1.28.2013
Lodgenet, School Specialty, and PowerWave filing for bankruptcy
Big day / weekend for distressed debt investors with three relatively decent size filings in Lodgenet, School Specialty, and PowerWave. Still seeing runs kinda all over the place given the lack of liquidity in some of the names. I'll be back with more on each of these throughout the next two days.
1.25.2013
4th Annual Global Distressed Debt Investing Summit
Over the past few years, Distressed Debt Investing has attended iGlobal's Forum Global Distressed Debt Investing Summit here in New York City. Each year the conference highlights issues highly topical to the distressed debt community while featuring a number of fantastic speakers. This year there will be speakers from the likes of Fortress, Highland, Marblegate, Marathon, Moab, Versa, WL Ross, Bowery, Watershed, and Halycon just to name a few.
Like last year, the agenda also highlights the issues most pertinent to credit investors today. Things like the opportunity for distressed debt overseas, what industries look most interesting in the tight spread environment of today, and the macro outlook and their impact on our market.
For more information, you can find the conference website here: 4th Global Distressed Debt Investing Summit. Hope to see you there!
Like last year, the agenda also highlights the issues most pertinent to credit investors today. Things like the opportunity for distressed debt overseas, what industries look most interesting in the tight spread environment of today, and the macro outlook and their impact on our market.
For more information, you can find the conference website here: 4th Global Distressed Debt Investing Summit. Hope to see you there!
1.23.2013
Advanced Distressed Debt Lesson: Trade Dispute Litigation
For the past few months, David Karp, partner at Schulte Roth & Zabel, has contributed a number of fascinating articles on issues pertinent to trading in distressed debt, both domestically and overseas. I have gotten to know David over the past few months and he undoubtedly is one of the best in the field at what he does best: making sure funds and their investments are protected when transacting and executing trades in distressed debt and claims.
He's back with another fantastic, and timely, post. This one concerning a very recent decision related to claims trading in an oldie, but a goodie: the KB Toys bankruptcy and ASM Capital (defined below as Purchaser). This is a long one, but funds and desks transacting in claims will learn a great deal from the post. Enjoy!
Advanced Distressed Debt Trading & Trade Dispute Litigation: Debtor vs. Secondary Market Claims Purchaser
Our last post, Advanced Distressed Debt Lesson: Trade Dispute Litigation: What Distressed Investors Need to Know, focused on a claim buyer’s rights against a claims seller in the event that the specific claim sold is or becomes impaired. This post discusses the risk of impairment in the context of a dispute between the debtor’s liquidating trustee and a claims purchaser. On Jan. 4, 2013, the U.S. District Court for the District of Delaware upheld a bankruptcy court ruling that a so-called “section 502(d)” claim impairment travels with a claim in a typical claims trading transaction, rather than staying with the seller as a “personal disability.” In re KB Toys Inc., et al., Civ. No. 12-716 (D. Del. entered Jan. 4, 2013). Regardless of this district court ruling on these highly debated issues, or the outcome of any potential appeal to the Third Circuit, traders and analysts should focus on the diligence pointers provided by this case, which demonstrate that this trip to court by the claims purchaser might have been avoided.
KB Toys, a mall-based toy retailer, filed for Chapter 11 protection in early 2004. Between the Chapter 11 petition date and confirmation of its plan of reorganization in the summer of 2005 (followed by a second Chapter 11 filing and liquidation in 2008), “Purchaser” acquired 34 trade vendor claims ranging in size from $792.00 to $2.6 million, for a total combined face amount of approximately $7.5 million.
When purchasing multiple claims to build a position, it is not uncommon for claims investors to utilize a “portfolio theory” approach to aggregating claims against one debtor and spreading the risk that an individual claim is or will become impaired across a bundle of small claims, with the expectation that actual losses on any “bad” individual claim would be exceeded by higher returns on the bundle. Appearing to use this strategy, the Purchaser acquired each of the 34 claims on a short-form assignment agreement consisting of one to two pages of basic representations, warranties and indemnities. That being said, the Purchaser’s forms used for the KB Toys claim purchases, redacted copies of which were filed with the court, vary slightly between the different trades and are on a modified short-form recourse structure, meaning the risk of an impairment of a claim should remain with the claims seller through a put right and indemnification for breach of representations and warranties. For a more detailed discussion of recourse structures and claims trading risk allocation structures, see Claims Traders Beware: More Risk Than You Bargained For! Each of the nine purchase agreement forms for the disputed claims included a put right and four out of nine included indemnification for the seller’s breach of representations and warranties, which included, among others, that the claim was valid in the amount specified and that no objections to the claim existed.
In late July 2009, after the Purchaser had settled more than 30 trades and accumulated more than $7 million in face value of claims, the KB Toys trustee filed an omnibus objection to certain claims based on section 502(d) of the Bankruptcy Code. Section 502(d) requires the court to "disallow any claim of any entity from which property is recoverable" under an avoidance action, such as a preference claim "unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable." See 11 U.S.C. § 502(d). The Purchaser may have been surprised to see nine of its claims listed in that objection. The nine claims listed, the largest of which was for only $163,000, totaled about $672,000 or approximately 9.5 percent of the Purchaser’s total position.
In many cases, one of the hallmarks of a portfolio strategy for claims purchasers is less claim and seller-specific diligence and lighter purchase documents in order to facilitate a quick trade and settlement. Light diligence aside, the Purchaser might have easily discovered, in advance of buying the claims, that many of the claims it was buying were subject to potential section 502(d) disallowance. As required of all Chapter 11 debtors, KB Toys had filed a Statement of Financial Affairs (“SOFA”) that listed all payments to creditors of more than $600 in the 90 days immediately preceding the petition date. KB Toys’s SOFA listed the nine claimants from which the Purchaser purchased the claims at issue, including the dates and amounts of the payments from KB Toys to the creditors. While we will delve more deeply into avoidance action law below, certain payments from a debtor in the 90 days prior to its filing can be avoided by the trustee or debtor-in-possession. Had the Purchaser reviewed KB Toys’s SOFA, it would have been aware that those original sellers were potentially subject to preference actions by the trustee and, therefore, their claims were also potentially subject to disallowance under section 502(d). In addition, the original holder of the largest claim was already subject to a default judgment in the amount of $18,181 obtained by the trustee in advance of the Purchaser purchasing the claim. This fact was readily discoverable in a search of the debtor’s case docket.
The public record is unclear on what, if any, efforts the Purchaser took to collect from the original claimholders under the assignment agreements’ put-right or indemnification provisions. We can speculate that such efforts have not been successful to date, as the Purchaser has since gone to great lengths to challenge the trustee’s objection to its nine claims since it was filed in July 2009 — arguing, among other things, that the trustee’s section 502(d) defense does not travel with the claim to the transferee.
As is the case with most assignment of claims agreements, the Purchaser’s assignments are governed by New York law. Unfortunately for market participants (and their counsel), but perhaps fortunate for the Purchaser, the state of New York law as to whether or not claim impairments are specific to the claim can be characterized as murky, at best. This is due to the oft-criticized decision known as Enron II. Enron Corp. v. Springfield Assocs., LLC (In re Enron Corp.), 379 B.R. 425 (S.D.N.Y. 2007) (“Enron II”). In the Enron case, the debtor sought to use section 502(d) to disallow claims held by secondary market transferees. As with the Purchaser’s claims, one of the issues for the court to consider in Enron was the extent, if any, to which a claim subject to section 502(d) disallowance in the hands of the transferor remains subject to section 502(d) disallowance in the hands of a transferee that was not involved in the avoidable transfer that gave rise to the 502(d) defense. The bankruptcy court, in Enron I, held that, since the claims in the hands of the transferor would be subject to section 502(d), the transferees are subject to the same claim disallowance under section 502(d). Enron Corp. v. Avenue Special Situation Funds II, LP (In re Enron Corp.), 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (“Enron I”).
In the appeal of the Enron I decision, Enron II, the district court considered “whether . . . disallowance under 502(d) can be applied, as a matter of law, to claims held by transferees to the same extent they would be applied to the claims if they were still held by the transferor based on alleged acts or omissions on the part of the transferor.” Enron II, 379 B.R. at 427-28. In its opinion, the district court considered the legislative objectives of the statute and cited the “twin aims” of disallowance under section 502(d): to assure equality of distribution of the estate assets and to coerce compliance with judicial orders. Id. at 435. The district court then attempted to make a distinction between the effect of a “sale” versus an “assignment.” The district court described an assignment as a transfer in which the assignee stands in the shoes of the assignor, taking the claim with whatever limitation it had in the hands of the assignor. See id. at 436. In other words, in an assignment of a claim, all limitations and disabilities of the claim and the transferor travel with the claim to the transferee, whereas in a sale, some limitations and disabilities can travel with the claim, but personal disabilities of the claimant remain with the claimant. Id. The district court looked at the language of 502(d) and determined that the emphasis on the entity suggested that 502(d) is a personal disability of the claimant that travels by assignment. Id. at 443. As to whether or not the Enron transfer was a sale or an assignment, the district court held that this determination required examination by the bankruptcy court of the “nature of the transfers.” Id. at 445-46. However, before the bankruptcy court could make a determination of that issue, the parties settled the claims, leaving claims and distressed debt trading market participants scratching their heads and wondering what exactly makes a transfer an assignment versus a sale.
This leads us back to the Purchaser’s purchases (or were they assignments?) of the KB Toys claims. Faced with the KB Toys trustee’s objection to the nine claims on section 502(d) disallowance grounds, the Purchaser naturally responded by waving the Enron II flag. In response to the trustee’s objections, the Purchaser argued to Judge Carey in the Delaware bankruptcy court that, based on Enron II, the claims at issue were transferred as “sales” and that the language of section 502(d) focuses on the claimant and, therefore, is a personal disability of the claimant that did not travel with the claim in the sale. In re KB Toys, Inc., 470 B.R. 331, 335 (Bankr. D. Del. 2012). Conversely, the KB Toys trustee questioned the analysis of Enron II and the resulting policy concerns and argued that, even if accepting Enron II, the transfers to the Purchaser were assignments and that the Purchaser had at least constructive knowledge of the claims, making the Purchaser’s purchases of the claims not in good faith. Id.
