Request: Tracking Dockets

I had a question for readers: How are you tracking new filings on bankruptcy dockets?

Am I missing a way to get all new filings emailed to me via PACER? Is there a service that does this for funds? Or is everyone just manually checking each docket throughout the day (unlikely)? We have readers across the buy and sell side, but also most prominent law firms in the restructuring practice, so it would be great to get feedback from a variety of readers.

If you have resources, services or ideas I might not be utilizing, would you mind emailing me (hunter [at] distressed-debt-investing [dot] com). It would be greatly appreciated.

Thanks!

Read more...

Stressed High Yield: CEDC

Every few months, I post a recent idea from the Distressed Debt Investors Club (the "DDIC") to give potential members and guests a feel for some of the ideas being posted to the site. In recent months, ideas ranging from deep value equity to distressed debt ideas have populated the site. For those interested, you can find a list of all the ideas every posted to the site here (scroll navigation at the bottom of the page): List of DDIC Ideas

If my memory serves me right, this is the first idea posted to the blog from the DDIC since we established new compliance policies. We hired a compliance consultant to test our procedures and formulate a robust policy that will encourage idea sharing while at the same providing the correct disclosures and attestations for members. You can view those policies here: DDIC's Compliance Policy.

Every few days, I receive emails from potential members that inquire about the policies and procedures of the site. As stated previously, the DDIC is 100% anonymous. I will be the only one to know members identities and I will never share that information per our privacy policy. Members are free to contact each other via our online messaging system securely and anonymously.

If you, or better yet, your compliance department has questions, please let me know. I have written a number of letters attesting the above facts and can do so for potential members as well. We currently have 215 members versus our stated quota of 250 members and many many more guests (guests have a 50 day delay to the database and no read access to our forums). Theses members come from both the buy and sell side, across a variety of backgrounds. As time progresses, our database of ideas grows larger and I hope you'll consider joining in the near future. To apply as a member, you can go here: DDIC Member Application and Terms

With all that said, enjoy the write up from one of our members on stressed high yield name CEDC.

CEDC - Central European Distribution Corp

Synopsis

I recommend a long position in CEDC’s 9.125% Senior Secured Notes due 2016 at the current price of 60. On a risk adjusted basis, these bonds trade below fair value.

Challenging European spirits markets and several one-off events have challenged investor confidence in recent quarters. The Company’s shares as well as its public debt traded down following the FY2010 results and abridged discussion by management. Lackluster Q1 results followed by the aftermath of Russian licensing challenges and a shift in the excise tax burden announced in 2Q perpetuated the market’s concerns. In 3Q, CEDC’s modest progress in Poland was countered by excise tax in Russia and spirit cost challenges. Class action lawsuits now allege the management team and board misrepresented the severity operating and financial challenges during 2H10 and in the outlook for 2011. Today’s relevant comparables highlight the CEDC’s toxicity in the market.

However, the fundamental investment appeal of CEDC’s credit remains intact. The enterprise continues to demonstrate strong free cash flow potential with favorable positions in value-oriented market share. Given the strong liquidity position, the Company’s credit profile is robust. An eventually normalized Russian market, continued gains in Poland with Biala, and a focus on more profitable sales channels should further bolster CEDC’s creditworthiness as well as the bonds’ pricing following a strong 4Q11 / Q112. Under such a scenario, the bonds can be expected to trade a more appropriate yield of 10-12%, providing very aggressive return potential (40%+ IRR) upon a sale in a 4-6 month timeframe. Alternatively, the attached recovery analysis shows that an investment in today’s bonds would likely be covered, albeit with a thin equity cushion, in the event of a Chapter 11 reorg or out of court restructuring.

Investment Write Up

CEDC is one of the largest producers of Vodka in the world and the largest integrated spirit beverages business in Central and Eastern Europe when measured by volume. The Company produced and distributed 32.7 million nine-liter cases in 2010. Business activities include the production and sale of proprietary brands of spirits, and the exclusive importation of a variety of other branded spirits, wines, and beers in select locales. CEDC operates primarily in Poland, Russia, and Hungary. The Company maintains seven production facilities in Poland and Russia, and employs a workforce of 4,150 people as of year end 2010.

