Edison Mission Files for Bankruptcy

Earlier today, Edison Mission filed for bankruptcy in the Northern District of Illinois. This was long expected by the distressed debt and restructuring community. In fact, in the first day affidavit (embedded below), states:

 "Given EME’s financial outlook, earlier this year, EME’s board, management, and professional advisors began exploring various restructuring alternatives with EME’s two major stakeholders: EIX, as EME’s sole shareholder; and a group of holders of the Senior Notes. After approximately six months of vigorous, arm’s-length negotiations, EME, EIX, and the holders of a majority of the Senior Notes by outstanding principal amount (collectively, the “Consenting Noteholders”), reached an agreement that provides the foundation for a comprehensive settlement transaction between the parties that is designed to maximize the value of the Debtors’ estates and ultimately result in a substantial deleveraging of EME’s balance sheet (the “Settlement Transaction”)

Edison Mission bonds closed the day up a few points, but up about 4 points points from before news sources reported an imminent bankruptcy filing. The bonds are currently quoted two ways:

• TSA - Transaction Support Agreement bonds or bonds that have signed off on the TSA
• Non-TSA bonds - Bonds attached to parties that have not signed the transaction support agreement

 From the sidelines it looks like the two bonds are pricing on top of one another (depending on the flavor), but the TSA bonds are bid without. This is a result of the TSA agreement which states a "Consenting Noteholder" agrees only to sell his/her bonds to another "Consenting Noteholder" or if the buyer is not a party to the TSA, that buyer must sign the TSA. These stipulations though do not forbid parties to the TSA from going out and buying other bonds.

Here is the Exhibit 3 of the First Day Affidavit (Transaction Support Agreement (including the Equity Term Sheet and the Restructuring Term Sheet exhibits thereto):

TSA EIX

You can see signature pages in the back listing parties involved in the case. They include:

• AllianceBernstein
• Arrowgrass
• Avenue
• Barclays Capital
• BlueMountain Capital
• Canyon Capital
• Cincinnati High Yield Group of JPM Investment Management
• Citi Capital Advisors (Distressed Debt Strategies Group)
• Claren Road
• Credit Value Partners
• Distressed Debt Trading Desk of Citigroup
• Jefferies High Yield Trading
• Litespeed
• Nomura
• Och-Ziff
• River Birch
• SVP
• TCW
• York Capital - (It is rumored that York is one of the bondholders running the show here)

In another filing exhibit (Docket 36), there is also a list of noteholders committee members as disclosed by the Debtors to its financial advisers for potential parties of interest. This is dated 9/14/2012. There are some missing funds from the above list relative to this one:

I'm not sure if these means these parties have sold out of the bonds or simply did not sign the TSA.

The plan currently contemplated would be bondholders taking over the equity in Edison Mission from EIX with the current tax sharing agreement to remain in place. The tax sharing agreement is incredibly salient in this case given the way money has flown to and from Edision Mission over the past few years which was dramatically altered due to tax code changes regarding accelerated depreciation.

Along with that, Edison Mission's cash flow potential is driven by nat gas prices. As an IPP with ~50% of its generation coming from coal, if nat gas is strong in the outer years, EME cash flows increase dramatically. You can see some projections Houlihan put together in an 8K below:


Interestingly, the wind assets that EME control did not file for bankruptcy. The wind assets are tremendously valuable. Some other assets (California gas fired plants) in the structure are also tremendously valuable. Depending on how you value those two pieces of the puzzle + tax allocation payments + cash, the market is ascribing very little value (or not value at all) to the Midwest Gen assets.

The first day hearing is tomorrow, 12/18 at 1:30PM in Chicago. We will update readers as the case unfolds.

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Distressd Debt Lesson: The Auction

Many times, the penultimate act in a bankruptcy is the auction of the debtors assets. After the auction is settled, the only thing remaining is papering the disclosure statement and plan of reorg and confirmation. With that said, oftentimes when the market learns the results of an auction, it becomes much clearer as to the recovery of securities in the debtor's capital structure.