With analysis harkening back to the pre-1978 Bankruptcy Act (and even to case law from 1902), Judge Carey concluded that legislative history and case precedent support the notion that disabilities travel with the claim to the transferee. Id. at 335-37. Judge Carey echoed the analysis in Enron I and questioned the “sale versus assignment” distinction advanced in Enron II. Id. at 337-41. Judge Carey noted that the distinction has been highly criticized and observed that, “even if there exists a clean and principled way to distinguish between assignment and sale, the exercise, in this context, is unhelpful and unrevealing of the appropriate outcome.” Id. at 341.
Judge Carey also rejected the Enron II policy assertion that burdening the transferee with the disabilities imposed on the claim would upset the trading markets as a “hobgobin [sic] without a house to haunt,” because buyers of debt are highly sophisticated and fully capable of performing due diligence before any acquisition. Id. at 342. Even without any due diligence, market players are fully aware of the ever-present possibility of avoidance actions based on preference liability or fraudulent conveyances. Id. Judge Carey observed that the Purchaser could have discovered the potential for disallowance with very little due diligence and could have factored that into the price. Id. The fact that some of the assignment agreements had indemnification for disallowance evidenced the Purchaser’s understanding of the possible risks and its leverage to appropriately protect itself. Id.
Judge Carey also rejected the Purchaser’s argument that it should be protected from disallowance as a purchaser in good faith, reasoning that a purchaser of bankruptcy claims is well aware of the debtor’s financial difficulties and is entering a market in which claims are allowed and disallowed in accordance with the Bankruptcy Code. Id. at 343. In short, purchasers of bankruptcy claims are not entitled to the protections of a good faith purchaser. Id. Judge Carey was careful to point out in a footnote, however, that the ruling only relates to trade claims purchased from an original holder and not to other types of transfers, such as publicly traded notes, etc. Id. at 342 n.14.
The Purchaser then appealed Judge Carey’s ruling to the District Court for the District of Delaware and the appeal papers more or less rehashed the same issues and arguments as presented to the bankruptcy court. Oral argument on the appeal was held on Jan. 4, 2013 and Judge Richard G. Andrews upheld Judge Carey’s ruling. According to the hearing transcript, Judge Andrews’s view of the language of section 502(d) is that it could be read either way, but he nevertheless agreed with the rest of Judge Carey’s analysis. Judge Andrews was particularly focused on the policy rationale that the Purchaser should bear the risk of a section 502(d) impairment because it is in a better position to protect itself, as opposed to other unnamed creditors whose claims would be diluted if transfers had the effect of cleansing claims of such impairments. Feeling that he would not have much to add on the matter, Judge Andrews refrained from issuing a written opinion but welcomed the Purchaser to seek appeal to the Third Circuit to perhaps move closer to a definitive resolution of this issue. We would like to be able to say this ruling, or the outcome of any potential appeal to the Third Circuit, provides clarity on the state of the law in this area, but a Delaware district court ruling, or even a Third Circuit decision on appeal, will not have the precedential force to change the fact that Enron II is still out there and, despite widespread criticism, is still the law in New York.
No matter the outcome, the KB Toys case is a good reminder to the market that disallowance under section 502(d) is a real risk. The sale/assignment, personal/non-personal disabilities distinctions are too vague and legally opaque to be relied on by purchasers of claims. There are many more practical and reliable techniques available for purchasers to protect themselves. First, through due diligence. Even when accumulating small trade claims, work with your attorneys to create a diligence checklist for each debtor you are considering, review the SOFA, the case docket, and do an Internet search on the seller to see if you uncover any potential "insider" (as defined under the Bankruptcy Code) connections to the debtor, which could increase the preference period from 90 days to one year. Second, protect yourself in the trade documents (which you should do in most cases, regardless of the due diligence outcomes). Make sure your documents have strong seller representations, including that the claim is not (and will not be) subject to “disallowance (including, without limitation, pursuant to section 502(d) of the Bankruptcy Code),” avoidance, subordination, or be otherwise impaired. Have a clear indemnification provision for breach of representations and claim impairments. Of course, document-based protections do come with the credit risk of the seller, which brings you back to due diligence.
What should you do if your due diligence does uncover potential section 502(d) issues? Run for the hills? Not necessarily. There are some circumstances in which claims could be attractive even with the potential for section 502(d) disallowance. The potential section 502(d) disallowance can be settled, whereby the amount paid to the seller is used to resolve the trustee’s avoidance action in order to get the claim allowed. Or, the avoidance action could be priced into the trade or the seller might be willing to escrow the avoidance action claim amount until the claim objection is resolved. The bottom line is that even where a purchaser is quickly aggregating small claims through a “portfolio theory” approach, an upfront investment in pre-trade diligence and transaction structuring far outweighs the time, cost and expense required if a dispute arises and it finds itself in court.
David J. Karp is a partner in the New York and London offices of Schulte Roth & Zabel LLP, where his practice focuses on corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions, and the bankruptcy aspects of structured finance. David leads the firm’s Distressed Debt & Claims Trading Group, which provides advice in connection with U.S., European and emerging market credit trading matters. David is a frequent speaker and writer on distressed investing related issues, recently co-authoring “European Insolvency Claims Trading: Is Iceland the Paradigm?” for Butterworths Journal of International Banking and Financial Law and “Trade Risk in European Secondary Loans” for The Hedge Fund Law Report. David is an active member of the LMA, APLMA, INSOL Europe and the LSTA where he is a member of the Trade Practices and Forms Committee. Neil Begley, an associates at SRZ, assisted in the preparation of this entry.
He's back with another fantastic, and timely, post. This one concerning a very recent decision related to claims trading in an oldie, but a goodie: the KB Toys bankruptcy and ASM Capital (defined below as Purchaser). This is a long one, but funds and desks transacting in claims will learn a great deal from the post. Enjoy!
Advanced Distressed Debt Trading & Trade Dispute Litigation: Debtor vs. Secondary Market Claims Purchaser
Our last post, Advanced Distressed Debt Lesson: Trade Dispute Litigation: What Distressed Investors Need to Know, focused on a claim buyer’s rights against a claims seller in the event that the specific claim sold is or becomes impaired. This post discusses the risk of impairment in the context of a dispute between the debtor’s liquidating trustee and a claims purchaser. On Jan. 4, 2013, the U.S. District Court for the District of Delaware upheld a bankruptcy court ruling that a so-called “section 502(d)” claim impairment travels with a claim in a typical claims trading transaction, rather than staying with the seller as a “personal disability.” In re KB Toys Inc., et al., Civ. No. 12-716 (D. Del. entered Jan. 4, 2013). Regardless of this district court ruling on these highly debated issues, or the outcome of any potential appeal to the Third Circuit, traders and analysts should focus on the diligence pointers provided by this case, which demonstrate that this trip to court by the claims purchaser might have been avoided.
KB Toys, a mall-based toy retailer, filed for Chapter 11 protection in early 2004. Between the Chapter 11 petition date and confirmation of its plan of reorganization in the summer of 2005 (followed by a second Chapter 11 filing and liquidation in 2008), “Purchaser” acquired 34 trade vendor claims ranging in size from $792.00 to $2.6 million, for a total combined face amount of approximately $7.5 million.
When purchasing multiple claims to build a position, it is not uncommon for claims investors to utilize a “portfolio theory” approach to aggregating claims against one debtor and spreading the risk that an individual claim is or will become impaired across a bundle of small claims, with the expectation that actual losses on any “bad” individual claim would be exceeded by higher returns on the bundle. Appearing to use this strategy, the Purchaser acquired each of the 34 claims on a short-form assignment agreement consisting of one to two pages of basic representations, warranties and indemnities. That being said, the Purchaser’s forms used for the KB Toys claim purchases, redacted copies of which were filed with the court, vary slightly between the different trades and are on a modified short-form recourse structure, meaning the risk of an impairment of a claim should remain with the claims seller through a put right and indemnification for breach of representations and warranties. For a more detailed discussion of recourse structures and claims trading risk allocation structures, see Claims Traders Beware: More Risk Than You Bargained For! Each of the nine purchase agreement forms for the disputed claims included a put right and four out of nine included indemnification for the seller’s breach of representations and warranties, which included, among others, that the claim was valid in the amount specified and that no objections to the claim existed.
In late July 2009, after the Purchaser had settled more than 30 trades and accumulated more than $7 million in face value of claims, the KB Toys trustee filed an omnibus objection to certain claims based on section 502(d) of the Bankruptcy Code. Section 502(d) requires the court to "disallow any claim of any entity from which property is recoverable" under an avoidance action, such as a preference claim "unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable." See 11 U.S.C. § 502(d). The Purchaser may have been surprised to see nine of its claims listed in that objection. The nine claims listed, the largest of which was for only $163,000, totaled about $672,000 or approximately 9.5 percent of the Purchaser’s total position.
In many cases, one of the hallmarks of a portfolio strategy for claims purchasers is less claim and seller-specific diligence and lighter purchase documents in order to facilitate a quick trade and settlement. Light diligence aside, the Purchaser might have easily discovered, in advance of buying the claims, that many of the claims it was buying were subject to potential section 502(d) disallowance. As required of all Chapter 11 debtors, KB Toys had filed a Statement of Financial Affairs (“SOFA”) that listed all payments to creditors of more than $600 in the 90 days immediately preceding the petition date. KB Toys’s SOFA listed the nine claimants from which the Purchaser purchased the claims at issue, including the dates and amounts of the payments from KB Toys to the creditors. While we will delve more deeply into avoidance action law below, certain payments from a debtor in the 90 days prior to its filing can be avoided by the trustee or debtor-in-possession. Had the Purchaser reviewed KB Toys’s SOFA, it would have been aware that those original sellers were potentially subject to preference actions by the trustee and, therefore, their claims were also potentially subject to disallowance under section 502(d). In addition, the original holder of the largest claim was already subject to a default judgment in the amount of $18,181 obtained by the trustee in advance of the Purchaser purchasing the claim. This fact was readily discoverable in a search of the debtor’s case docket.
The public record is unclear on what, if any, efforts the Purchaser took to collect from the original claimholders under the assignment agreements’ put-right or indemnification provisions. We can speculate that such efforts have not been successful to date, as the Purchaser has since gone to great lengths to challenge the trustee’s objection to its nine claims since it was filed in July 2009 — arguing, among other things, that the trustee’s section 502(d) defense does not travel with the claim to the transferee.