Poland (8.6 million nine-liter cases sold in 2010 / 21 million liters sold in 3Q11):

CEDC is one of the leading producers of vodka in Poland and maintains two production facilities there. The Company maintains top marketshare among traditional channels as well as discounters. Principal brands produced include Bols, Soplica, Absolwent, and Zubrowka. Absolwent and Zubrowka are leading mainstream brands locally, and Zubrowka is exported to many countries including the United States (via Remy Cointreau). The Company also exclusively imports 40 leading brands of spirits, 40 wine brands, and 5 brands of beer. Sales in Poland typically break down into vodka (70%), beer (7%), wine (12%), and other spirits (8%), other (3%). In terms of exports from Poland, the principal brand is Zubrowka into the United Kingdom, France, Japan, and the United States. Additional export possibilities include third party private label production where brands are sold by other labels in countries outside of Poland.

Russia (21.3 million nine-liter cases sold in 2010 / 38 million liters sold in 3Q11):

The Company is the leading integrated spirits company in Russia and maintains 12.4% market share in vodka production. CEDC produces Green Mark, the best-selling vodka in Russia, as well as Parliament and Zhuravli, the two leading sub-premium vodkas in Russia. Other products produced in Russia include Yamskaya, the best-selling economy vodka in Russia, and premixed alcoholic beverages. Primary distribution is through large retail chains and hypermarkets, and CEDC’s relationships with these companies continue to allow penetration in both urban and rural parts of Russia. Operations in Russia also include the Whitehall Group, a recently acquired company that holds the exclusive rights to import premium wines and spirits into Russia and includes several key distribution centers and its own retail network. This acquisition made CEDC one of the leading importers of wine and spirits in Russia. Full financial results including Whitehall are included in 2011 figures in public filings and herein. Sales in Russia break down into vodka (85%) and wine and others including long drinks (15%). In 2010, the Company launched a small operation in the Ukraine to sell its branded vodkas including Green Mark. Market share initiated around 4% at the end of 4Q10, and has grown to 6.7% as of 3Q11.

Hungary (2.8 million nine-liter cases sold in 2010):

CEDC’s business operation in Hungary principally includes the sale of Royal Vodka. This trademark was acquired by the Company in 2006, and the vodka is currently produced in Poland and sold in Hungary where it is the leading seller with 33% market share. Similar to activities in other countries, CEDC maintains importation rights to several other spirit brands as well.

The Company uses Polish zloty, Russian ruble and Hungarian forint as functional currencies in daily operations, but financials are reported in USD. As such, CEDC is exposed to translation movements both on its balance sheet and operating financials. Additionally, CEDC’s Convertible Notes due 2013 and Senior Secured Notes 2016 are denominated in U.S. dollars and euros, and these proceeds have been lent to operations with different functional currencies. The Company has entered into only very limited foreign exchange risk hedging in the past. Financial results and projections in this report for 2011 going forward reflect the full integration of the Whitehall acquisition.

Valuation Waterfall

Comps

Recent Company News

Covenant Violation of Bank Facility – The Company violated its bank covenants as of 12/31/2010 and successfully negotiated relief.

• During 2010, CEDC’s bank credit facility covenants included net leverage and consolidated coverage, tested at the end of every quarter. At 12/31, the Company’s reported net leverage 6.4x (using covenant EBITDA calculation which includes some cash adjustments not described in public filings) due to the decline in EBITDA suffered in FY10, which violated the 5.0x covenant. CEDC also reported an actual coverage ratio of 1.7x, violating a 2.0x covenant. Credit facility lenders waived any breach of the two covenants at the end of FY10 and amended the two covenants to 8.35x and 1.28x for the end of FY10 as well as for the end of 1Q11. In connection with this waiver/amendment, the Company paid a one-time waiver fee of PLN 3.3 million (approximately US$1.15 million) as well as agreed to a reduction of the overdraft facility to PLN 120 million (approximately US$41.6 million) and an increase to the margins on term loan and overdraft facilities to 4.25% and 3.25%, respectively.
• In April 2011, management reached agreement with select lenders to amend the Bank Facility to eliminate the aforementioned covenants out right. This refinancing successfully avoided an event of default until the Bank Facility as well as cross default provisions for the Company’s other debt which included acceleration implications. Analysis shows that the Company would clearly have violated these covenants at 6/30. Based on the limited information in the Company filings, these credit facilities only extend until 4Q2012.