As reported earlier in the week, A123 (AONEQ) held its bankruptcy auction with Wanxiang emerging as the winner with a bid of $256.6M - a number that was not countered by JCI and NEC, who joint bid during the auction. The implications for the recovery on the converts of A123 will be for another post.

Surprisingly (I've only seen it in a few occasions), the transcript of the auction was filed with the bankruptcy court. I have embedded the document below:


AOne Bankruptcy Auction

I would encourage all readers that want to get a better handle on these auctions read the transcript. It's actually a fantastic read especially when Wanxiang just "goes over the top" with a huge bid increase that can't be matched by JCI/NEC. One thing I'd like readers to take away from the transcript is the way in which the parties at the auction value certain gives and takes.

More specifically, there are many things that a buyer can bid other than cash. Cash of course is the easiest to value but its NOT the only thing of value. Throughout the auction, Wanxiang and JCI/NEC offer different sources of value that benefit the debtors estate. The dollar values of these benefits, seemingly, were agreed to by all parties prior to the auction (probably in tandem with work done by AONE's investment bankers).

Enjoy the read. It's a fantastic learning lesson.

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Two Great Interviews with Two Distressed Fund Managers

Last week, Bloomberg interviewed two of the best managers in the distressed business: Avenue Capital's Marc Lasry and Knighthead Capital's Thomas Wagner. Knighthead was recently in the news for their position in Euro denominated Argentine bonds and Avenue Capital has made an appearance in many current bankruptcy situations including AMR, Newpage, and Houghton.  For those that missed the interviews, our notes are below:

Thomas Wagner, co-founder of Knighthead Capital

• There is over $300 billion of stressed and distressed debt just in the United States (excluding Lehman). Definition of stressed / distressed = loans trading below 80, high yield or converts yielding over 15%
• Means there are still a lot of companies in trouble. This is due to the fact that leverage was put on in anticipation of a robust economy that never panned out. Companies have been unable to grow into their capital structures
• Wagner is frustrated to watch the world's economies kick the can down the road and not deal their problems but it hasn't affected Knighthead's ability to find interesting opportunities
• Distressed investors that have been doing this for a long time (and have been successful at it) are astute at finding good "value with catalysts" opportunities in a variety of markets
• Best opportunities right now: Knighthead is finding a lot of new investments in the energy space broadly defined (coal, power plants). Shipping is a focus in which they were short the past two years but now are looking at opportunities on the long side. Still waiting for healthcare opportunities. Financials are an ever present opportunity since the crisis
• Knighthead thinks that there will be an increased opportunity set of opportunities over the next year and a half (which will used to soak up Lehman distributions)
• Knighthead's investments are many times businesses that right themselves (turn things around) and begin to operate better versus simply liquidate / go insolvent
• Discussed coal as an example: Coal companies need to go into bankruptcy to fix some of the inherent problems in their business (reduce contracts, right size operations). These business become healthier and stronger down the road as a result
• When the fiscal cliff / "day of reckoning" actually comes it will be an amazing investing opportunities. But Wagner doesn't think it is coming anytime soon. He anticipates some deal getting done, but not the grand bargain people are hoping for - and that in itself won't create a large opportunity set of investments
• By being in debt, you're investing with a margin of safety given its place in the capital structure. This is especially important when macro swings can affect things like growth and how companies allocate their capital
• "Investing in distressed at the end of the day is seeing through the uncertainty and trying to forecast how things look on the other side." - fantastic quote!
• It is all about free cash flows. Can a company generate free cash flow in a tough environment? If they can, you only benefit when normalcy returns.
• Knighthead typically investment in the top at the top of a company's capital structure. Not in the equity where they would be exposed to variability in cash flows and sales that can be swung around from macroeconomic factors
• Majority of most hedge funds' investors are offshore investments not subject to U.S. taxation (cited pensions, endowments)
• A fund's lockup must match its strategy. Knighthead has capital that is locked up due the timeline of their investments that require them to work through multi-year periods
• That doesn't mean they are only in illiquid securities - they are actually in liquid structure that trade everyday but they want to go from initiation of investment -> catalyst -> value realization
• On the question of uncertainty in the market: Wagner notes that the uncertainties that investors face have the prospect of making BIGGER impacts on investors than probably ever before
• Because of this, pushing investors like Knighthead (I assume he meant bottom ups players) to consider macro in their investment thesis
• Discussed in general the opportunity set in distressed financial liquidations and tier one investments in Europe with a legal nuance they find attractive