As is the case with most assignment of claims agreements, the Purchaser’s assignments are governed by New York law. Unfortunately for market participants (and their counsel), but perhaps fortunate for the Purchaser, the state of New York law as to whether or not claim impairments are specific to the claim can be characterized as murky, at best. This is due to the oft-criticized decision known as Enron II. Enron Corp. v. Springfield Assocs., LLC (In re Enron Corp.), 379 B.R. 425 (S.D.N.Y. 2007) (“Enron II”). In the Enron case, the debtor sought to use section 502(d) to disallow claims held by secondary market transferees. As with the Purchaser’s claims, one of the issues for the court to consider in Enron was the extent, if any, to which a claim subject to section 502(d) disallowance in the hands of the transferor remains subject to section 502(d) disallowance in the hands of a transferee that was not involved in the avoidable transfer that gave rise to the 502(d) defense. The bankruptcy court, in Enron I, held that, since the claims in the hands of the transferor would be subject to section 502(d), the transferees are subject to the same claim disallowance under section 502(d). Enron Corp. v. Avenue Special Situation Funds II, LP (In re Enron Corp.), 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (“Enron I”).
In the appeal of the Enron I decision, Enron II, the district court considered “whether . . . disallowance under 502(d) can be applied, as a matter of law, to claims held by transferees to the same extent they would be applied to the claims if they were still held by the transferor based on alleged acts or omissions on the part of the transferor.” Enron II, 379 B.R. at 427-28. In its opinion, the district court considered the legislative objectives of the statute and cited the “twin aims” of disallowance under section 502(d): to assure equality of distribution of the estate assets and to coerce compliance with judicial orders. Id. at 435. The district court then attempted to make a distinction between the effect of a “sale” versus an “assignment.” The district court described an assignment as a transfer in which the assignee stands in the shoes of the assignor, taking the claim with whatever limitation it had in the hands of the assignor. See id. at 436. In other words, in an assignment of a claim, all limitations and disabilities of the claim and the transferor travel with the claim to the transferee, whereas in a sale, some limitations and disabilities can travel with the claim, but personal disabilities of the claimant remain with the claimant. Id. The district court looked at the language of 502(d) and determined that the emphasis on the entity suggested that 502(d) is a personal disability of the claimant that travels by assignment. Id. at 443. As to whether or not the Enron transfer was a sale or an assignment, the district court held that this determination required examination by the bankruptcy court of the “nature of the transfers.” Id. at 445-46. However, before the bankruptcy court could make a determination of that issue, the parties settled the claims, leaving claims and distressed debt trading market participants scratching their heads and wondering what exactly makes a transfer an assignment versus a sale.
This leads us back to the Purchaser’s purchases (or were they assignments?) of the KB Toys claims. Faced with the KB Toys trustee’s objection to the nine claims on section 502(d) disallowance grounds, the Purchaser naturally responded by waving the Enron II flag. In response to the trustee’s objections, the Purchaser argued to Judge Carey in the Delaware bankruptcy court that, based on Enron II, the claims at issue were transferred as “sales” and that the language of section 502(d) focuses on the claimant and, therefore, is a personal disability of the claimant that did not travel with the claim in the sale. In re KB Toys, Inc., 470 B.R. 331, 335 (Bankr. D. Del. 2012). Conversely, the KB Toys trustee questioned the analysis of Enron II and the resulting policy concerns and argued that, even if accepting Enron II, the transfers to the Purchaser were assignments and that the Purchaser had at least constructive knowledge of the claims, making the Purchaser’s purchases of the claims not in good faith. Id.
With analysis harkening back to the pre-1978 Bankruptcy Act (and even to case law from 1902), Judge Carey concluded that legislative history and case precedent support the notion that disabilities travel with the claim to the transferee. Id. at 335-37. Judge Carey echoed the analysis in Enron I and questioned the “sale versus assignment” distinction advanced in Enron II. Id. at 337-41. Judge Carey noted that the distinction has been highly criticized and observed that, “even if there exists a clean and principled way to distinguish between assignment and sale, the exercise, in this context, is unhelpful and unrevealing of the appropriate outcome.” Id. at 341.
Judge Carey also rejected the Enron II policy assertion that burdening the transferee with the disabilities imposed on the claim would upset the trading markets as a “hobgobin [sic] without a house to haunt,” because buyers of debt are highly sophisticated and fully capable of performing due diligence before any acquisition. Id. at 342. Even without any due diligence, market players are fully aware of the ever-present possibility of avoidance actions based on preference liability or fraudulent conveyances. Id. Judge Carey observed that the Purchaser could have discovered the potential for disallowance with very little due diligence and could have factored that into the price. Id. The fact that some of the assignment agreements had indemnification for disallowance evidenced the Purchaser’s understanding of the possible risks and its leverage to appropriately protect itself. Id.
Judge Carey also rejected the Purchaser’s argument that it should be protected from disallowance as a purchaser in good faith, reasoning that a purchaser of bankruptcy claims is well aware of the debtor’s financial difficulties and is entering a market in which claims are allowed and disallowed in accordance with the Bankruptcy Code. Id. at 343. In short, purchasers of bankruptcy claims are not entitled to the protections of a good faith purchaser. Id. Judge Carey was careful to point out in a footnote, however, that the ruling only relates to trade claims purchased from an original holder and not to other types of transfers, such as publicly traded notes, etc. Id. at 342 n.14.
The Purchaser then appealed Judge Carey’s ruling to the District Court for the District of Delaware and the appeal papers more or less rehashed the same issues and arguments as presented to the bankruptcy court. Oral argument on the appeal was held on Jan. 4, 2013 and Judge Richard G. Andrews upheld Judge Carey’s ruling. According to the hearing transcript, Judge Andrews’s view of the language of section 502(d) is that it could be read either way, but he nevertheless agreed with the rest of Judge Carey’s analysis. Judge Andrews was particularly focused on the policy rationale that the Purchaser should bear the risk of a section 502(d) impairment because it is in a better position to protect itself, as opposed to other unnamed creditors whose claims would be diluted if transfers had the effect of cleansing claims of such impairments. Feeling that he would not have much to add on the matter, Judge Andrews refrained from issuing a written opinion but welcomed the Purchaser to seek appeal to the Third Circuit to perhaps move closer to a definitive resolution of this issue. We would like to be able to say this ruling, or the outcome of any potential appeal to the Third Circuit, provides clarity on the state of the law in this area, but a Delaware district court ruling, or even a Third Circuit decision on appeal, will not have the precedential force to change the fact that Enron II is still out there and, despite widespread criticism, is still the law in New York.
No matter the outcome, the KB Toys case is a good reminder to the market that disallowance under section 502(d) is a real risk. The sale/assignment, personal/non-personal disabilities distinctions are too vague and legally opaque to be relied on by purchasers of claims. There are many more practical and reliable techniques available for purchasers to protect themselves. First, through due diligence. Even when accumulating small trade claims, work with your attorneys to create a diligence checklist for each debtor you are considering, review the SOFA, the case docket, and do an Internet search on the seller to see if you uncover any potential "insider" (as defined under the Bankruptcy Code) connections to the debtor, which could increase the preference period from 90 days to one year. Second, protect yourself in the trade documents (which you should do in most cases, regardless of the due diligence outcomes). Make sure your documents have strong seller representations, including that the claim is not (and will not be) subject to “disallowance (including, without limitation, pursuant to section 502(d) of the Bankruptcy Code),” avoidance, subordination, or be otherwise impaired. Have a clear indemnification provision for breach of representations and claim impairments. Of course, document-based protections do come with the credit risk of the seller, which brings you back to due diligence.
What should you do if your due diligence does uncover potential section 502(d) issues? Run for the hills? Not necessarily. There are some circumstances in which claims could be attractive even with the potential for section 502(d) disallowance. The potential section 502(d) disallowance can be settled, whereby the amount paid to the seller is used to resolve the trustee’s avoidance action in order to get the claim allowed. Or, the avoidance action could be priced into the trade or the seller might be willing to escrow the avoidance action claim amount until the claim objection is resolved. The bottom line is that even where a purchaser is quickly aggregating small claims through a “portfolio theory” approach, an upfront investment in pre-trade diligence and transaction structuring far outweighs the time, cost and expense required if a dispute arises and it finds itself in court.
David J. Karp is a partner in the New York and London offices of Schulte Roth & Zabel LLP, where his practice focuses on corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions, and the bankruptcy aspects of structured finance. David leads the firm’s Distressed Debt & Claims Trading Group, which provides advice in connection with U.S., European and emerging market credit trading matters. David is a frequent speaker and writer on distressed investing related issues, recently co-authoring “European Insolvency Claims Trading: Is Iceland the Paradigm?” for Butterworths Journal of International Banking and Financial Law and “Trade Risk in European Secondary Loans” for The Hedge Fund Law Report. David is an active member of the LMA, APLMA, INSOL Europe and the LSTA where he is a member of the Trade Practices and Forms Committee. Neil Begley, an associates at SRZ, assisted in the preparation of this entry.
1.17.2013
Post Reorg Equity: Tribune (TRBAA)
Every few months, I post a recent idea from the Distressed Debt Investors Club. Started a year or so after I launched the blog, the DDIC has grown to be an amazing community of buy and sell side analysts covering everything from distressed, special situation equities, cap structure arbs and outright shorts. For a list of ideas on the site you can go here: DDIC List of Ideas. Because of turnover (members are required to post an idea once every 6 months), we are always looking for talented analysts to join our community. A thorough investment idea is a requirement for admission. For those interested, you can apply here: http://distresseddebtinvestorsclub.com/home/apply/member
Post reorg equities often interest the special sit equity community of funds. And Tribune (TRBAA) is getting a lot of coverage from both distressed desks as well as on the run equity shops. Last week, a member of the DDIC wrote up his thesis on the stock. Enjoy!
Idea: TRBAA
Company Name: Tribune
Type: Post Reorg Equities
Synopsis
Tribune is a media conglomerate with TV stations, newspapers, and valuable interests in Food Network, CareerBuilder and Classified Ventures.
Fortunately, the majority of the value comes from the non-publishing assets (compared to 2007 when 70% of the core operating EBITDA was from publishing) - unfortunately, that's because the publishing business has shrunk rapidly.
I think Tribune is fairly valued here at around $49, although there is upside from:
Company Overview
Tribune is a media conglomerate with TV stations, newspapers, and valuable interests in Food Network, CareerBuilder and Classified Ventures.
Fortunately, the majority of the value comes from the non-publishing assets (compared to 2007 when 70% of the core operating EBITDA was from publishing) - unfortunately, that's because the publishing business has shrunk rapidly.