Completion of Whitehall / Kauffman Acquisition

• The Company completed the full purchase of the Whitehall Group on February 7, 2011 for $68.5 million in cash and issued common stock worth $23.0 million at the date of close. Additionally, the Company also gained the global intellectual property rights for the Kauffman vodka brand. CEDC owned a minority position in Whitehall prior to this purchase, and that ownership was treated as an equity interest in the Company’s financials. Notably, following the sale, CEDC remained liable for a cash payment to the seller in the amount of the difference between $23 million value of the equity compensation at the sale date and the present value at a specific trigger date. This was settled in March 2011 through a payment of $0.7 million as and stock to the seller.
• The Whitehall Group is one of the leading importers and distributors of premium wines and spirits in Russia. Kauffman vodka is one of the leading super-premium vodkas in Russia with a strong presence in top end restaurants and hotels and key accounts. The brand is also exported to high-end customers in over 25 countries.

Production Disruption and Licensing Problems in Russia

• In 11/10, the Company disputed with Russian authorities on the use of old excise stamps to distribute stocked product and the timing of acquisitions of new stamps.
• This misunderstanding halted production at key factories for two weeks during peak production season (Oct and Nov). The loss of capacity resulted in increased cost of enhanced throughput at other plants and additional transportation expenditures to distribute product.
• Estimates suggest that this incident cost the Company about $30-35 million through 3Q 2010. The incident also exposed management weakness at the local level.
• The Company successfully renewed its wholesaler business licenses in Russia, but certain of the Company’s wholesale customers failed to do so. This perpetuated the destocking trend seen earlier in the year, and ultimately cost the Company around $10 million of operating profit in Q2 alone. The complete of the relicensing process is expected to be completed soon as only 25 out of 140 are left to renew their licenses as of 8/4 and the Company is working to sign contacts with new, licensed wholesalers.

Regulatory Shift – Russian Excise Tax

• During the Company’s 2Q11 earnings call, management announced a change to excise tax regulation in Russia. Effective August 1 (practically September 1 given the Company’s spirit stock), the remaining portion of excise tax that had been paid by spirit producers in the past is now shifted to vodka producers. The cited aim is to provide transparency into the collection of those funds. Notably, even at current higher rates, excise taxes in Russia are only 65% of the rate in Poland.
• Unfortunately, this increases the Company’s cost of spirit by 35% - which equates to an increase of $11 milion cost of sales for the 4Q11 period.
• Looking ahead, this increase could be mitigated by a plentiful grain harvest which is expected for 3Q and 4Q in Eastern Europe.

Outside Shareholder Announces Large Equity Stake

• On 8/29/11, Mark Kaufman reported a 9.6% stake in CEDC. Mr. Kaufman was the chief executive of the Whitehall Group.
• Kaufman has requested a meeting with the CEDC board to “contribute ideas” and “facilitate additional investment”.

Board of Directors Adopts Stockholder Rights Plan / Poison Pill

• On 9/6/11, CEDC announced the adoption of a stockholder rights plan / poison pill, likely in response to Mr. Kaufman’s announcement. This is designed to deter hostile takeover efforts as the potential buyer would likely have to negotiate with the board to acquire / control the Company.
• Functionally, one preferred stock purchase right will be distributed as a dividend on each common share held as of 9/19/11.

