Third Point 2Q 2010 Letter

In the past, we have discussed Dan Loeb's hedge fund: Third Point. I have always enjoyed Loeb's commentary on the market and certain distressed debt positions (a place I know they enjoy to play). Below you will find their most recent letter, and below that some commentary from me. Enjoy!

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Hunter Commentary

• Wow. Blames the market pullback on Goldman Sachs (disclosure: I am long the equity - actually bought it the day after the SEC investigation was announced). You know what: I tend to partially agree with this - It definitely left jitters in the market - I get daily runs from BNP with the title "CDS: Where we are since the GS annoyance" (see below). That being said, I do think the market ran way too hard into April and we were do for a pullback, no matter the catalyst.

• Agree with his point about spreading the "punitive" costs across the general population. The card program is just one example - The health care bill is of course the prime example.
• As many money managers have pointed out, its hard to invest when the rules are changing nearly EVERY SINGLE DAY.
• Commentary on corporate boards: Spot on. 8 times out of 10 I am disgusted when I read XYZ company's proxy.
• Third Point was short the for-profit education sector that has gotten annihilated recently.
• Lowest gross and net exposure since March 2009. Looking for ideas with hard catalysts (think emergence from bankruptcy...)
• Put in place some Baupost like 'blow up' hedges
• "...the sidelines is perhaps the most 'crowded trade.'" I have never thought about it like that but he is spot on
• Significant positions in post-reorg equities hurt performance during the quarter - still has "high convictions" in the names
• As he notes beautifully in the letter, post-reorg equities are sometimes referred to as "roach motels" - i.e. easy to get in and impossible to get out.
• Incredible discussion on REMICs and Re-REMICS, a place we are also invested. Something everyone should read. The upside/downside of the Alt A trades have been spectacular.

As always, an incredible read from Dan Loeb.

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Pershing Square 2Q 2010 Letter

Here is Pershing Square's 2Q 2010 Letter to Investors. See below for some commentary:

Pershing Square Q2 10 Investor Letter

• I have been following the Landry's Restaurant situation with earnest, as I have been looking at some of their debt securities. Mick McGuire strikes again.
• ADP: I have spent a lot of time on this one as well. In my opinion, undervalued, but not enough to get me allocating any more than a small bit of capital.
• Very much like how they phrase their upside downside bets: "In light of this greater risk, we require the potential for a materially greater reward if we are successful, and we size the investments appropriately. Depending upon the risk of loss, these investments may individually comprise a few percent or less of capital, and often less than one percent of the portfolio. "
• Interesting to see them being long protection in BP versus Whitney Tilson, who in the past has invested in similar situations to Pershing, being long the stock. Yes different capital structures - but reading the thesis doesn't look good for the equity.
• Peter Cooper Village: This is going to be such an interesting case study - The bankruptcy proceedings have been fascinating up to this point and with Pershing Square's involvement will only get better (no position at this time).
• As always, I am always impressed with Bill Ackman's writing. Great read.

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Profiting from Short Duration Opportunities

When I first started on the buy side, investing in high yield and distressed debt, my boss gave me a book on Michael Milken (Fall From Grace for all those that are interested). In the book, there is a passage, and I am not quoting directly here, on Milken's take on corporate insolvency. Essentially, his take was: It is very hard for a company to file for bankruptcy.

There are really only a few reasons for a company to file for bankruptcy: 1) They run out of cash 2) There is an "unforgiven" covenant default 3) They are trying to eliminate a legacy liability 4) They can't refinance maturing debt and enter in some sort of pre-pack/exchange/etc. In my experience, I have seen very few companies truly run out of cash, have seen very little "pressure" from lenders of covenant defaults (MGM Studios has been in forbearance for nearly a year now), and legacy liability filings get smaller every year.