Catalysts
It’s been widely reported and expected that the company will look to sell newspaper assets (reportedly, Murdoch is interested particularly in the LA Times – acquiring some of Tribune’s newspapers could give him broader geographic reach and better content – although we’ve seen how bad USA Today has been so that may not be a great strategy). They’re in the process of hiring bankers.
Supposedly Warren Buffet is interested in a few of them as well (particularly the small newspapers in smaller markets with limited TV competition – like Tribune’s paper in Allentown Pennsylvania).
Scripps network interactive (co-owner of Food network, travel channel, HGTV) is very publicly interested in buying the 31% of Food network that Tribune owns (SNI owns the rest), and they'll likely try to reorganize around their broadcasting assets (which are mostly CW affiliated stations - which have poor ratings - and WGN).
GTCR is reportedly interested in some of Tribune equity stakes in their digital assets.
In the credit facility terms, there are carve-outs for asset sale proceeds from Publishing assets and businesses, real estate, and equity interests: “in all cases will allow the Borrower to sell or spin-off (i) any Publishing assets or businesses (including Classified Ventures and CareerBuilder) and (ii) any real estate or real estate holding company, in each case subject to customary conditions for financings of this type “
In addition, they reportedly want to sell some of the broadcast assets as well. TV station multiples have been surprisingly high lately for the past few years (high single digits EBITDA multiples) and the M&A has been pretty active. LIN TV, Sinclair, EW Scripps, and Providence Equity have all been active.
WGN Radio has also been of interest for Hubbard Broadcasting – but that is a small piece of the business.
Oaktree and Angelo Gordon clearly want to cash out at some point. Angelo Gordon was involved in the Freedom Communications bankruptcy. Subsequent to exit, Freedom sold its TV stations and is selling the newspapers.
Unlike some others, I don't give the company value for its other equity investments and real estate. The company has recently said that their real estate is probably worth the ~$540mm as listed in the Lazard valuation, but also said that it's hard to disentangle that value from the operations. They have a few other small stakes that are probably worth $50-100mm. Plus, the re-zoning and other issues for re purposing would be difficult
Capital Structure
$325mm cash
$0 Asset Backed revolver (undrawn, $300mm capacity)
$1.1bn term loan + $344mm in deferred tax payments (resulting from previous sales of the Cubs and Newsday)
101 shares (after some management/employee stock grants); 105.3mm shares (on a fully diluted basis)
Stock currently at $49
$4.95bn market cap
$6.16bn EV
Valuation
At $49, I think it’s fairly valued here:
Sum of the parts:
Using 5x on newspapers (inline with NYT), 7x for broadcast, and 12x for Foodnetwork, I get to $55. That would be 7% FCF yield, and 7x the core Tribune EBITDA after backing out Foodnetwork. So not unreasonable if you want to give them some higher multiples
If you want to give value to the real estate, that’s another $540mm in value/share, gets you to $60.3 / share
If you don’t include the pension (or deferred taxes), you’ve got another ~$4.8 in value so you can get to $65 / share
Tax Concern: Tax Leakage
But if they start selling everything, they’d better get some significantly higher valuations because there is no tax shield, no NOLs, and the tax basis for everything is fairly low (this happened because as a S-corp, the company doesn’t hold onto the NOL assets, the shareholders do supposedly).
So they’d have to get bids that are 25-30% higher in order to get incremental value from the sum-of-the-parts value I show above, which is potentially doable for the Broadcast assets (given the recent M&A transaction comps there), Careerbuilder, and Classified Ventures. But probably tougher for the Publishing assets.
Or they could spin off the newsprint assets to help revalue the core broadcasting business higher. I believe they should be allowed to do a tax free spin of the newsprint assets.
Taking a Step Back: Tribune History
Tribune was bought out by Sam Zell in the ill fated LBO that was doomed from the start. The company was pretty much insolvent from day 1 (fairly clear even without the benefit of hindsight). Hence part of the distribution includes a litigation trust that will go after former Directors, the banks that put together the debt deals, and fraudulent convyance claims.
The company went through a lengthy 4 year bankruptcy (it took so long because of a hard nosed fight put up by Aurelius who fought for the bond classes and did quite well for themselves; and they made a big stink about fraudulent conveyance and litigating the architects of this LBO deal), and through that time the newspaper segment continued to shrink quickly, while publishing held up. And its major equity investments did well overall.
But the core business, and the industry fundamentals, were not transformed much during the bankruptcy – if anything Tribune wasn’t run very well (certianly not very offensively) aside from cost cutting. So there’s room for operational improvements, especially in the broadcast assets.
New Management
The new CEO is reportedly going to be Peter Liguori (formerly a top executive at Fox and Discovery – where he helped launch that Oprah Winfrey network) – he’s already on the board. He helped build FX’s current presence. He’s also an advisor to Carlyle at the moment. So it shows that they’re more focused on the broadcasting side, as they should be. There’s plenty of room for improvement at WGN and their TV station assets.
Reportedly, the plan from Oaktree is to liquidate as much as they can. “They have a plan, I'm told. ”They’re going to liquidate as much as they can,” said this senior [Oaktree] insider.”
In particular, they want to sell the LA Times (which is the largest contributor to the newspaper division), reportedly for 4x
The new leadership will want several months to figure out what to sell and what to keep.
Tribune's Businesses - Broadcast, Publishing, Food Network, Careerbuilder, Classified Ventures, other
Broadcast Segment
Tribune's broadcast segment is mostly TV stations tied to CW and Fox (which is bad considering how poor the ratings are for those 2 – way below NBC & CBS). Although this new Arrow show supposedly has some signs of life - they have a long way to go. But at least the stations are generally in great markets.
Tribune has been negligent in pushing for more retransmission fees. In 2012, they started pushing for it a bit with DTV and CVC, but there's a lot of room to go.
WGN America is distributed to over 76mm US homes. It is the 35th highest rated cable channel (similar to ESPN2, BET and E1 Network). WGN gets subscriber revenue and advertising revenue, and they have yet to push retransmissions fees as much as other cable channels have. They have some locally produced programming (news) and broadcast Chicago's NBA, NHL, and MLB games (Cubs and White sox), but not NFL - subject to some limitations. Aside from that, they usually re-run old TV shows.
Most investors believe that WGN America (the national feed) is worth more than regular TV stations, but less than the top cable / content companies. WGN mostly broadcasts reruns like Futurama, How I met your Mother, 30 Rock, Scrubs, and old movies etc. And WGN-TV (local) produces a lot of news of course.
There's definitely room for improvement in their TV stations and WGN. So that could be potential upside, but for now they should definitley not trade richer than better positioned TV & cable companies. Maybe they’ll try to get some more original content on it, which would be a plus
Basically, the company's CW stations are worse than average (poor ratings), but WGN is better than average, so it averages out in my mind. There is probably longer term upside, but not immediately.
Some have compared it to AMC, SNI, Discovery, and TBS, but those all have significantly higher ratings than WGN. In TBS' case, their ratings are surprising given that they (like WGN) don't have much original content - it's probably because they show Big Bang Theory so much followed by Conan. And their ads are better.
Like most TV stations, Tribune broadcasting as fared reasonably well as advertisers still find TV an efffective and necesary advertising medium. Advertising dollars to TV had actually grown (the only other mediums that have grows advertising share is outdoor and online/digital).
On the negative side, generally, Tribune broadcast doesn't have benefit much from political advertising (it's only 2-3% of revenues in on-cycle years). This negative is due to Tribune's having more CW and FOX affiliates (most political advertising goes to ABC, CBS, and NBC) and its stations aren't in battleground states. Tribune broadcasting makes about $30-55mm in political advertising in even numbered years.
In comparison, Gannet has experienced 27% revenue growth in 2012 (mostly due to Olympics and Political), in addition to 44% growth in EBITDA.
2012 was an abnormally good year for Broadcasting with a 1 time copyright benefit and a political boost. I think EBITDA comes back down to $370mm in 2013 (down from $425mm in 2012), which may prove to be a little optimistic. I forecast costs to stay steady (except a slight bump in programming costs) and core revenues to stay about flat in 2013.
At a 6.25x EBITDA multiple (inline with other publicly traded stations like Sinclair, AHC, Gannet, etc.), I think this division is worth $2.425bn
Publishing (i.e. newspapers)
Generally Tribune's newspapers have outperformed other publicly traded newspapers over the last year. And it looks on track to outperform the disclosure statement projections by quite a bit next year.
LTM 9/30/2012 revenues have only been down 1% YoY and EBITDA is actually up from $265mm in 2011 to $299mm. Meanwhile Gannet's newspaper 2012 revenues were down 5.3% and EBITDA is down about 20% YoY. For T ribune, advertising was down a lot as expected, but Tribune's commercial printing services (utilizing unused capacity) continued to do well (in October 2011, Tribune began printing and distributing the Chicago Sun-Times). Also, selective price increases helped offset advertising revenue declines (both arguably will be more of a 1 time benefit).
The use of paywalls in the newspaper industry is starting to gain traction and has been going on mostly in the last year or 2, but I suspect it will provide a 1 time benefit and they will find their pricing power fairly weak on further price hikes. Besides, it's the ad spending that has been the tougher headwind, which doesn't seem to be abating.
McCalthy's 2012 revenues are down about 5.1% and EBITDA is down about 12%
I project Publishing EBITDA to go to $256mm in 2013 down from $312mm in 2012 due mostly to continued declines in ROP advertising (down 9.5%), with everything else (costs and revenues) staying on the same trends as they have for the last few years.
Putting a 4.5x EBITDA multiple (higher than the 3-4x I'd normally use because there appears to be a sale process going on and there's interest), on $256mm of 2013 EBITDA, I get $1.52bn of value
Plus the company has done a very good job reducing publishing expenses as well in all areas: compensation, newsprint & ink, and other various items.
Equity Investments (Food Network, Careerbuilder, Classified Ventures)
Food Network + Cooking Channel
We all know what Food Network is. It's been very successful and currently gets $0.19 affiliate fee / sub - so it has some upside there. Scripps has been very public for the last few years about wanting to buy Tribune's stake and own all of Food Network. Food Network's demographics (middle aged women) are highly sought after by advertisers. Food Network's ratings have been a little weak recently - causing some weakness in SNI stock - but according to management that was partly due to the election, calendar, timing of sports, etc. They saw something similar in the 2010 political year.