Class Action Lawsuits filed regarding 2H10 events

• During the week of 10/24/11, several class action lawsuits were filed citing CEDC management and board members as defendants.
• Allegations state that defendants misrepresented and/or failed to disclose the following: (i) that CEDC had double digit declines in its vodka portfolio and its loss of market share in Poland was growing steeper as discounters were taking shares; (ii) that the seriousness in the market share declines required that CEDC take an impairment charge which CEDC did not record on a timely basis; (iii) that the launch of Central European Distribution’s new vodka product, Zubrowka Biala, with significant market spending in the form of rebates, was having a materially adverse effect on gross margin and impacted the channel mix in the market; and (iv) that, based on the foregoing, defendants lacked a reasonable basis for their positive statements about the company, its prospects and growth. It is further alleged that defendants’ false statements caused CEDC’s stock to trade at artificially inflated prices during a period between August 2010 and February 2011.

Industry and Market Overview

Poland – The total sales value of alcoholic beverages in Poland is estimated at $7 to $9 billion in 2010, a 1.9% decrease from 2009 principally due to the global economic recession. Through 3Q11, the Polish vodka market is down 5-6% in volume and spirit prices are up 3-5%. The country is the fourth largest market for the consumption of vodka and in the top 25 markets for total alcohol consumption. CEDC produces vodkas in all four segments (top premium, premium, mainstream, and economy). Poland is the fourth largest beer market in Europe. Sales of beer remained stable in volume in 2010 but still account for 50% of the total sales value of alcoholic beverages in Poland.

Russia - Russia is the largest vodka market in the world with production of approximately 1.05 billion liters in 2010. Vodka represents 95% of all spirit consumption in the country. The market is fragmented with the top five producers containing up to 50% market share. While traditionally there has been a large black market for vodka in Russia, the government recently introduced minimum pricing in 2010 which moved some consumers back into the official market. The long term effects of this change are yet to be determined. Wine and long drinks represent a very small portion of the market, but each has strong growth potential ahead. Overall, regulation of alcohol in Russia is a highly debated and politicized topic today, and both 2011 and 2012 are election years.

Hungary – The spirits market in Hungary is concentrated in brown liquors and bitters. Overall spirit trends in Hungary are decreasing and shifting to import brands from local producers which have traditionally produced lower quality spirits. The a large increase in the amount of imported spirits due to elimination of local duties and increased purchase power by the Hungarian population since the country joined the EU.

Industry and Market Overview

Russia / Whitehall

• 2010 – 16.9% top line increase reflecting Russian Alcohol Group(RAG) acquisition benefit for the full year, countered by effects of production disruption in Q4 and a heat wave in Q3. Decline in overall market share to 15.3% estimated from 18% in 2009.
• 2011 Forecast – Topline growth of between 6 and 8%(60%/40% split between existing and new brand growth) as Whitehall completes integration; Restyling of Green Mark and introduction of a new economy brand (Sotka) and a sub premium brand. Diminishing effect of licensing issues into 4Q and an overall a stabilizing market in line with Russian economic recovery (including price increases, as successfully implemented in 1Q11) and a diminishing black market due to minimum pricing. Gross margins will be challenged by the 35% increase in cost of spirit due to excise tax shift initiated in 8/11. Strong export growth into Ukraine and overall improvement in value over volume.

Poland

• 2010 – 14.8% decline reflecting overall market decline, mourning period for the President, increased competition, aggressive marketing spend, and increased raw materials cost. Decline of 3% in marketshare to 22% in 2010. Recovery expected ahead due to enlarged sales force and decline of marketing expenses.
• 2011 Forecast – Increases in revenue nearing 10% following aggressive marketing yields (Biala) results and larger salesforce, but in a declining overall market; flavor extensions introduced to Zubrowka and Jezowka family in 4Q and others and restyling of Soplica in July; erosion of competitor’s market share; CEDC’s own marketshare remains in the low to mid 20%’s (25% by 4Q) while value to volume continues to improve by the end of the year and exports gain on imports· 2010 – 16.6% decrease reflecting increases in local excise taxes as well as adverse exchange rate changes
• 2011 – Top line growth of 10% reflecting normalization of pricing and adjustment of costs towards profitability