With that said, a lot of bankruptcies are the result of an over leveraged balance sheet that cannot refinance maturing debt (or cannot conceive of a situation where in the future they WILL be able to refinance said debt). Over levered balance sheets are the result of boom cycles of past, where senior and sub lenders would lever corporations at 80% of inflated LTVs. Gaming historically trades at 8x cash flow, but in 2006 it traded for 14x cash flow, so people levered the entities to 12x. An obvious mismatch of normalized cash flow generation and run-rate leverage.

With that in mind, why do default rates peak and then (generally) decline significantly within 12-18 months of the peak? Because the capital markets open up and corporations can get in front of maturing debt. And with that, there are lots of opportunities to make very high cash on cash returns, if you can use this dynamic to your advantage.

For instance, a few months ago, we posted a DDIC entry on Tembec. At the time, the debt was trading at 86, with two years until maturity. Last week, Tembec announced a refinancing of the debt (http://ca.news.finance.yahoo.com/s/17082010/30/link-f-cnw-tembec-announces-closing-senior-secured-notes-offering-achieves.html). 14 points, on 86 of invested capital in five months...I am sure I don't have to tell you but those are nice returns.

The question the naturally becomes: How do you know which debtors will be able to refinance existing debt versus the debtors that will be blocked from the capital markets? This is where the art comes in but I want to try to give readers a flavor of how I approach these situations?

First, what is the health of the industry? Are there other similar companies doing equity or debt deals? If so, what were the leverage on those deals? Ratings? Spread? Weak covenants? Why covenants? A struggling debtor has a better chance of raising debt capital with tight covenants. It sometimes even gets the deal across the proverbial "goal line." The debtors most assuredly hate this, but nevertheless, the debt is refinanced and they get breathing room.

Second, who holds the debt? Who holds the equity? If there is a large equity holder, there may be a reverse inquiry to also do a debt deal. This gives the equity a long runway to turn its operations around or just wait for the recession to subside. Is the debt held by hedge funds? CLOs? How would you find this out? By developing relationships with your sales coverage and other buy side investors.

Third, the company itself. Is there a story to the EBITDA decline? Did the whole industry decline? Melting ice cube or a cyclical? Is leverage at least reasonable under the new structure? Could sub debt be more easily refinanced into senior debt and if so, will outstanding covenants allow it? A company that is 6x levered with 1 turn of bank leverage and 5 turns of senior leverage may find that doing a 3x and 3x deal respectively may make it easier to raise capital (assuming senior lenders are on board). What is the company's market cap? Could they raise equity? Converts? Remember, bankers are talking to these companies all the time - giving them intel on the various markets - the bankers want them to do a deal for the fees, and the company wants to do a deal to survive (even if management can make more in a bankruptcy via management compensation plans).

Fourth, and really a natural extension to the third point above, what do covenants allow? Will the company be tripped up by tight debt incurrence baskets? Is the current debt outstanding guaranteed by all the subsidiaries? If not, maybe the company could get a guaranteed deal done easier. As noted above, would investors be more "approachable" if the covenants were tighter? If the deal was secured? Etc.

With all this in mind, you still want to focus on the downside. Let's say you are wrong and the company does file: What will be your worst case recovery? If its a zero, stay away - I tend to only do these situations high up in the capital structure. Remember - always focus on the downside.

Is this post a recommendation to get long a lot of short dated paper? No - but I will say that a lot of my time has been spent on these sort of situations - especially given where the curve is and how investors are not getting compensated whatsoever (in terms of total return) for moving further out the curve.

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Distressed Debt Analysis - Fairpoint

Every few months, I post a recent idea from the distressed debt investors club. As a reference to readers, there are about 150 members on the site with over 2000 guests (guests see the ideas on a 50 day delay). In addition, over the past month, over 20 ideas have been submitted to the site. I really could not be happier with the success and encourage all those able to apply. Remember, at 250 members, I will close the application process. With that in mind, here is a recent distressed debt idea on Fairpoint Communications.

Fairpoint Communications: Distressed Debt Analysis

FairPoint ("Company") is a rural telephone company with over 1.2M access line equivalents (ALE). Company is based in Charlotte, NC and operates 33 Local Exchange Carriers (LECs) in 18 states. Company offers telephony, high speed and video services to its customers. Approximately 63% of access lines provide service to residential customers, 29% serve business customers and the rest are wholesale lines.

