Six Flags and Incremental Recoveries to Junior Bondholders

Approximately a year ago, we analyzed the debt of Six Flags. Our recommendation was to buy the bank debt at 72. Currently that debt trades at 101. In round numbers, about a 40% IRR. On an absolute basis a strong number, relative to where we could have played in the capital structure: Not so much...

Currently, the senior opco notes at Six Flags trades at 113-115 and the holdco notes trade in the 31-33 context. Those are doubles and triples from when we wrote the post a year ago. Hindsight is 20/20 of course - I sacrificed upside potential, for downside protection. A better question to ask: Has Six Flags fundamentally changed so much in one year that the intrinsic value is really that much higher?

Some background: Six Flags has gone through a number of plan iterations. First the bank debt holders were going to get the majority of the equity. Then the opco holders were going to get the majority of the equity. And finally the hold-co debt, as the plan is currently filed, will get a majority of the equity. Initially they said they were going to force current management out, but when the plan emerged and it was revealed management was going to get 15% of NewCo (yes, you read that right), it was plain to see that incentives were aligned for the holdco plan to be taken up and adopted by management.

A Dow Jones Daily Bankruptcy Review article points out that Avenue Capital (the driving bondholder representing the opco notes) will lead a challenge of the Chapter 11 confirmation. They will argue that the plan that gives the majority of the equity to holdco noteholders will leave the new Six Flags with a burdensome load of debt and will challenge the feasibility of the plan. Therefore nothing is decided at this point, but we fashion a guess that the hold-co plan, which now pays out senior lenders in cash (vs. reinstating) will be approved.

Nonetheless, back to the original question: Has Six Flags fundamentally changed so much in one year that the intrinsic value is really that much higher?

For one, multiples have moved higher in the industry. At the time, Cedar Fair traded at 6.5x; Now with the proposed Apollo buyout, it trades for 7.5x. Using 7.5x versus the projected 2011 EBITDA of 260M (I initially forecast slightly higher), derives an EV of $1.95B more than enough to pay off both senior lenders and opco bond holders. So I was too low on my multiple.

Secondly, credit markets are WIDE open right now. On both the bank and bond side, most deals (except for the hold-co dividend deals which are reappearing) are well oversubscribed and dealers are flexing terms. While the hold co note holders didn't technically NEED to appease the bank debt holders by paying them in cash versus reinstating their low coupon paper, they did it to ensure their plan gets accepted by one of the larger creditors groups in the case. Six Flags did a term loan a month or so ago that was to finance the opco plan- that deal was oversubscribed. That being said it wasn't a stretch to assume you could layer on more senior secured debt (second lien) to get more cash in the door to help pay pre-petition claims. Would I have guessed this the case a year ago? Frankly, no.

Finally, and something that very few people are talking about right now, but from what I have heard, hedge funds are no longer in "deal with redemptions" mode. As returns continued to be impressive throughout 2009, more redemption requests were withdrawn, and funds that were sitting with idle cash on the side, ready to meet redemptions, needed to put that money to work to at least keep up with this rocketship of a market. That being said, funds are more able and willing to backstop rights offerings or provide fresh capital to reorganized debtors without having to deal with their LPs on their backs. A year ago, no one fund, or even groups of funds, would be able to step up to the plate and execute a $600 or $700M rights offering.

In my opinion, higher valuation, easier access to exit/debt capital, and more parties willing to fight over providing fresh capital to debtors via right-offerings has been the real driver of returns in distressed land over the past 12-18 months. Yes, some companies have seen dramatic improvements in operating performance, but to me the real driver to this rally (which has disproportionately helped junior creditors and equity holders) has been the multiple expansion (valuation in the bankruptcy court still relies on comp analysis) and the capital markets being awash with liquidity.