 Marc Lasry. founder of Avenue Capital

• A few weeks ago, Lasry led a group of hedge fund managers to meet with members of the Treasury and the National Economic Council.  Purpose: Gain a better understanding of the issues; brainstorm potential ways to come to agreement on the fiscal cliff.  Group included Republicans critical of the administration including Barry Sternlicht of Starwood Capital
• Conclusion: We need to get this thing resolved, regardless of political affiliation.  “Everyone who was there understands that taxes have to go up.”  
• Ideas that came from it: If taxes have to go up, where are the taxes going – that is the issue.   Tax Credit for businesses in exchange for hiring people and training them, use extra income to rebuild infrastructure and invest in the future, education etc
• Lasry thinks there will be a last minute compromise on fiscal cliff – How do you position your portfolio to take advantage of that?
• Normally, if there is a problem, you try to solve it as quickly as possible because it has an impact on everything you’re doing; you don’t wait for the last minute.
• Problem in DC – nobody wants to appear weak.  Perception game.  Will be harmful to economy, but that’s how DC works.
• Lasry is going into the end of the year with 20-25% cash (vs. average of 15%)  -- Hopes to take advantage of nervousness that deal will not get done and buy some things on the cheap
• When asked about the overall opportunity set, Lasry thinks that there will be upside surprise in the US:  “   
• 70% of GDP is consumer spending – if people are feeling better, they will spend more and that’s good for the economy. Consensus GDP growth was 1.5-2.0%; Looks now closer to 2-3%
• These numbers are ok for equity guys, but great if you’re a debt guy.  Debt guys happy with anything over 1.5%; Equity likes closer to 3-4%+
• Currently $1.2 trillion of distressed debt trading – very large number.  Huge amount of paper with a lot to do spread across many different industries and situations
• With an economy that is picking up, thinks distressed will do well in 2013
• In 2008 – 75-80% of HY market trading at distressed levels.  2009 – 31% with default rate of 5-6%; Today – 1% default rate; 26% of HY trading at distressed levels
• Larry goes on to talk about how difficult the environment is right now with interest rates close to zero, with your pension clients wanting an 8% return. Characterized it as a hard investing environment
• Pension and Endowments face a problem: In 2007, with 2-yr treasury at 4%, you could stay in cash and make half your “bogie” of 7-8%.  Market would expect Lasry to generate 15-20%, or 4-5x risk free rate -- The environment was a lot easier
• Risk free rate today is 25bps – Hedge funds (and pensions) have to generate 40x the risk free rate to make the bogie – and by the way, don’t take risk, and make sure its liquid.  Environment is substantially harder.
• The only way you can make money today in situations where the “perceived risk is substantially greater than the actual risk” - probably my favorite quote out of the interview; worthy of a post even
• Sees a lot of this in Europe – Perceived risk of whether the ECB will continue funding; Lasry thinks they will.
• People are demanding same level returns in a much more difficult environment.  Funds are taking on substantially more risk to achieve those returns
• There is a rush towards liquidity – everyone wants to be liquid.  The problem is, if you want to make money, you have to move to illiquid things because that is where there is less capital.
• In this environment, if you’re not providing returns, investors will move on.  If you want to keep your capital, you need to show investors that you are capable of finding those opportunities by looking where others are not.
• Europe – Where specifically are the opportunities? One year ago the opportunities were in: corporate debt, NPLs, private equity  Today: ECB gave banks access to liquidity and allowed banks to delever at their own pace. This in turn knocked out NPL market – can’t go out and by $2-$5bn portfolio because banks no longer feel the pressure to sell
• On private equity in Europe, Lasry doesn’t believe you’re receiving an adequate premium to invest in illiquid private equity over public equities. Avenue is therefore focused on corporate debt
• Avenue’s Europe portfolio is 90% senior secured securities. 80-90% Northern Europe, 10-15% Southern Europe
• They are buying loans between 50-75 cents on the dollar – being overpaid for the risk in his opinion. As long as Europe muddles through, you should be able to do very well in senior secured debt
• Lasry’s view is that Europe will take 2 years to play out, but the senior secured status gives you luxury that if it takes a little longer, you won’t get hurt
• Question: Thoughts on funds raised to invest in Europe.  Will that make opportunities disappear more quickly? Lasry thinks banks will be required to sell more over the next couple of years.
• Trillions of dollars of paper for sale in Europe compared with $10-$20 billion raised by funds and the capital raised is focused more on investing in real estate and equities vs. corporate debt
• You have to do your work.  “It’s not a macro trade, it’s a credit trade.”  Have to know the company, the legal system. Southern Europe – beautiful place to visit, but legal system is not there. Northern Europe – legal systems are more solid than the US

