Third Point 4Q 2012 Letter

Today I received Dan Loeb's Third Point Fourth Quarter 2012 Investor Letter. As usual its a fantastic read (embedded below). As has been reported in recent weeks, Third Point made an absolute killing getting long Greek sovreign debt. Assets under management now top an impressive $10B.

A favorite quote from the letter: "We dug deep beyond the frightening headlines and conducted in-depth research on the state of political and economic affairs globally, helping us develop a variant view and giving us confidence to deploy capital. Our ability to generate returns was boosted by a breakdown in correlations, and this shift provided the key for us to deliver alpha across asset classes, sectors and geographies."

Loeb goes on to discuss their position in Herbalife and lays out a very compelling case for a long position in the stock. His take-away: "Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point. Given that the Company has historically traded more in the 12-14x range (and traded at 16-20x earnings through much of 2011 and early 2012), the opportunity for the Company to tell its side of the story tomorrow at its Analyst Day in New York, and the significant short interest, we believe shares could even trade well above our current price target."

Loeb also discloses positions in Morgan Stanley and Tesoro Corporation.  You can read the long arguments in the letter below. Enjoy! thirdpoint.4q12investorletter.010913

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Distressed Debt: THQ Bankruptcy Update

After adjourning its first hearing today, THQ reconvened at 3:00PM and announced that a compromised was made among various parties. A form of order has yet to be presented but the general takeaways:

• Bids are due 9am January 22nd
• Auction will be held 3pm on January 22nd
• Sale Hearing January 23rd at 9am
• The auction will allow for bidders to bid on only certain assets (titles, studios, etc) in the auction

Other details from the hearing concerned the minimum overbid which was reduced as well as the extension of Clearlake Capital's DIP term loan to January 25th (as an over-advance line).

In the morning hearing, it was announced that Clearlake Capital's bid would remove the $10M 2% note they originally had offered in exchange for extending the auction deadline. One thing to note: It remains to be seen how much secured debt (and for that matter assumed liabilities) will there actually be on the auction date. It was noted in the hearing this morning the company has begun the "slow pay" its bills which would alleviate need for cash but in theory increased assumed liabilities to a purchaser. As has been noted in the hearing, Clearlake can pick and choose which liabilities its assuming, but their counsel did note that it would be a more concrete number (to determine overbids) at the auction.

Currently bonds are trading in the 15-16 context. I had heard from traders on Friday that bonds were difficult to find (the issue is only $100M) but some bonds have traded this morning.

For bondholders, the only recovery (under Clearlake's stalking horse bids) they were going to receive was the $10M promissory note which seems to have been pulled away. If any of the parties involved (so far EA, Warner Brothers have been named in court) bid for all or just some of the titles, there is a chance bond holders could see a recovery here. Exact bid procedures have yet to be filed so I do not have a good assessment on how bids will be evaluated.

For instance, what happens if two studios are purchased for an aggregate consideration more than Clearlake's bid but the remaining studios need to be wound down? That may actually drain resources from the estate for wind down expenses.

For what its worth, when I first saw Clearlake's bid I wanted to be an LP in their fund because they would make a fortune off their purchase price. Given the way cash flows will begin to pick up (and possibly roll in if they are successful, not to mention cash already overseas) at THQI after their two releases in the first half of this year, with which a lot of developmental costs have been already spent, the return to Clearlake would have been impressive.

A few questions remain: Where are the massive swings in potential unsecured liabilities (from the first day affidavit) from Europe arising from? No one has given me a good answer on that. Why hasn't bond holders (or strategics for that matter) stepped up with their own DIP?

As we get more answers, we will update readers, especially after new items hit the docket.

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THQI Reconvening on Monday (more coming later)

After an very, very long hearing, Judge Mary Walrath, a favorite of mine, did not approved the DIP motion or bidding procedures motion in the THQ case. She instructed parties to discuss and work out their issues over the weekend and set a new hearing on Monday. I will be writing a more thorough post this weekend on the day's events.

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Distressed Debt: What I Will Remember About 2012 and a look to 2013

As investors, we are bombarded with information. Whether it be macro news, political turmoil, or earnings releases (just to name a few), its oftentimes hard for investors to filter out the noise from things that actually change the intrinsic value of securities. With so many things happening through the year, the one thing I'll remember about 2012: equity recoveries in bankruptcy.

Do not get me wrong. When I tell friends or family about what stocks I am invested in, most of them think I am speculating on some pump and dump scheme of a failing company. Maybe I monitor Twitter or Yahoo message boards for the next stock that's going to EXPLODE. Look at most of the stock message boards for companies entering the Chapter 11 process and you may go blind and/or cry.

2012 was different. In 2012, there were huge returns to be made by diligent investors invested in the bankrupcies of certain equities. During 2012, I was invested in (and in many case still invested in via the liquidation trust)

• CDCAQ
• CDCSY
• AGUNF
• TRIDQ
• CAGAQ

Of those five, I am currently still involved in 3 via the liquidation trusts as well as being invested in the HEARQ liquidation trust which was a 2011/2012 event.

If Europe imploded, or China went into a deep deep recession, maybe my returns would have been lower than what they printed at for the year. But probably not terribly different because at the end of the day, the macro news (noise) had little effect on the intrinsic value of these securities.

I do not remember a year when there was so much money to be made in bankrupt equities and seriously doubt 2013 will come close to the sort of opportunities that were presented. There have definitely been years prior (2009) where buying incredibly stressed, levered equities was the most profitable trade out there (Dollar Thrifty anyone?).