Prior to acquisition of the Verizon New England lines in March 2008, Company was a public company with a little over 300K lines. FairPoint acquired 1.6M lines from Verizon which were located in Maine, New Hampshire and Vermont. The $2.7B acquisition was funded with $1.8B term loan, $551M of bonds and 54M of Fairpoint shares (pro-forma, Verizon owned 60% of Fairpoint). The agreement with Verizon allowed Fairpoint to use Verizon systems for operating functions (including IT, accounting, HR, billing etc) under a Transition Services Agreement (TSA) while the Company built new systems to accommodate the acquisition. Capgemini was hired to build the new systems under a $160M contract.

The original transition date was September 2008. The new systems were not ready for transition in September and the cut-over date was pushed out to January 2009. Fairpoint started experiencing problems following the January cut-over. Processing times for new orders spiked and billing and collection systems experienced serious issues. Customer service call volumes increased and Company was overwhelmed. Customer frustration translated to increased churn and attracted regulatory attention. As quality of service slipped, the Public Utility Commissions (PUC) (regulate the telecom companies) in Maine, New Hampshire and Vermont imposed penalties on Fairpoint. FairPoint started incurring large incremental expenses as it threw all resources it could to deal with cutover issues. Bad debt due to poor collection, additional expenses to solve the transition issues and penalties caused the Company’s EBITDA margins to drop meaningfully below its peers.

Fairpoint had approximately $2.5bn of pro forma debt outstanding. Financial leverage issues coupled with the problems it incurred in its transition process are the primary reasons Fairpoint found itself in financial distress. The Company exchanged a portion of its bonds for PIK bonds to comply with financial covenants in the bank debt. But increased costs and transition problems made a bankruptcy filing inevitable. The Company filed for Chapter 11 on October 26, 2009 in the Southern District of New York. In the initial plan proposed by the Company, the bank debt holders were to receive 98% of the equity and the bond holders were to receive the remaining 2%. The bond holders started throwing roadblocks into the bankruptcy process, including a request to appoint an examiner. The company filed a new plan on Feb, 08 2010 which has the support of bank debt holders and bond holders. Under the new plan bank debt holders and bond holders received 92% and 8% of the equity respectively ( In addition the bank debt holders will receive excess cash at emergence and bond holders will receive warrants for an additional 12% of the Company at a strike price implied by $2.3B enterprise value). Further, the company renegotiated the union deal to freeze wages until 2013 and reached a deal with the state PUCs on revised capital investments and penalties. On March 11, 2010, the Bankruptcy Court approved the adequacy of the Disclosure Statement and the Company was expected to emerge from bankruptcy in summer of 2010. The plan confirmation required approvals from the PUCs of Maine, New Hampshire, Vermont and other 15 states. Vermont rejected the plan even as the other 17 states approved it. Vermont acknowledged that the Company had made material improvement in its service but believes that the projections were too rosy, inconsistent with Fairpoint’s recent performance and that the Company will overleveraged post-emergence. New Hampshire in its order of approval also noted that while the Company had resolved a number of issues and improved customer satisfaction since the cutover issue, its projections appeared optimistic. Fairpoint does not want to make any changes to the plan at this late stage and is exploring all possible options to address this late surprise. In early August Fairpoint indicated it was going back to Vermont with new information to try and get the board’s approval. The lingering uncertainty and a chance that the whole plan might blow up caused the bank debt to trade down to mid 60s from 80s in early May (it was around 73-74 in late June before the Vermont order came out).