On 1/8/2013, SNI reiterated their belief that the ratings weakness is not structural and something similar happened in late 2010 (when women watched more sports), and more people watching “the Voice”. Food network has 99.1mm subscribers
Food Network is likely to do $850mm of revenues and $504mm of EBITDA in 2012 (assuming a 59% EBITDA margin) - which is approximately where consensus is at. SNI reports revenues for each of their cable networks, but doesn't break down segment EBITDA or EBIT. Cooking Channel should do about $84mm of revenues and $23.9mm of EBITDA (much lower margins of 28.5% as it is a newer network).
When Scripps bought a 65% controlling interest in Travel Channel in 11/2009, they paid $975mm or 10-12x Travel Channel 2010 EBITDA (without synergies) or about 10x with synergies (they didn't provide the financials at the time of the transaction so this is an educated guess). At the time, SNI traded at around 9.5-10x forward EBITDA. It was also implied a value of about $10 / sub for Travel Channel - which was slightly cheap/in-line at the time. But also, at the time Travel Channel had a lot more upside from increasing affiliate fee growth as it was only getting 6 cents / sub.
Scripps has said that they'd only buy the rest of the Food Network stake if it's accretive (it seems on both an EPS and EV/EBITDA basis), hence implying that they wouldn't want to pay more than their current multiple of around 10x EBITDA (of course depending on how they want to finance it). Sell siders I’ve spoken to expect SNI to want to bid at 10x EBITDA, while they expect Tribune to look for 12x.
The best comparables are AMC, Scripps, and Discovery. Hence I think a takeout at 11x 2012 EBITDA is fairly reasonable - but probably not more (given how much they paid for Travel channel and Food being arguably more mature) - hence valuing Food Network + Cooking Channel at $5.8bn total (11x 2013 EBITDA of $536.2mm), or $1.82bn for Tribune's stake. Could be tough to see them bidding much higher. Food Network is currently under going a bit of a ratings slump, which management attributes to election issues and timing. This could potentially lower the valuation, but it seems that the longer-term story for Food Network is still quite positive. Tribune's tax basis is likely very low - estimated to be $133.7mm + $52.8mm (from the Cooking Channel contribution)
Assuming a sale and tax leakage, you could get to $1.47bn of net proceeds.
As a side note, the Travel Channel Cox / Scripps deal was structured similar to Tribune's Newsday and Cubs deals. From Scripps 11/5/2009 press release: "As proposed, the transaction is structured as a leveraged joint venture between Scripps Networks Interactive and Cox Communications. Cox will contribute the Travel Channel, valued at $975 million, and Scripps Networks Interactive will contribute$181 million in cash to a newly created partnership. The partnership, in turn, will take on $878 million in third-party debt that will be guaranteed by Scripps and indemnified by Cox, with the proceeds to be distributed to Cox."
Careerbuilder Details
CareerBuilder is the No. 1 employment web site in the U.S. with rapidly expanding international operations. It's a bit hard to get any concrete numbers about Careerbuilder, and GCI is generally pretty tightlipped about it. Tribune ownes 32% of Careerbuilder, with Gannett owning 53% and McClathy owning 15%.
Gannet has noted that Careerbuilder is approximately 82% of their digital segment revenues. And generally Careerbuilder drives that segment's financial results. So the digital segment at GCI is a good proxy, which generated approximately 23% EBITDA margins.
GCI expects Careerbuilder to continue growing revenues in the low teens area, with fairly steady margins (as they continue to grow the business) over the next few years. Of course Monster Worldwide (MWW) is the most similar business, but they've been underperforming by a lot. With revenues down low teens for most of 2012, and EBITDA down 23%. Hence why it's trading at 5x EBITDA, and exploring strategic alternatives. Careerbuilder on the other hand has been doing very well and taking share. It should probably trade more similar to Dice and other employment firms that are doing well - i.e. more like 7-9x forward EBITDA. At about $169mm of EBITDA for 2012 at 8x EBITDA, it's worth $1.35bn. McCalthy owns 15% of it and carries it at an implied $1.51bn valuation
If Careerbuilder grows revenues another 12% in 2012 and keeps margins about the same (which management seems to think is the case), then at 8x Careerbuilder is worth $1.5bn. There is no debt at Careerbuilder.
Classified Ventures
Tribune owns 28% of Classified Ventures LLC, a company that offers classified websites such as the auto website Cars.com and the rental website Apartments.com. It was started in 1997 and sells ads through 150 newspapers. Cars.com is the largest source of revenues for it. They compete with AutoTrader, which has done better than Cars.com (25% of AutoTrader is owned by Providence Equity Partners)
MNI owns 26%, GCI owns 24%, Washington Post owns 16%, and AH Belo owns 6%.
I forecast approximately $98mm of EBITDA for 2013. Using an 10x EBITDA multiple (higher than classified ventures given how it's been able to grow through the recession), it's worth $986mm, and so Tribune's 28% stake is worth $276mm.
Classified Ventures earnings have been growing rapidly at 28% in 2010 and 27.6% in 2011 (adjusting for goodwill impairment).
McClatchy books Classified Ventures at a lower $321mm total valuation (not sure why they're so low to be honest - but I think it's partly because of some impairments that other internet properties that Classfied Ventures owns). Lazard came up with $697-$830mm 2 years ago for the total value.
Classified Ventures has received interest from private equity firms in the past few years. But the crowded ownership makes it hard for anything to get done there. The owners just seem content to take dividends from it. There is no debt at Classified Ventures.
Further Tax Detail
Tribune has guided people to a 41% tax rate (they will exit with little tax benefits, in fact they have tax liabilities from the sale of the Cubs and the Newsday newspaper ($153mm and $211mm respectively) to be paid out $27mm a year through 2017 and the rest in 2018).
Because Tribune was an S-Corp before it filed, the income and losses were passed through to shareholders, so the NOLs were not the property of the company. The S-Corp & ESOP structure created by Zell during the bankruptcy was pretty ingenious and would have been a great tax dodge / shelter if it actually worked. S corps are limited to 100 shareholders, so he had the ESOP own the thing (which can be counted as a single shareholder)
The 95% Cubs stake was sold at $845mm in October 2009 (they retain a 5% stake). It was sold in a leveraged partnership. I've seen some old research reports estimate that the Cub's tax base is $50-100mm. The tax liability is $211mm, implying a 28% tax rate on the gain. After present valuing the future tax payments, it's an effective 22% tax rate
Newsday was sold in July 2008 to Cablevision for $650mm (Rupert Murdoch and Zuckerman bid $580mm as well) - and it's pretty public that Murdoch wants to bid for other Tribune newspapers. The $164mm tax liability is a 27% tax on the gain; after present valuing the payments it's an effective 21% tax rate. Supposedly, at the time Newsday was losing money, but others thought they could turn it around.
Given their inability to avoid taxes in these sales and the low tax bases in all their holdings, I think there will be plenty of tax leakage in other asset sales - perhaps on the order of 21-22% which is similar to what their previous sales were, potentially 3-5% higher given recent tax law changes.
The PV of the future tax payments (from Newsday and the Cubs) is about $344mm - which I add to the debt balance. However, I don't add all the guaranteed debt of Tribune's various partnerships given that it seems pretty unlikely that they'll have to pony up (for that to happen, CVC and Newsday would have to file, or the Cubs would have to file and lenders would have to lose money).
Tax guru, Robert Willens, believes that a tax free spin-off of Tribune's newspaper assets is achievable, which would be a positive of course - although there would be some disynergies. He also notes that the tax deferrals from the Newsday and Cubs sales could be changed.
More tax details below.
Technicals
Post reorg equities often interest the special sit equity community of funds. And Tribune (TRBAA) is getting a lot of coverage from both distressed desks as well as on the run equity shops. Last week, a member of the DDIC wrote up his thesis on the stock. Enjoy!
Idea: TRBAA
Company Name: Tribune
Type: Post Reorg Equities
Synopsis
Tribune is a media conglomerate with TV stations, newspapers, and valuable interests in Food Network, CareerBuilder and Classified Ventures.
Fortunately, the majority of the value comes from the non-publishing assets (compared to 2007 when 70% of the core operating EBITDA was from publishing) - unfortunately, that's because the publishing business has shrunk rapidly.
I think Tribune is fairly valued here at around $49, although there is upside from:
- operational improvements
- asset sales
- could see some multiple expansion
Company Overview
Tribune is a media conglomerate with TV stations, newspapers, and valuable interests in Food Network, CareerBuilder and Classified Ventures.
Fortunately, the majority of the value comes from the non-publishing assets (compared to 2007 when 70% of the core operating EBITDA was from publishing) - unfortunately, that's because the publishing business has shrunk rapidly.
Catalysts
It’s been widely reported and expected that the company will look to sell newspaper assets (reportedly, Murdoch is interested particularly in the LA Times – acquiring some of Tribune’s newspapers could give him broader geographic reach and better content – although we’ve seen how bad USA Today has been so that may not be a great strategy). They’re in the process of hiring bankers.
Supposedly Warren Buffet is interested in a few of them as well (particularly the small newspapers in smaller markets with limited TV competition – like Tribune’s paper in Allentown Pennsylvania).
Scripps network interactive (co-owner of Food network, travel channel, HGTV) is very publicly interested in buying the 31% of Food network that Tribune owns (SNI owns the rest), and they'll likely try to reorganize around their broadcasting assets (which are mostly CW affiliated stations - which have poor ratings - and WGN).
GTCR is reportedly interested in some of Tribune equity stakes in their digital assets.
In the credit facility terms, there are carve-outs for asset sale proceeds from Publishing assets and businesses, real estate, and equity interests: “in all cases will allow the Borrower to sell or spin-off (i) any Publishing assets or businesses (including Classified Ventures and CareerBuilder) and (ii) any real estate or real estate holding company, in each case subject to customary conditions for financings of this type “
In addition, they reportedly want to sell some of the broadcast assets as well. TV station multiples have been surprisingly high lately for the past few years (high single digits EBITDA multiples) and the M&A has been pretty active. LIN TV, Sinclair, EW Scripps, and Providence Equity have all been active.
WGN Radio has also been of interest for Hubbard Broadcasting – but that is a small piece of the business.
Oaktree and Angelo Gordon clearly want to cash out at some point. Angelo Gordon was involved in the Freedom Communications bankruptcy. Subsequent to exit, Freedom sold its TV stations and is selling the newspapers.