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Distressed Debt: Eastman Kodak and Roll-Up Facilities

Last night, Eastman Kodak (EK) filed a motion to enter into a new financing for Supplemental DIP. There has been numerous reports in the last few weeks about the shape of this financing. This motion (embedded below) lay out all the details.

EK Financing Motion

One of the more interesting details to come out of the motion is the ten institutional lenders that have committed to provide the financing. These parties (dubbed the Steering Committee Lenders) include:

• Archview
• Bennett Management
• Contrarian Capital
• D.E. Shaw
• Goldentree
• Litespeed
• P. Schoenfeld Asset Management
• Serengeti
• Stone Lion
• Capital Ventures

If you remember, EK had already received a commitment Centerbridge, GSO, JPM, and UBS, who collectively held $274M of the 2nd liens, to provide a similar financing. This is a "Who's Who" of distressed investors (The Steering Committee Lenders hold in aggregate $342M of 2nd liens).

Defending this decision, the Debtors go on to note that the Steering Committee's financing will save them over $35M in fees / interest over the remainder of the case. In addition, and what I thought most salient was the permission of pro-rata participation in the roll-up provision of the financing by ALL second lien note holders.

Roll-up provisions in financing are generally tricky. Depending on the case and judge, there can be situations where the roll-up option is only available to a select group of prepetition creditors. This is, more often then not, a windfall for these creditors as their once junior claim just hopped the ladder up in priority at the expense of junior creditors. The concept of new money and roll-up is coming to play in this financing. For instance, out of the proposed financing ("Proposed Supplemental DIP Facility"), only $455M of that is new, fresh capital. The balance is roll-up loans (one for one exchange for prepetition 2nd liens). The formula for how much debt is getting rolled up also changes from case to case. In the Blockbuster case, for every $2 of DIP you committed to, you got to roll up $1 of prepetition 2nd liens. In EK's case, there is a 6 page annex in the motion walking potential parties through the various scenarios that could play out.

According to the motion, the new DIP facility will be used to repay the term loan portion of EK's existing DIP in full, with the revolver remaining outstanding. When this occurs, the new money loans will then have a first lien on existing DIP term loan collateral. I have included a schedule of the commitment parties included in the motion:

 

The term sheet of the new money junior DIP facility portends a juicy piece of paper: "The First Lien First Out Loans shall bear interest at the rate of L+9.5% per annum. The First Lien Last Out Loans shall bear interest at the rate of L+11.0% per annum. Both loans shall have Libor floors of 100 bps." The First Lien Last Out Loans also have 2 points of OID.  In addition, similar to the original financing contemplated, there is a condition that EK sell its IP property as a condition of funding.

Over the past few months, the 2nd liens have rallied substantially, driven by prospects of new money coming into the structure as well as more positive thoughts on the valuation of the IP assets (combined with a very recent MOR that showed cash burn has slowed). It remains to be seen what sort of equity ownership Kodak will emerge with. In other words, will the holdco bonds receive anything material? We will keep readers updated on changes to the docket as the case plays out.