At the current price you are basically creating the company at 4.8x 2009 EBITDA where the average comparable Rural LEC (RLEC) trades for 5.7x EBITDA. Moreover, Company’s EBITDA is loaded with extra costs due to cutover issues and penalties as evidenced by its margin of 26.9% (as opposed to average industry margin of 42.8%). Hence, it trades at half the valuation of the comparables on an access line and revenue multiple basis (see comparables table in the valuation section for details). While the number of RLEC voice lines is declining, Companies have replaced some of the lost voice line revenue with growth in broadband subscriptions and created value through acquisition of other RLECs and cost reduction. Windstream’s recent acquisition of Iowa telecom and CenturyLink’s pending acquisition of Qwest fit this pattern. Fairpoint is unlikely to remain an independent company for long after it emerges from bankruptcy. The current discounted multiple and opportunity to realize higher EBITDA margin presents an opportunity to buy the Fairpoint pre-petition bank debt. Whether the Company emerges with lower than currently proposed debt or a slightly different plan, there is enough margin of safety to realize value once it emerges from bankruptcy. If the plan falls apart and the assets are sold in the bankruptcy, a strategic acquirer should be able to pay more than the value implied by the current price of the bank debt.

Highlights

• Fairpoint’s footprint quality is not very different from other RLECs. From the company's annual reports you can see that the Company’s access line density and the cable telephony competition it faces are comparable to other RLECs. Fairpoint’s larger than average line losses and EBITDA decline has been largely a result of poor management of the systems and the transition problems
• Fairpoint has lower DSL penetration of its access lines compared to the industry. This is mainly because Verizon did not upgrade the New England systems to provide data services. Company has invested in upgrades and started selling data product in region since the middle of last year and has an upside revenue opportunity from increasing data penetration.
• Company’s EBITDA margin is significantly lower than peers due to inefficiencies and additional costs resulting from transition problems. Fairpoint’s EBITDA margin was about 40% pre-cutover but has declined dramatically in the last year indicating that Company has an opportunity to increase its margins meaningfully as it resolves its systems transition issues.
• The plan calls for a recovery of 88 points to the term loan holders (48 pts in new bank debt and the rest in equity) based on 5.4x multiple of 2009 estimated EBITDA of $362. Peers on an average trade at 5.7x EBITDA (see comparables in valuation section). However the pre-petition debt trades around 66 implying a 4.8x multiple of projected 2010 EBITDA. The recovery should be 90 pts based on a normalized EBITDA of $350M and multiple of 5.7x.
• This is a consolidating industry and Fairpoint will likely be acquired by one of the other RLECs. Windstream recently acquired two companies in 2009 and CenturyLink has announced a merger with Qwest (see Appendix for transaction comparables)

Risks

• Company’s recent performance has been worse than industry – access lines declined 12.4% YOY in 1Q10 vs. 6.8% decline for the industry. Anecdotal information from the New England PUCs indicates that the Company has meaningfully improved its service metrics as system issues have been resolved over the past year. This should improve churn metrics and stabilize revenue. Current valuation is already pricing in significantly more deterioration so investors are getting paid to wait for a turnaround.
• Industry has been losing retail lines due to competition from cable and wireless. There were meaningful losses to wireless and cable telephony when the competing products were first introduced to the market and access line loss metric has improved as the competitive landscape has stabilized. Verizon did not market aggressively to business customers in the assets acquired by Fairpoint, which presents an upside revenue opportunity. Other RLECs have been making up for line losses by selling data services. Companies generate a significant amount of free cash flow allowing them to pay large dividends, which has kept the EBTIDA multiple around 6x for a number of years.
• Stock will initially trade without dividends due to restrictions from exit facility (leverage has to be below 2x to pay any dividend and starting leverage should be around 3.0x)
• Plan projections were put together in the summer/fall of 2009. Company’s performance since has been worse than projections. Fairpoint has not updated its projections and actual 2009 performance is below initial projections. It is hard to figure out the precise proforma 2009 EBITDA since one time costs are not all disclosed in the filings. We have revised the projections with an estimate of 2009 EBITDA and modest turn-around expectations going forward. With some EBITDA margin expansion, Company should be able reach about $350M in EBITDA and generate cumulative FCF of $300M+ within three years.
• Vermont’s rejection of the plan creates additional uncertainty in timing and threatens to blow up the deal. It is not exactly clear whether Vermont wants leverage reduced or if they want payment or penalties or something else. But the state realizes (acknowledged clearly in the PUC order) that a Fairpoint stuck in bankruptcy court creates a lot of risk and potentially more problems for telecom customers in its state so Vermont is incentivized to cut a deal.

