can compare notes not just on a specific bond or equity, but also shares ideas or what we are spending our time on. In addition, I read my "competitors"
SumZero and
VIC for ideas on the equity side that I may have missed. I also read notes and presentations from the sell side's distressed desk analysts to see what is topical to investors and what the market is pricing in.
I read a ton of bankruptcy filings. Too many probably. It's a guilty pleasure. All those references to 363s, lease rejections, cram-downs...Is it getting hot in here? In all seriousness, I try to keep a calendar of all major bankruptcy proceedings coming up and either listen in via CourtCall or know someone attending the proceeding to see if any news comes out that isn't fully reflected in the price at the time. From a
post re-org perspective, I want to know the first day the stock trades (when issued) and want to have an opinion on valuation before that so I can act accordingly.
In addition, and some will call me crazy, but I take a cursory glance at every publicly traded bankruptcy filing that has a listed ticker. Many times the equity in these are zero. With that said, one out of every twenty-five in my estimation is a hidden goldmine. Last year, at one point in time, I had 30% of my personal account allocated to the equity of a company in bankruptcy. The downside was diminimus (there was a stalking horse bid already at above the equity trading price) with substantial upside (someone came in well above the stalking horse resulting in a nice gain). For those interested, you can run the function BNKF in Bloomberg for all bankruptcy filings (Note: This is not for the faint of heart).
Moving back real quickly to post re-org equities, I have a Bloomberg monitor with every reasonably liquid company that has emerged in the last five years showing me all time lows, 52-week lows, emergence price. If something is really ticking down hard, I'll refresh on the situation (I probably covered it in bankruptcy so shouldn't be that hard to get up to speed) and see if I have a reasonable idea on valuation.
I think a way to describe my search process is "pain." Where is the most pain for investors? Where is it hurting the most? Some call it "blood in the water" ... I simply think of it as opportunity. Pain usually is synonymous with forced selling, Taking advantages of forced selling is where money is made for the enterprising investor and that's where you should be looking. Nearly two years ago on the DDIC, I made a quick list of a few these opportunities:
Distressed
- Post-Re org equities - Many investors (i.e. CLOs) can't hold equity and are forced to sell
- CCC downgrade effect (certain accounts can't hold CCC assets or are penalized holding CCCs and are forced to sell)
- Default or hiring financial adviser effect (certain accounts need to sell bankrupt companies)
On-the-run Credit
- CLO "80" effect - CLOs mark purchases above 80 at par. If bought below par, bad issues arise
- Cross-over effect (certain accounts can't buy sub IG credit. When upgraded, natural tightening of spreads)
- Primary versus Secondary Trades: If a deal comes tight in the primary, secondary spreads should also tighten
Equity
- Merger Arbitrage
- Index additions and deletions
- Tax loss harvesting causes irrational selling in the 4th quarter (see Mike Burry)
- New lows cause irrational selling
- Spin offs selling effect
- Dual class A/B arbitrages
- SPAC investing (warrants, arbitrage)
- Closed End Fund Discounts
- Super micro-cap / illiquid stocks
- Thrift conversions
- Busted MLPs
Where else are investors finding market inefficiencies created by forced selling? Would love to hear about them in the comments.
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