Key Investment Considerations

• Integration of Kauffman / Whitehall cash flow - Recent concern over the Company’s inflated leverage may be overblown. In addition to anticipated demand recovery for 4Q11, the Company can expect to realize the financial upside of the Whitehall acquisition and normalized pricing as marketing yields are recognized. Whitehall was financed with cash and stock, and should contribute $30 to $40 million of EBITDA going forward as operations normalize in Russia in 2012.
• Continued Strong Liquidity Profile / Free Cash Flow Generation – The Company maintains over $110 million of cash on the balance sheet and significant capacity (close to $50 million) under its credit facilities. Looking ahead, the Company should be able to produce an average of $50 to $60 million of free cash flow in each of the next years (25 to 30% EBITDA conversion rate). Accordingly, management is equipped to handle any additional market hiccups and is positioned to de-lever the balance sheet in coming years.
• Realization of benefit of marketing spend in Poland and Russia – As reflected in historical marketing expenditures, the Company has focused on the promotion of some of its new and up and coming brands over the past 12-18 months. This was done in response to consistent and accelerating losses of market share in 2010, primarily in Poland. One example is Zubrowka Biala (White) launched in Poland in November 2010 where sales volumes came in far above expectations. Here, promotional pricing squeezed margins in Q4, but new customers should add to cash flow levels as promotions burn off and pricing normalizes in 2012.
• Relicensing in Russia / Destocking reversal – The Company has successfully negotiated new licenses for its operations in Russia, but a few wholesalers are still in the process. The practical implication here is a reduction in inventory levels of wholesalers as they successfully renew their licenses. New wholesalers are brought on board to replace those who fail to renew. Previously, stock had been increased to protect against another production outage for regulatory reasons. Since wholesalers are contractually bound to 4 to 5 weeks of inventory, destocking will reverse naturally. Based on Q3 results, a significant portion of this destocking is still to be realized by the Company in 4Q via both new and old wholesalers.

Investment Concerns

• Impairment charges in Poland (2010) and Russia (2011) – In 2010, CEDC recognized impairment charges of $131.8 million related to the Absolwent brand in Poland, and an impairment charge in 2009 of $20.3 million related to the Bols brand in Poland. While these charges are non-cash, questions arose regarding the Russian and Hungarian brand valuations and the potential business impact of further similar charges ahead. In 3Q, CEDC incurred goodwill impairment of $547 million ($88 for Poland / $459 for Russia) and brand impairment of $128 million for Polish brands due to cannibalization by Biala.
• Negotiations with Bank Lenders / Refinancing of Convertible Notes – The Company successfully negotiated with Bank lenders for covenant relief through 4Q12, and the convertible notes are due to mature in 2013. In light of recent financial hiccups, there is a risk that the market may not be receptive to another covenant light facility or a refinance of the Company’s convertible notes at a reasonable cost to borrow. An inability to negotiate could lead to an in or out of court restructuring that would be costly for the CEDC equity holders.
• Risk of another mismanaged product launch / Poor management decision making. The launch of Zubrowka Biala in Poland led to a sale of three times expected volume in 4Q 2010. Excessive rebates had a negative impact on gross margins and the overall profitability for the Company during that period. These promotions expired in January 2011, but management’s mistakes highlight an apparent inability to control new product launches completely. As such, further gains in market share from marketing pushes could again come at the expense of margins.
• Higher Spirit Costs / Excise tax shift – A large percentage (40-45%) of the Company’s COGS is raw spirit, the cost of which already increased in 2010 and early 2011 as a result of a poor grain harvest in Eastern Europe. The Company purchases grain at spot prices or on short term contracts. The market, however, believes that the 2011 harvest in the autumn will be much more successful. Management reaffirmed its positive outlook for the late 2011 crop during the 2Q earning call, but management announced a change to excise tax regulation in Russia that suggests a 35% increase in the Company’s cost of spirit, which equates to as much as a $33 million increase in the Company’s cost structure annually.
• Principal Assets located in Europe / Complications in Chapter 11 or other Restructuring.