Valuation

The valuation put forth by the Company’s advisor, Rothschild values the company based on 2009 projected EBITDA and multiple slightly below the trading and transaction multiples for comparable companies. Comparable public companies trade at an average EBITDA multiple of 5.7x. Recent transaction comps support an EBITDA multiple of 6.0x and above

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Distressed Debt Investing Interviews Tanja Aalto

It gives me great pleasure to bring to our readers an exclusive Distressed Debt Investing interview with Tanja Aalto, a Managing Director with the Global Restructuring Group of Barclays Capital. She joined Barclays Capital in October 2009 after more than 12 years spent in the Financial Restructuring Group at Houlihan Lokey. Ms. Aalto has extensive domestic and international distressed experience having represented companies, creditors’ committees and ad hoc groups in connection with in-court and out-of-court restructurings, distressed sale processes and financings. She has advised clients across a range of industries with more recent focus on financial, retail and automotive companies.

In addition, Ms. Aalto will be speaking at the upcoming Global Forum on Investing in Distressed Debt in New York coming up in September - An event we are encouraging all readers to attend.

This interview has incredible amounts of information from someone on the ground, doing deals on a daily basis. Enjoy the read.

Tanja - Give us a little background on yourself

I started at Barclays Capital in the Restructuring & Finance group in October 2009 after more than 13 years in the restructuring group at Houlihan Lokey. In aggregate, I have worked on well over 50 large restructuring transactions, in addition to other smaller and/or shorter engagements, representing companies, secured creditors, unsecured creditors and even shareholders in Chapter 11 and out-of-court processes. While at Houlihan, I also did a meaningful amount of work in Europe and Brazil in the 2000 through 2005 time period as those markets were busy with “distressed” work. I joined Houlihan in 1997 out of business school, and was at the time fascinated by the idea of focusing on distressed situations to help companies and stakeholders maximize value (have remained hooked ever since). Prior to business school, I worked at a boutique consulting firm focused on competitive strategy and new market entry for Fortune 500 companies. I graduated from Princeton University with a B.A. in Economics in 1992, and subsequently graduated from the Darden School of Management with an M.B.A. in 1997.

You were an advisor to the bond holding steering committee in CIT's bankruptcy. Given the speed that CIT emerged from Chapter 11, combined with the 2005 changes to the bankruptcy code, it is your sense that negotiated pre-packs will be the norm going forward and what does that mean for various creditor constituencies "giving up" value to facilitate a quit bankruptcy exit?

Each situation is unique in that liquidity need, capital structure, regulatory influence, composition of stakeholders and other variables will inevitably influence a restructuring process. CIT was one of those unique situations where the structure of the transaction and the associated timing reflected the outcome of extensive negotiations between and among the company and the ad hoc committee of bondholders. The possibility of an out-of-court exchange offer was preserved in the dual path plan, which solicited votes for both the exchange offer and a pre-packaged Chapter 11 plan simultaneously to ensure certainty in a timely manner upon the expiry of the solicitation period. The exchange offer satisfied the company’s desire for an out-of-court alternative while the pre-packaged Chapter 11 plan provided the “back-stop” needed to ensure a successful transaction. Speed was perceived to be critical in the CIT situation given concerns regarding the potential dilutive effect on value of prolonged uncertainty on CIT Bank and the company’s vendor and trade finance businesses. The concept of “giving up” value is fairly complex as I suspect many stakeholders viewed the exchange/restructuring as one of exchanging the form of value (debt-for-equity conversion) to preserve and/or ultimately create opportunities for higher value with a deleveraged post-transaction CIT.