Unlike some others, I don't give the company value for its other equity investments and real estate. The company has recently said that their real estate is probably worth the ~$540mm as listed in the Lazard valuation, but also said that it's hard to disentangle that value from the operations. They have a few other small stakes that are probably worth $50-100mm. Plus, the re-zoning and other issues for re purposing would be difficult
Capital Structure
$325mm cash
$0 Asset Backed revolver (undrawn, $300mm capacity)
$1.1bn term loan + $344mm in deferred tax payments (resulting from previous sales of the Cubs and Newsday)
101 shares (after some management/employee stock grants); 105.3mm shares (on a fully diluted basis)
Stock currently at $49
$4.95bn market cap
$6.16bn EV
Valuation
At $49, I think it’s fairly valued here:
- 7.25x my 2013 EV/total company consolidated EBITDA of $850mm (normalizing for the political ad spend)
- 7.6x 2013 EV / company defined EBITDA
- 6.3x 2013 EV / EBITDA after backing out Food Network
- 7.75% FCF yield to the equity
Sum of the parts:
- Publishing worth 4.5x 2013 EBITDA of $256mm = $1.152bn
- Broadcast worth 6.25x 2013 EBITDA of $420mm = $2.625bn
- Food Network worth 11x 2013 EBITDA of $536mm x 31.3% stake = $1.846bn
- Careerbuilder worth 8x 2013 EBITDA of $190mmx 23% stake = $467mm
- Classified Ventures worth 10x 2013 EBITDA of $98.6mm x 28% stake = $276mm
- Corporate overhead 6x 2013 -$40mm of EBITDA contribution = $240mm
Using 5x on newspapers (inline with NYT), 7x for broadcast, and 12x for Foodnetwork, I get to $55. That would be 7% FCF yield, and 7x the core Tribune EBITDA after backing out Foodnetwork. So not unreasonable if you want to give them some higher multiples
If you want to give value to the real estate, that’s another $540mm in value/share, gets you to $60.3 / share
If you don’t include the pension (or deferred taxes), you’ve got another ~$4.8 in value so you can get to $65 / share
Tax Concern: Tax Leakage
But if they start selling everything, they’d better get some significantly higher valuations because there is no tax shield, no NOLs, and the tax basis for everything is fairly low (this happened because as a S-corp, the company doesn’t hold onto the NOL assets, the shareholders do supposedly).
So they’d have to get bids that are 25-30% higher in order to get incremental value from the sum-of-the-parts value I show above, which is potentially doable for the Broadcast assets (given the recent M&A transaction comps there), Careerbuilder, and Classified Ventures. But probably tougher for the Publishing assets.
Or they could spin off the newsprint assets to help revalue the core broadcasting business higher. I believe they should be allowed to do a tax free spin of the newsprint assets.
Taking a Step Back: Tribune History
Tribune was bought out by Sam Zell in the ill fated LBO that was doomed from the start. The company was pretty much insolvent from day 1 (fairly clear even without the benefit of hindsight). Hence part of the distribution includes a litigation trust that will go after former Directors, the banks that put together the debt deals, and fraudulent convyance claims.
The company went through a lengthy 4 year bankruptcy (it took so long because of a hard nosed fight put up by Aurelius who fought for the bond classes and did quite well for themselves; and they made a big stink about fraudulent conveyance and litigating the architects of this LBO deal), and through that time the newspaper segment continued to shrink quickly, while publishing held up. And its major equity investments did well overall.
But the core business, and the industry fundamentals, were not transformed much during the bankruptcy – if anything Tribune wasn’t run very well (certianly not very offensively) aside from cost cutting. So there’s room for operational improvements, especially in the broadcast assets.
New Management
The new CEO is reportedly going to be Peter Liguori (formerly a top executive at Fox and Discovery – where he helped launch that Oprah Winfrey network) – he’s already on the board. He helped build FX’s current presence. He’s also an advisor to Carlyle at the moment. So it shows that they’re more focused on the broadcasting side, as they should be. There’s plenty of room for improvement at WGN and their TV station assets.
Reportedly, the plan from Oaktree is to liquidate as much as they can. “They have a plan, I'm told. ”They’re going to liquidate as much as they can,” said this senior [Oaktree] insider.”
In particular, they want to sell the LA Times (which is the largest contributor to the newspaper division), reportedly for 4x
The new leadership will want several months to figure out what to sell and what to keep.
Tribune's Businesses - Broadcast, Publishing, Food Network, Careerbuilder, Classified Ventures, other
Broadcast Segment
Tribune's broadcast segment is mostly TV stations tied to CW and Fox (which is bad considering how poor the ratings are for those 2 – way below NBC & CBS). Although this new Arrow show supposedly has some signs of life - they have a long way to go. But at least the stations are generally in great markets.
Tribune has been negligent in pushing for more retransmission fees. In 2012, they started pushing for it a bit with DTV and CVC, but there's a lot of room to go.
WGN America is distributed to over 76mm US homes. It is the 35th highest rated cable channel (similar to ESPN2, BET and E1 Network). WGN gets subscriber revenue and advertising revenue, and they have yet to push retransmissions fees as much as other cable channels have. They have some locally produced programming (news) and broadcast Chicago's NBA, NHL, and MLB games (Cubs and White sox), but not NFL - subject to some limitations. Aside from that, they usually re-run old TV shows.
Most investors believe that WGN America (the national feed) is worth more than regular TV stations, but less than the top cable / content companies. WGN mostly broadcasts reruns like Futurama, How I met your Mother, 30 Rock, Scrubs, and old movies etc. And WGN-TV (local) produces a lot of news of course.
There's definitely room for improvement in their TV stations and WGN. So that could be potential upside, but for now they should definitley not trade richer than better positioned TV & cable companies. Maybe they’ll try to get some more original content on it, which would be a plus
Basically, the company's CW stations are worse than average (poor ratings), but WGN is better than average, so it averages out in my mind. There is probably longer term upside, but not immediately.
Some have compared it to AMC, SNI, Discovery, and TBS, but those all have significantly higher ratings than WGN. In TBS' case, their ratings are surprising given that they (like WGN) don't have much original content - it's probably because they show Big Bang Theory so much followed by Conan. And their ads are better.
Like most TV stations, Tribune broadcasting as fared reasonably well as advertisers still find TV an efffective and necesary advertising medium. Advertising dollars to TV had actually grown (the only other mediums that have grows advertising share is outdoor and online/digital).
On the negative side, generally, Tribune broadcast doesn't have benefit much from political advertising (it's only 2-3% of revenues in on-cycle years). This negative is due to Tribune's having more CW and FOX affiliates (most political advertising goes to ABC, CBS, and NBC) and its stations aren't in battleground states. Tribune broadcasting makes about $30-55mm in political advertising in even numbered years.
In comparison, Gannet has experienced 27% revenue growth in 2012 (mostly due to Olympics and Political), in addition to 44% growth in EBITDA.
2012 was an abnormally good year for Broadcasting with a 1 time copyright benefit and a political boost. I think EBITDA comes back down to $370mm in 2013 (down from $425mm in 2012), which may prove to be a little optimistic. I forecast costs to stay steady (except a slight bump in programming costs) and core revenues to stay about flat in 2013.
At a 6.25x EBITDA multiple (inline with other publicly traded stations like Sinclair, AHC, Gannet, etc.), I think this division is worth $2.425bn
Publishing (i.e. newspapers)
Generally Tribune's newspapers have outperformed other publicly traded newspapers over the last year. And it looks on track to outperform the disclosure statement projections by quite a bit next year.
LTM 9/30/2012 revenues have only been down 1% YoY and EBITDA is actually up from $265mm in 2011 to $299mm. Meanwhile Gannet's newspaper 2012 revenues were down 5.3% and EBITDA is down about 20% YoY. For T ribune, advertising was down a lot as expected, but Tribune's commercial printing services (utilizing unused capacity) continued to do well (in October 2011, Tribune began printing and distributing the Chicago Sun-Times). Also, selective price increases helped offset advertising revenue declines (both arguably will be more of a 1 time benefit).
The use of paywalls in the newspaper industry is starting to gain traction and has been going on mostly in the last year or 2, but I suspect it will provide a 1 time benefit and they will find their pricing power fairly weak on further price hikes. Besides, it's the ad spending that has been the tougher headwind, which doesn't seem to be abating.
McCalthy's 2012 revenues are down about 5.1% and EBITDA is down about 12%
I project Publishing EBITDA to go to $256mm in 2013 down from $312mm in 2012 due mostly to continued declines in ROP advertising (down 9.5%), with everything else (costs and revenues) staying on the same trends as they have for the last few years.
Putting a 4.5x EBITDA multiple (higher than the 3-4x I'd normally use because there appears to be a sale process going on and there's interest), on $256mm of 2013 EBITDA, I get $1.52bn of value
Plus the company has done a very good job reducing publishing expenses as well in all areas: compensation, newsprint & ink, and other various items.
Equity Investments (Food Network, Careerbuilder, Classified Ventures)
Food Network + Cooking Channel
We all know what Food Network is. It's been very successful and currently gets $0.19 affiliate fee / sub - so it has some upside there. Scripps has been very public for the last few years about wanting to buy Tribune's stake and own all of Food Network. Food Network's demographics (middle aged women) are highly sought after by advertisers. Food Network's ratings have been a little weak recently - causing some weakness in SNI stock - but according to management that was partly due to the election, calendar, timing of sports, etc. They saw something similar in the 2010 political year.
On 1/8/2013, SNI reiterated their belief that the ratings weakness is not structural and something similar happened in late 2010 (when women watched more sports), and more people watching “the Voice”. Food network has 99.1mm subscribers
Food Network is likely to do $850mm of revenues and $504mm of EBITDA in 2012 (assuming a 59% EBITDA margin) - which is approximately where consensus is at. SNI reports revenues for each of their cable networks, but doesn't break down segment EBITDA or EBIT. Cooking Channel should do about $84mm of revenues and $23.9mm of EBITDA (much lower margins of 28.5% as it is a newer network).
When Scripps bought a 65% controlling interest in Travel Channel in 11/2009, they paid $975mm or 10-12x Travel Channel 2010 EBITDA (without synergies) or about 10x with synergies (they didn't provide the financials at the time of the transaction so this is an educated guess). At the time, SNI traded at around 9.5-10x forward EBITDA. It was also implied a value of about $10 / sub for Travel Channel - which was slightly cheap/in-line at the time. But also, at the time Travel Channel had a lot more upside from increasing affiliate fee growth as it was only getting 6 cents / sub.