Comically, there are a number of trades I still missed despite being deeply knowledgeable about the players, docket, and companies that had filed. In fact, one of the most profitable trade I've seen in my life is right in front of me but I haven't been able to buy the stock for 3 months. Frustrating to say the least.

The distressed cyle in general in 2012 was in line with what people had expected. I am hearing numbers all over the place for fund returns for 2012 with some eye popping numbers barbelled with some generally poor numbers and a number of funds in the mid single digits - low teens. This relative to a low double digit return for high yield is frustrating to funds that hedged rate and only picked up spread tightening which would contribute a far less return. If you were long housing (via homebuilders, subprime mortgages, Ambac etc) you did very well. Some on and off the run situations that I spoke about in the blog were all over the place (Petroplus dropping to 10 then quickly doubling, MF Global grinding to 60+, etc).

2013 inevitably will be a harder year for funds to generate absolute returns but probably an easier year to generate better returns than their benchmarks. If you were long S&P vs short funds in 2012 you are now counting your money. I don't think that will be the case this year for a variety of reasons. I really do think this year will be a stock pickers market where money will be made in catalyst driven opportunities on the long side (when financing is cheap, event driven things pick up...think M&A, spin offs, IPO of business units) and on the short side simply because valuations are stretched for a number of industries especially if you consider a sub optimal growth tragectory for the U.S. and abroad. Commodities are interesting from the short perspective given the supply outlook for a number of materials in the 2014-2015 time frame.

The stars were definitely aligned for distressed equities in 2012. Here's to hoping a few more come down the pipe in 2013.

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Distressed Debt News: Objections in the THQI Bankruptcy

I have been following the THQI bankruptcy very closely over the last few weeks since its filing in Delaware on December 19th. Pursuant to the first day motions of CEO Brian Farrell, the company is to be sold to Clearlake Capital (Clearlake) for an aggregate contribution of approximately $60.5M, comprised of cash, assumption of liabilities, and promissory notes. In addition, Clearlake, along with pre-petition lender Walls Fargo will provide financing to THQ during its bankruptcy process. What surprised me was how fast the process was going especially given the potential large values of  THQ's IP.

Clearlake is the stalking horse bidder in THQ's sale. According to the sales motion on the bankruptcy docket, Clearview will acquire substantially all of the Debtors' operating assets. The exact sale consideration that Clearlake is offering is as follows:

i)    Fund payment in full of secured claims, including repayment of the DIP facility, projected to be approximately $29M                                          
ii)    Pay $6.65m in cash at closing                                          
iii)    Assume certain liabilities estimated at approximately $15M                                          
iv)    Deliver to the debtors a promissory note for $10M (at a 2% rate) due in 7 years for the benefit of creditors                                          
                                              
for a total consideration, on paper, of approximately $60.5M. I view it lower than this due to the fact that a 2% note would be worth far less than 100 cents on the dollar. The DIP here, with 2.5% fee for a January 18th maturity (and a 15% PIK rate to boot), looks overly punitive given the short window here.                                             

To give you a sense of the valuation, here is the Debtor's projections per the first day filings:

This afternoon, Roberta DeAngelis, U.S. Trustee overseeing the THQ bankruptcy filed an objection to the Motion Of Debtors For Entry Of (I) An Order (A) Authorizing And Approving Bid Procedures In Connection With The Sale Of Substantially All Of The Debtors' Assets, (B) Authorizing And Approving Stalking Horse Protections, (C) Authorizing And Approving Procedures Related To The Assumption And Assignment Of Executory Contracts And Unexpired Leases In Connection With The Sale, (D) Scheduling Auction And Sale Approval Hearing, (E) Approving The Form And Manner Of The Notice Of The Sale Hearing And (F) Granting Certain Related Relief.

In her objection she states the following:

• The timing of the sale is on too short of a window to let interested parties participate in the sales process. In fact she goes on to point that the rush to get the sale process through was a result of the secured lender's actions (who are intended to be paid in full)
• The break-up fee and expense reimbursements ($1.75 and $500k respectively) are excessive when measured against the cash portion of the purchase price ($29M + $6.65M in cash)
• The overbid procedures "may chill bidding". Currently, the minimum overbid must equal $2.75M despite such a small cash component.
• Break up fee is contemplated to be treated as a superiority admin expense. She states "The granting of superpriority status to a break-up fee is not authorized by the Bankruptcy Code."
• The current bidding procedures only allow a small subset of people to attend whereas the Local Rule in the court states that "the auction be conducted openly and all creditors will be permitted to attend.                                               

While writing this post, another objection similarly hit the docket: this time filed by the Ad Hoc Committee of Convertible Noteholders. The funds listed include:

• Silverback Asset Management
• Third Avenue Focused Credit Fund
• Wolverine

 which hold ~41% of the converts.

The note holders objection is embedded below. Its a fascinating read that deserves its own post. Looks like the main argument here, which I've heard from talking to parties involved: "a requirement that prospective purchasers bid on the Debtors “as a whole” rather than on a “piecemeal” or “title-by-title” basis". Here's a great snippet:

"During August and September, 2012, Centerview and the Debtors’ management  began a so-called marketing “process” focused  on finding an investor to either: (i) fund the  Debtors’ business plan or (ii) acquire the Debtors’ entire business (as a whole). During this  “process,” the Debtors and their advisors focused their attention on contacting “growth-oriented” financial investors (i.e., venture capital and private equity firms) and, by marketing the company as a whole, effectively precluded strategic investors from participating in a sale process. The financial investors that the Debtors and their advisors did approach included only a few firms known for “distressed” investing, which likely further hindered the process."

Here is the noteholders' objections.

THQI Noteholder Objection

It will be interesting to see how this plays out. If you are following the case, feel free to give me a shout to discuss.

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