Financials

Summary Terms

Read more...

Off Topic: SOPA or H.R. 3261

For nearly two and a half years, I refrained from discussing politics on the blog. If political rants are not your bag, you can close your browser now, and wait until I post something more relevant to the blog's subject matter.

Today, the full Judiciary Committee of the US House of Representatives held a hearing on the “Stop Online Piracy Act” (H.R. 3261) or SOPA for short. You can read the full text of the bill here: “Stop Online Piracy Act” Full Bill. This bill was introduced in October of this year, and if you have not heard about it yet, you will start hearing about it very soon.

Executive Summary: This bill is a testament to the idiocy of our elected Congress.

Is that short enough for you? On the surface, the bill's intended directive is to strengthen copyrights owners rights as related to the protection of their intellectual property, over and above the Digital Millennium Copyright Act which has been the standard for 15 years. The motive behind this is summarized by Judiciary Committee Chairman Lamar Smith commentary on the bill: "Unfortunately, the theft of America’s intellectual property costs the U.S. economy more than $100 billion annually and results in the loss of thousands of American jobs." Much of the Judiciary Committee commentary on the bill speaks to foreign and rogue websites that must be dealt with harshly and punitively.

As always though, the ACTUAL legislation does not match up with the "talking points" espoused by Congress.

In fact, H.R. 3261 completely undermines the safe harbor afforded by the Digital Millennium Copy Right Act which holds that websites will not be liable for their users posting copyrighted materials if they remove said material claiming copyright infringement. Furthermore, and this is a real gem, it FORCES search engines and payment processors (Paypal, Mastercard, etc) to cut all tied with allegedly infringing sites in effect dropping them off the face of the earth. Worse yet, if I, as a content provider, link to an infringing site, I can also be held liable, and my site can be cut off from search engines, advertising networks, etc.

The example I have used to friends in the investment community is that of Scribd. I would wager that 90% of the hedge fund letters or sell side presentations posted on the web are posted via Scribd. I've done it myself, and oftentimes link to hedge fund letters others have put up on Scribd.

Under SOPA, Scribd would no longer be able to exist. And as I've linked to Scribd in the past, I and many other prominent financial bloggers could be held liable and cut off from the DNS directory and search engines.

Google , AOL, eBay, Facebook, LinkedIn, Mozilla, Twitter, Yahoo and Zynga are all vehemently opposed to the legislation. Think about it: If some person uploads to YouTube just one unauthorized piece of copyrighted material, the ENTIRE SITE CAN BE SHUT DOWN. Where are we living? China? Pre-revolution Egypt? This puts an unprecedented level of censorship in the hands of content providers and, if passed, will literally change the way content is consumed on the internet. Definitely for the worse.

For more information, you can read more here: Gizmodo on SOPA as well as the hundreds of articles that will soon be coming out on the issue.

Read more...

Takeaways from Citi's Distressed Desk Analysts (Average Returns, Cash Balances, MF Global)

Yesterday, Citi kicked off its 2011 North America Credit Conference. As usual, Citi provided a strong offering of management presentations across the credit spectrum as well as many fascinating panel discussions (just to name a few: Global CDS Central Clearing Update, 2012 Implications of Dodd-Frank and Changes to the Banking Regulatory Scheme, a high yield panel, etc). Most relevant to us, Citi's distressed desk analysts presented a variety of actionable ideas to a large audience of distressed debt investors.

Before the analysts discussed their investment ideas, Rohit Bansal, the head distressed trader at Citigroup, kicked off the discussion with a few interesting observations. First, he noted that after to speaking to a number of clients, the average distressed fund was ranging from -5% to 2% in terms of return for 2011. Second, he noted that there was a significant amount of cash waiting on the sidelines, to the range of 25-40%. The "pain trade" as it were is making accounts want to wait until there is more clarity on the macro scene before risking capital. He did note that funds with locked up, long-term capital will be more willing to bid on blocks whereas funds beholden to redemption risks are significantly more cautious.