Scripps has said that they'd only buy the rest of the Food Network stake if it's accretive (it seems on both an EPS and EV/EBITDA basis), hence implying that they wouldn't want to pay more than their current multiple of around 10x EBITDA (of course depending on how they want to finance it). Sell siders I’ve spoken to expect SNI to want to bid at 10x EBITDA, while they expect Tribune to look for 12x.
The best comparables are AMC, Scripps, and Discovery. Hence I think a takeout at 11x 2012 EBITDA is fairly reasonable - but probably not more (given how much they paid for Travel channel and Food being arguably more mature) - hence valuing Food Network + Cooking Channel at $5.8bn total (11x 2013 EBITDA of $536.2mm), or $1.82bn for Tribune's stake. Could be tough to see them bidding much higher. Food Network is currently under going a bit of a ratings slump, which management attributes to election issues and timing. This could potentially lower the valuation, but it seems that the longer-term story for Food Network is still quite positive. Tribune's tax basis is likely very low - estimated to be $133.7mm + $52.8mm (from the Cooking Channel contribution)
Assuming a sale and tax leakage, you could get to $1.47bn of net proceeds.
As a side note, the Travel Channel Cox / Scripps deal was structured similar to Tribune's Newsday and Cubs deals. From Scripps 11/5/2009 press release: "As proposed, the transaction is structured as a leveraged joint venture between Scripps Networks Interactive and Cox Communications. Cox will contribute the Travel Channel, valued at $975 million, and Scripps Networks Interactive will contribute$181 million in cash to a newly created partnership. The partnership, in turn, will take on $878 million in third-party debt that will be guaranteed by Scripps and indemnified by Cox, with the proceeds to be distributed to Cox."
Careerbuilder Details
CareerBuilder is the No. 1 employment web site in the U.S. with rapidly expanding international operations. It's a bit hard to get any concrete numbers about Careerbuilder, and GCI is generally pretty tightlipped about it. Tribune ownes 32% of Careerbuilder, with Gannett owning 53% and McClathy owning 15%.
Gannet has noted that Careerbuilder is approximately 82% of their digital segment revenues. And generally Careerbuilder drives that segment's financial results. So the digital segment at GCI is a good proxy, which generated approximately 23% EBITDA margins.
GCI expects Careerbuilder to continue growing revenues in the low teens area, with fairly steady margins (as they continue to grow the business) over the next few years. Of course Monster Worldwide (MWW) is the most similar business, but they've been underperforming by a lot. With revenues down low teens for most of 2012, and EBITDA down 23%. Hence why it's trading at 5x EBITDA, and exploring strategic alternatives. Careerbuilder on the other hand has been doing very well and taking share. It should probably trade more similar to Dice and other employment firms that are doing well - i.e. more like 7-9x forward EBITDA. At about $169mm of EBITDA for 2012 at 8x EBITDA, it's worth $1.35bn. McCalthy owns 15% of it and carries it at an implied $1.51bn valuation
If Careerbuilder grows revenues another 12% in 2012 and keeps margins about the same (which management seems to think is the case), then at 8x Careerbuilder is worth $1.5bn. There is no debt at Careerbuilder.
Classified Ventures
Tribune owns 28% of Classified Ventures LLC, a company that offers classified websites such as the auto website Cars.com and the rental website Apartments.com. It was started in 1997 and sells ads through 150 newspapers. Cars.com is the largest source of revenues for it. They compete with AutoTrader, which has done better than Cars.com (25% of AutoTrader is owned by Providence Equity Partners)
MNI owns 26%, GCI owns 24%, Washington Post owns 16%, and AH Belo owns 6%.
I forecast approximately $98mm of EBITDA for 2013. Using an 10x EBITDA multiple (higher than classified ventures given how it's been able to grow through the recession), it's worth $986mm, and so Tribune's 28% stake is worth $276mm.
Classified Ventures earnings have been growing rapidly at 28% in 2010 and 27.6% in 2011 (adjusting for goodwill impairment).
McClatchy books Classified Ventures at a lower $321mm total valuation (not sure why they're so low to be honest - but I think it's partly because of some impairments that other internet properties that Classfied Ventures owns). Lazard came up with $697-$830mm 2 years ago for the total value.
Classified Ventures has received interest from private equity firms in the past few years. But the crowded ownership makes it hard for anything to get done there. The owners just seem content to take dividends from it. There is no debt at Classified Ventures.
Further Tax Detail
Tribune has guided people to a 41% tax rate (they will exit with little tax benefits, in fact they have tax liabilities from the sale of the Cubs and the Newsday newspaper ($153mm and $211mm respectively) to be paid out $27mm a year through 2017 and the rest in 2018).
Because Tribune was an S-Corp before it filed, the income and losses were passed through to shareholders, so the NOLs were not the property of the company. The S-Corp & ESOP structure created by Zell during the bankruptcy was pretty ingenious and would have been a great tax dodge / shelter if it actually worked. S corps are limited to 100 shareholders, so he had the ESOP own the thing (which can be counted as a single shareholder)
The 95% Cubs stake was sold at $845mm in October 2009 (they retain a 5% stake). It was sold in a leveraged partnership. I've seen some old research reports estimate that the Cub's tax base is $50-100mm. The tax liability is $211mm, implying a 28% tax rate on the gain. After present valuing the future tax payments, it's an effective 22% tax rate
Newsday was sold in July 2008 to Cablevision for $650mm (Rupert Murdoch and Zuckerman bid $580mm as well) - and it's pretty public that Murdoch wants to bid for other Tribune newspapers. The $164mm tax liability is a 27% tax on the gain; after present valuing the payments it's an effective 21% tax rate. Supposedly, at the time Newsday was losing money, but others thought they could turn it around.
Given their inability to avoid taxes in these sales and the low tax bases in all their holdings, I think there will be plenty of tax leakage in other asset sales - perhaps on the order of 21-22% which is similar to what their previous sales were, potentially 3-5% higher given recent tax law changes.
The PV of the future tax payments (from Newsday and the Cubs) is about $344mm - which I add to the debt balance. However, I don't add all the guaranteed debt of Tribune's various partnerships given that it seems pretty unlikely that they'll have to pony up (for that to happen, CVC and Newsday would have to file, or the Cubs would have to file and lenders would have to lose money).
Tax guru, Robert Willens, believes that a tax free spin-off of Tribune's newspaper assets is achievable, which would be a positive of course - although there would be some disynergies. He also notes that the tax deferrals from the Newsday and Cubs sales could be changed.
More tax details below.
Technicals
- The stock trades OTC right now
- The stock won't be listed in the near term, but will be listed within a year (the company must register within a year). I believe that the large holders are not eager to list the stock. Usually post-reorg names experience some forced selling when they list on an exchange as some funds are not allowed to hold bankrupt names when they exit or when they list.
- Share Details
- Tribune distributed ~100mm shares
- 79.2 Class A shares
- 4.3mm Class B shares
- 16.6mm warrants with a $0.001 strike price and a 20yr maturity (so basically the same as stock).
- 22% is owned by Oaktree Capital, 9% by Angelo Gordon, and 9% by JPM < given the ownership concentration, can be pretty confidant someone is working in your favor. Oaktree will appoint 2 members to the board, Angelo Gordon 1, JPM 1, and Plan proponents 2. The CEO will appoint the 7th and final member of the board.
1.16.2013
Update: Hedge Funds Involved in the Edison Mission Case
Today, The Ad Hoc Committee of Senior Noteholders of Edison Mission released a 2019 statement disclosing who is involved in the case.
The funds listed are:
The funds listed are:
- Alden Global
- Arrowgrass
- Avenue Capital
- Barclays
- BlueMountain Capital
- Brigade
- Canyon
- Citi Capital Advisors
- Claren Road
- Credit Value Partners
- Cincinnati High Yield Group (of JPM Investment Management)
- Jefferies High Yield Trading
- Litespeed
- Metropolitan West
- Neuberger
- Nomura Credit Research and Asset Management
- Och Ziff
- P. Schoenfeld Asset Management
- Perry Capital
- River Birch Capital
- SVP
- TCW
- Citi's Distressed Desk
- Visium
- Whitebox
- York Capital
1.14.2013
The High Yield Market is "Completely Out of Control."
The title of this post comes from a quote from a buy side friend working at one of the largest hedge funds out there. I 100% agree with his assertion. Howard Marks also agrees (see his most recent letter here: http://www.oaktreecapital.com/MemoTree/Ditto.pdf). He writes:
In all honesty, it is very very hard to be a mega fund in high yield credit. How many times can you look at TXU or CZR/HET? Accounts were a little busy at the end of the year getting up to speed on Mittal but that too has been a buying frenzy. Where the value lies, in small, off-the-radar, thinly traded securities, is marginally off limits to these funds because 1) They can never get size on a position to move the needle 2) If they did get the size they wanted, they'd be a huge % of noteholder base, a position a lot of funds do not want to be in when everyone is running for the exit.
From talking to people on the syndicate desks it looks like issuance will continue to ramp throughout the month, especially considering some of the macro concerns (debt limit being hit, more negotiations on grand comprise) that await us in February / March context. I wouldn't be surprised if we also saw a big M&A issuance calendar as we move throughout the year.
In September 2012, I wrote a post entitled "An Open Letter to CFOs Across America." It seems like many CFOs / corporate treasuries read my post and took the advice to heart. We've seen a significant amount of refinancing, dividend deals, M&A (to a lesser extend than I would have thought). For those that were around in 2005/2006, you may remember this exact feeling you are feeling today. Probably less so because absolute yields are just so low now relative to that time period.
The problem of course is bullish behavior which turns into recklessness continues until it doesn't. A very good friend and mentor of mine once said "Liquidity in the market, just in general, it can change on a dime." I often tell this story but in 1Q 2007, I met with a number of CSFB salesmen about the current market environment at that time (crazy). One of the quotes I wrote down, and still remember to this day: "It seems overdone, but its hard to imagine what's going to stop this." We know how that turned out.
Howard Marks, in his letter, also wrote:
A tenet, never proved, but often said in passing among the buy side is that the credit guys lead the equity markets. When credit gets shaky, soon after equities do as well. Its hard to tell if the forced buying, i.e. yield chasing, will spill over into the equity market in the form of stretched valuations. In theory though, when credit is robust, investors start pulling out things like the LBO calculator, or sum of parts valuation - in evaluating spin offs, that almost inevitably lead to higher equity values.