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Family Offices Investing in Distressed Debt

Last week, Distressed Debt Investing attended the 19th Annual Distressed Investing Conference. Myself and  DDI contributor, Joshua Nahas, principal of Wold Capital Advisors, were in attendance taking notes. Throughout this week, we will be highlighting some of the conference, with particular emphasis on the panels we ourselves were thoroughly impressed with. The first of these panels focused on family offices investing in distressed debt, an emerging trend in the marketplace.

Readers of the site who aspire to move to the buy side or raise their own distressed fund someday (who in this business doesn’t want their own fund!) will find the highlights of the Family Office Panel quite beneficial.  Family offices have proliferated in both size and sophistication around the globe.  Family offices are a sought after destination by PMs and analysts as they have branched out into direct investing hiring their own internal portfolio managers and increasingly making direct investments in a variety of assets classes.

While all the panelists agreed that family office objectives differ significantly from most other investment vehicles, with capital preservation being their first objective, many family offices have multiple roles which include not only managing the family’s money but also foundations and endowments that more and more wealthy families are establishing.  Moreover, family offices have evolved from essentially an internal fund-of-funds to direct investment vehicles making investments in venture startups, mezzanine loans, direct private equity investments, real estate in addition to traditional allocations to hedge funds, PE funds and public equities.

The panelists noted several characteristics of family offices that make them attractive to work for as well as in partnership with.  Perhaps most important, is their long term time horizon (the topic of an important blog post coming) which spans multiple generations and frees them from being concerned with monthly NAVs and short term liquidity.  This makes family offices ideal as LPs as well as co-investors in distressed situations which can exhibit high volatility and long time horizons to effect a turn around and exit the investment.  Panelists also noted that they have unique abilities to pursue more creative structures than many institutional investors and in the right situations have the ability to act more quickly.  Nevertheless, they agreed that perception in the market is that family offices spend a lot of time looking at deals but rarely come to the table.

All the panelists agreed that co-investing has grown substantially as family offices have become more sophisticated and they see co-investing as a growing opportunity set.  It is typical for a family office to co-invest with investors that they already have a track record of investing along side of in the past.  Their capital tends to be sticky and the allocations increase to those funds or partners who they have had success with in the past.  These characteristics make family offices attractive capital partners, however, getting in the front door and earning their confidence is a high hurdle.  Once earned however, the family office can become a reliable and steady partner and provide a symbiotic relationship in sourcing deals as well as investing along side in deals.

In addition, to co-investing along side sponsors in deals, family offices are originating and leading their own direct investments.  The large majority of direct investing is in middle market PE deals, mezzanine lending, private placements and individual public securities.  Family offices employ an extensive due diligence process and many specialize in certain niches such as clean energy or sectors similar to where the family built its fortune.

Managers at family offices maintain both formal and informal networks for sourcing investment opportunities.  Furthermore, if an investor develops a good reputation with one family office, that will carry more credibility with other family office managers.  That operating leverage can make it worth the time and effort to cultivate these relationships.  Any investor looking to develop these networks though needs to spend the time understanding the family’s unique situation, requirements and interests.  This means avoid boiler plate presentations and demonstrate your understanding of the family’s needs.

Most family offices seek to maintain a low profile and want to avoid negative publicity.  Managing a family office requires strong diplomacy skills, particularly where there are multiple generations of children and grand children who are heirs.  First generation family offices tend to be heavily influenced by the family’s patriarch who looks to maintain final decision making authority. Succeeding generations tend to be more democratic, but that can generate much conflict given conflicting interests, sibling rivalries and other family dynamics that need to be managed.  Wealthy families are increasingly looking to provide their members with greater financial training and sophistication so as to be better able to handle the responsibility of great wealth.  Managers need to incorporate succession plans, protocols for investment committees and often times may have to play the tie breaker when the family is divided over an issue, which all the panelists agreed was not a pleasant situation since regardless of what you decide there will be a disappointed party.

In conclusion, family offices have grown in size and sophistication and represent a unique opportunity for distressed funds as both LP investors as well as co-investors.  However, hedge fund and PE managers looking to develop these relationships have their work cut out for them as these relationships take along time to cultivate and getting in the front door can be difficult.  But for those who succeed they will likely be pleased wit the results.

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