As you note, pre-packaged Chapter 11 processes have become more prevalent than at any other time in my own experience working on distressed situations. One reason pre-packs were often challenging was that companies did not have adequate liquidity to continue to fund operations through what was frequently a protracted time period of negotiations with stakeholders. Additionally, the presence of a “blocking” position in a key voting security can also complicate the success of a pre-pack restructuring to the extent that the larger holder(s) have an agenda that differs from the company and/or other stakeholders. Capital structure layering frequently complicates reaching a quick agreement with stakeholders as intercreditor issues often prove to be a distraction. Companies tend to prefer out-of-court exchange offers to the extent requisite deleveraging can be successfully negotiating with high enough participation levels. A pre-packaged Chapter 11 is the ‘middle ground’ where a company is concerned about the “holdout” risk inherent in most exchange offers, but has the requisite votes for a plan of reorganization pre-filing to satisfy confirmation standards. While it is true that pre-packs are less costly than the typical longer Chapter 11 process (thus preserving additional value), the implementation of a restructuring through a pre-packaged process is more frequently dictated by stakeholder negotiating dynamics and the company’s liquidity cushion rather than any “give up” of value. That said, there are businesses (such as CIT) for which the potential value loss related to a prolonged bankruptcy process is meaningful enough that stakeholders are motivated to reach a speedier agreement for a more expedited process.

Can you give us a sense of the state of the DIP market today? We know from cases like GGP that rate has come down dramatically, but are lenders still driving the process in negotiating terms or has the market overshot itself where debtors are really the one calling the shots?

The DIP market generally fluctuates in line with the overall financing markets as it relates to economics. Year-to-date leveraged loan and high yield volumes underscore the fact that we are currently in a very robust financing market. While competition for the fewer large DIPs and exit financings is certainly more intense now than it was when there were more opportunities in the market, banks still fundamentally base their proposals on prevailing market rates for comparable perceived risk. While a debtor/company may be more able to solicit a higher number of financing proposals in the current market environment, I have not myself seen situations where our fellow lending institutions are willing to propose below market terms to “win” the financing.

How have you found the transition to expand Barclays' restructuring group, where restructuring is one of many revenue drivers, versus Houlihan, where restructuring was THE business driver?

The two platforms are very different. While restructuring is certainly a key practice area for Houlihan, it is worth noting that Houlihan also has strong financial advisory and corporate finance practices that have historically served to support the firm’s steady growth through economic and market cycles. After more than 13 years at Houlihan, I was attracted by the broader array of strategic and financing services that the Barclays platform can offer stressed and distressed clients. The group I joined at Barclays has the ability to strategically deploy capital in distressed situations in addition to more traditional restructuring advisory services. Additionally, the ability to offer a client access to the resources of the full bank is something I find to be invaluable. Many over-leveraged and/or liquidity constrained companies have alternatives available to them that do not fall within the core expertise of boutique restructuring firms such as Houlihan (i.e., deleveraging equity offerings, refinancing, securitizations, etc.). The Barclays platform is premised on a “team” approach where the restructuring group is appreciated for its specific expertise by other product, coverage and industry groups. It is this “team” approach that creates a significant opportunity for my group to leverage its skill set in assisting a greater number of both existing and new clients.

Of all the bankruptcies you have been a part of (Globopar, Delphi, XO, Fruit of the Loom) which did you find most interesting and why?

While the Globopar restructuring process was fascinating due to its cross-border nature and the myriad large funds that accumulated enough debt to be influential in assisting or complicating the process, it admittedly was not an in-court process. Picking the most interesting bankruptcy process is very difficult as they are all very different, which hits on the crux of why I continue to remain excited about what could prove to be one of the largest distressed cycles within the next few years. I will focus here on the Chapter 11 restructuring of United Artists Theatre Company back in 2000 as it was the first transaction I worked on where investors leveraged ownership in the fulcrum security to gain control of the company post-emergence. As you may recall, Anschutz Corp. purchased stakes in both the bank and bond debt at a meaningful discount, which resulted in an implied purchase valuation for the company of ~4.0x. While hedge fund ownership strategies are more commonplace now across restructuring transactions, Anschutz’s strategy in United Artists was the first time I myself directly watched a smart and opportunistic outside investor map out a path to control through a Chapter 11 process. Anschutz subsequently applied a similar strategy in the Regal Cinemas bankruptcy process along with additional investors that were eager to replicate Anschutz’s success in the sector.