Next, Marc Heimowitz, Head of Credit Special Situations, touched on an issue that is plaguing the entire investment community: Markets are being driven by macro exogenous risks. In theory, the issues in Greece should not affect the fundamentals of numerous businesses in the United States, but those same issues are dramatically affecting the pricing of underlying securities.

He then moved on to the level of dealer inventory. Here is a chart from Bloomberg:

You can see the precipitous drop since the 1H of this year. What makes this chart even more frightening is when you compare the above to the amount of total corporate debt outstanding which rises year after year after year. This effectively means that the amount of dealer inventory over the amount of corporate debt outstanding is near decade lows.

Personally, this is making execution all the more difficult and dealers (rightly so) are having to make wider markets less they be picked off by aggressive accounts. He closed by nothing they think Lehman's recovery falls into the 31-32 range with a 1 year average life (versus a market near 25.5).

Next, the distressed desk analysts each presented an actionable long / short idea from the variety of their coverages. While, I will not list each of these ideas (contact your Citi sales coverage for the list of ideas), I did want to to touch on one idea in particular, especially given the price action today: MF Global.

We first introduced MF Global's bankruptcy a few weeks ago. Since then, the broker-dealer has been placed into liquidation, a creditor committee for the holding company has been named, and many, many buy side analysts still are doing the hard work to value the recovery to creditors. This price action since the bankruptcy has been anything but stable:

Bonds were up 6 points today, driven by three reasons (in my opinion and listed in reverse chronological order)

• Creditor Committee counsel, Martin Bienenstock (Dewey & LeBoeuf), said in court: "We think there is potentially quite an estate to be amassed here for the benefit of creditors."
• Rumors that Appaloosa had been buying bonds in the mid 30s according to unnamed sources
• Rina Joshi, Citi's distressed desk analyst covering MF, laying out a case that the bonds could be worth between 50 cents to par at Citi's credit conference yesterday.

Rina presented a compelling case and I had the feeling, given the size of the crowd in attendance, the bonds would be up with the pitch. They started the day up 2-3 points and then really rallied into the close as the case proceedings heated up.

Rina first noted, and I think everyone covering the MF situation understands deeply, that there is significant missing info and much of the info analysts are working with is dated (for instance, the last broker-dealer financials we are working with are from 3/31). In essence, the bond (and bank debt) will receive value two ways: 1) inter company receivables and loans 2) equity from subsidiaries, both domestic and abroad.

Most people I speak to have been deconstructing the balance sheet by matching assets and liabilities, and then applying a "friction cost" or haircuts (to both sides in some instances) to come up with equity value that, in theory, should flow up to the intermediate finco and the ultimate holding company. A basis for this is that according to the most recent data we have, MF Global had VERY few Level 3 assets and thus, again in theory, friction costs should not be onerous to the recovery of the estate(s).

Rina demonstrated this with a variety of assumptions of the level of haircuts which restulted in a par recovery for a small levels of haircuts and lower recoveries for larger haircuts for a range of 50-100 cents on the dollar. These levels have to then be discounted depending on your hurdle rate and how long until you expect to receive distributions. Ultimately, and I think this was my biggest takeaway, she noted that the trading level of the bonds imply $2.6B of equity was lost at the organization which she seemed to be aggressive. She did note that if the $500M+ of missing funds were not recovered, this would ultimately affect recoveries on the order of 20-30 cents, but she believes that money is somewhere in the system.

For full disclosure, I have yet to establish a position in the name, despite a nagging feeling that recoveries will be north of 50 cents here. ~$600M doesn't simply just go missing, assets were seemingly liquid, and some people I've spoken to say that a number of the overseas operations are amazing assets that will flow equity to boost holding company recoveries. The needle moves VERY quickly on this one given the leverage (i.e. an assumption of 1% friction costs to 2% friction costs greatly reduces recoveries). I continue to work through the issues and hopefully when the first MOR hits, I'll be able to update my model and share with readers. If you are working on this one, would love to hear your thoughts.

Read more...

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?

Read more...