Given the amount of capital that has migrated to the distressed space, do you believe that recoveries will be substantially higher than previous cycles? How is this impacted by more intricate capital structures (1st lien loans, 1st lien bonds, 2nd lien bonds, etc)

Recoveries are ultimately dependent on valuation and, perhaps more importantly, on valuation relative to the blended average purchase price of the stakeholder. The elevated amount of capital parsing through Chapter 11 situations, over-leveraged securities and distressed industries in general appears to contribute to what I perceive to be somewhat of a “distressed asset bubble” in the current market place. What this means is that I am running across over-leveraged situations where securities continue to trade at higher implied valuation multiples than historical averages. While there is certainly some logic to pricing in a rebound for companies negatively impacted by the prevailing soft economy, I do see valuation multiples that continue to exceed what I would myself deem to be an appropriate inflation for recovery “option” value. The uptick in distressed company security valuations will have some impact on implied recoveries to the extent that higher valuation multiples are not sustained and/or company performance does not rebound from current reduced levels. Previous cycles had their own disaster scenarios where valuations fell far short of original expectations. It is unfortunately difficult for me to provide a definitive prospective perspective on how the next cycle will average out relative to history.

Capital structure layering is absolutely another variable that will impact recoveries in the next restructuring cycle. Second lien securities are more prevalent, and are often “silent second” positions relative to senior first lien debt. The existence of multiple tranches of debt adds to complexity in negotiating a consensual restructuring to the extent that there is debate regarding the “fulcrum” security. The impact on recoveries will be case specific, but there are scenarios where a senior security may try to crowd out junior securities in an effort to gain control of the company post-emergence. Additionally, we are now seeing cases where junior stakeholders step up with rights offerings to facilitate a repayment in full of senior claims. Recoveries in either scenario will ultimately depend on the company’s performance and prevailing sector valuation multiples relative to the timing of an investor’s sale of post-emergence ownership interests.

We do not know if you have an opinion - but what is your outlook for defaults over the next few years - will the maturity wall in 2013 and 2014 lead to a rapid increase in pre-packs and distressed exchange offers over the next two to three years?

Most seasoned restructuring professionals did not anticipate the resurgence in capital markets activity that pushed out what was originally anticipated to be a year of double-digit default rates in 2010. The significant amount of amend-to-extend volume during the first quarter of 2010 added to the already staggering wall of debt maturing in the 2012 through 2014 time period. My own expectation is that the restructuring market will remain quieter into 2011 as highly leveraged companies continue to manage through the economic downturn with existing balance sheet liquidity. Activity should pick up in 2012 and thereafter as companies seek to actively manage upcoming debt maturities through opportunistic exchange offers and/or refinancing efforts. However, I will caveat that all remains highly dependent on the state of the capital markets. I do not specifically expect a rapid increase in pre-packs in 2012 as an expedited solution for management of over-leveraged companies as any Chapter 11 process (pre-packaged, pre-arranged or free-fall) tends to carry some taint from the perspective of most management teams. The ability to implement a pre-packaged Chapter 11 plan is generally determined by a company’s liquidity profile and stakeholder dynamics rather than by prevailing and expected default rates.

If you were to recommend one book to an aspiring distressed debt investor, which would it be and why?

I would recommend Martin Whitman’s book on Distressed Investing. The book is a great primer that provides an introduction to how to think about anticipating distressed cycles and evaluate over-leveraged situations. Additionally, the overview of bankruptcy processes and associated case examples provide additional background context for someone who may be new to investing in distressed assets. Understanding valuation waterfalls, creditor rights and the overall process is critical (in addition to having a perspective on valuation) to having a solid framework to evaluate any distressed security.

Thank you so much for your time with Distressed Debt Investing Tanja!

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