What excites me? The next cycle. Even assuming a modest default rate of 5-6%, given the amount of high yield and leveraged loans that have been issued in the past few years, the notional values are enormous, especially if you thrown in a few wildcards of huge complexes that file (Maybe not another Lehman, but another behemoth that will keep distressed investors busy). Add to this any opportunities that comes out of Europe and distressed investors will stay more than busy.
In the interim, companies are still filing for bankruptcy (THQ, Penson, etc). As distressed investors our job is to source, evaluate, and analyze those situations as they come across our desk and look to allocate capital where the return is much more commiserate for the risk, while offering downside protection in a margin of safety. That feels MUCH better than buying CCC bonds with a 6 handle.
"Regardless of the reason, things are happening again today - especially in the credit world - that are indicative of an elevated, risk-prone market:I find it interesting: Many many people realize the market is heavily overvalued in terms of compensation of return versus risk, but they still are buying. Maybe they NEED to buy because they are an insurance company or pension that can't find yield anywhere else that high yield bonds. Or maybe they NEED to allocate capital because they are getting inflows from retail/new investors. Maybe they think all is clear for the foreseeable future and hence are happy to clip a fat coupon for the interim period. I am hearing primary markets are simply a food fight amongst large funds trying to get whatever allocation they can get a hold of to put money to work for coffers that seem to be only growing from demand in the asset class.
- Total new issue leverage-finance volumes - loans and high yield bonds - reached a new high of $812 billion in 2012, according to Standard & Poor's, surpassing by 20% the previous record set in pre-crisis 2007.
- The yields on fixed incomes securities have declined markedly, and in many cases they're the lowest they've ever been in our nation's history. Yield spreads, or credit risk premiums, are fair to full - meaning the relative returns on riskier securities are attractive - but the absolute returns are minimal. I find it remarkable that the average high yield bond offers only about 6% today. Daily I see my partner Sheldon Stone selling callable bonds at prices of 110 and 115 because their yield to call or yields to worst start with numbers - 'handles' - of 3 or 4 percent. The yields are down to those levels because of strong demands for short paper with perspective returns in that range. I've never seen anything like it.
- As was the case in the years leading up to the onset of the crisis, the ability to execute aggressive transactions indicated the presence of risk tolerance in the markets. Triple-C bonds can be issued readily. Companies can borrow money for the purpose of paying dividends to their shareholders. And CLOs are again being formed to buy leveraged loans with heavy leverage."
In all honesty, it is very very hard to be a mega fund in high yield credit. How many times can you look at TXU or CZR/HET? Accounts were a little busy at the end of the year getting up to speed on Mittal but that too has been a buying frenzy. Where the value lies, in small, off-the-radar, thinly traded securities, is marginally off limits to these funds because 1) They can never get size on a position to move the needle 2) If they did get the size they wanted, they'd be a huge % of noteholder base, a position a lot of funds do not want to be in when everyone is running for the exit.
From talking to people on the syndicate desks it looks like issuance will continue to ramp throughout the month, especially considering some of the macro concerns (debt limit being hit, more negotiations on grand comprise) that await us in February / March context. I wouldn't be surprised if we also saw a big M&A issuance calendar as we move throughout the year.
In September 2012, I wrote a post entitled "An Open Letter to CFOs Across America." It seems like many CFOs / corporate treasuries read my post and took the advice to heart. We've seen a significant amount of refinancing, dividend deals, M&A (to a lesser extend than I would have thought). For those that were around in 2005/2006, you may remember this exact feeling you are feeling today. Probably less so because absolute yields are just so low now relative to that time period.
The problem of course is bullish behavior which turns into recklessness continues until it doesn't. A very good friend and mentor of mine once said "Liquidity in the market, just in general, it can change on a dime." I often tell this story but in 1Q 2007, I met with a number of CSFB salesmen about the current market environment at that time (crazy). One of the quotes I wrote down, and still remember to this day: "It seems overdone, but its hard to imagine what's going to stop this." We know how that turned out.
Howard Marks, in his letter, also wrote:
"Equities are still being disrespected, and equity allocations reduced. They they are not being lifted by comparable income-driven buying."
A tenet, never proved, but often said in passing among the buy side is that the credit guys lead the equity markets. When credit gets shaky, soon after equities do as well. Its hard to tell if the forced buying, i.e. yield chasing, will spill over into the equity market in the form of stretched valuations. In theory though, when credit is robust, investors start pulling out things like the LBO calculator, or sum of parts valuation - in evaluating spin offs, that almost inevitably lead to higher equity values.
What excites me? The next cycle. Even assuming a modest default rate of 5-6%, given the amount of high yield and leveraged loans that have been issued in the past few years, the notional values are enormous, especially if you thrown in a few wildcards of huge complexes that file (Maybe not another Lehman, but another behemoth that will keep distressed investors busy). Add to this any opportunities that comes out of Europe and distressed investors will stay more than busy.
In the interim, companies are still filing for bankruptcy (THQ, Penson, etc). As distressed investors our job is to source, evaluate, and analyze those situations as they come across our desk and look to allocate capital where the return is much more commiserate for the risk, while offering downside protection in a margin of safety. That feels MUCH better than buying CCC bonds with a 6 handle.
1.09.2013
Third Point 4Q 2012 Letter
Today I received Dan Loeb's Third Point Fourth Quarter 2012 Investor Letter. As usual its a fantastic read (embedded below). As has been reported in recent weeks, Third Point made an absolute killing getting long Greek sovreign debt. Assets under management now top an impressive $10B.
A favorite quote from the letter: "We dug deep beyond the frightening headlines and conducted in-depth research on the state of political and economic affairs globally, helping us develop a variant view and giving us confidence to deploy capital. Our ability to generate returns was boosted by a breakdown in correlations, and this shift provided the key for us to deliver alpha across asset classes, sectors and geographies."
Loeb goes on to discuss their position in Herbalife and lays out a very compelling case for a long position in the stock. His take-away: "Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point. Given that the Company has historically traded more in the 12-14x range (and traded at 16-20x earnings through much of 2011 and early 2012), the opportunity for the Company to tell its side of the story tomorrow at its Analyst Day in New York, and the significant short interest, we believe shares could even trade well above our current price target."
Loeb also discloses positions in Morgan Stanley and Tesoro Corporation. You can read the long arguments in the letter below. Enjoy! thirdpoint.4q12investorletter.010913
A favorite quote from the letter: "We dug deep beyond the frightening headlines and conducted in-depth research on the state of political and economic affairs globally, helping us develop a variant view and giving us confidence to deploy capital. Our ability to generate returns was boosted by a breakdown in correlations, and this shift provided the key for us to deliver alpha across asset classes, sectors and geographies."
Loeb goes on to discuss their position in Herbalife and lays out a very compelling case for a long position in the stock. His take-away: "Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point. Given that the Company has historically traded more in the 12-14x range (and traded at 16-20x earnings through much of 2011 and early 2012), the opportunity for the Company to tell its side of the story tomorrow at its Analyst Day in New York, and the significant short interest, we believe shares could even trade well above our current price target."
Loeb also discloses positions in Morgan Stanley and Tesoro Corporation. You can read the long arguments in the letter below. Enjoy! thirdpoint.4q12investorletter.010913
1.07.2013
Distressed Debt: THQ Bankruptcy Update
After adjourning its first hearing today, THQ reconvened at 3:00PM and announced that a compromised was made among various parties. A form of order has yet to be presented but the general takeaways:
In the morning hearing, it was announced that Clearlake Capital's bid would remove the $10M 2% note they originally had offered in exchange for extending the auction deadline. One thing to note: It remains to be seen how much secured debt (and for that matter assumed liabilities) will there actually be on the auction date. It was noted in the hearing this morning the company has begun the "slow pay" its bills which would alleviate need for cash but in theory increased assumed liabilities to a purchaser. As has been noted in the hearing, Clearlake can pick and choose which liabilities its assuming, but their counsel did note that it would be a more concrete number (to determine overbids) at the auction.
Currently bonds are trading in the 15-16 context. I had heard from traders on Friday that bonds were difficult to find (the issue is only $100M) but some bonds have traded this morning.
For bondholders, the only recovery (under Clearlake's stalking horse bids) they were going to receive was the $10M promissory note which seems to have been pulled away. If any of the parties involved (so far EA, Warner Brothers have been named in court) bid for all or just some of the titles, there is a chance bond holders could see a recovery here. Exact bid procedures have yet to be filed so I do not have a good assessment on how bids will be evaluated.
For instance, what happens if two studios are purchased for an aggregate consideration more than Clearlake's bid but the remaining studios need to be wound down? That may actually drain resources from the estate for wind down expenses.
For what its worth, when I first saw Clearlake's bid I wanted to be an LP in their fund because they would make a fortune off their purchase price. Given the way cash flows will begin to pick up (and possibly roll in if they are successful, not to mention cash already overseas) at THQI after their two releases in the first half of this year, with which a lot of developmental costs have been already spent, the return to Clearlake would have been impressive.
A few questions remain: Where are the massive swings in potential unsecured liabilities (from the first day affidavit) from Europe arising from? No one has given me a good answer on that. Why hasn't bond holders (or strategics for that matter) stepped up with their own DIP?
As we get more answers, we will update readers, especially after new items hit the docket.
- Bids are due 9am January 22nd
- Auction will be held 3pm on January 22nd
- Sale Hearing January 23rd at 9am
- The auction will allow for bidders to bid on only certain assets (titles, studios, etc) in the auction
In the morning hearing, it was announced that Clearlake Capital's bid would remove the $10M 2% note they originally had offered in exchange for extending the auction deadline. One thing to note: It remains to be seen how much secured debt (and for that matter assumed liabilities) will there actually be on the auction date. It was noted in the hearing this morning the company has begun the "slow pay" its bills which would alleviate need for cash but in theory increased assumed liabilities to a purchaser. As has been noted in the hearing, Clearlake can pick and choose which liabilities its assuming, but their counsel did note that it would be a more concrete number (to determine overbids) at the auction.
Currently bonds are trading in the 15-16 context. I had heard from traders on Friday that bonds were difficult to find (the issue is only $100M) but some bonds have traded this morning.
For bondholders, the only recovery (under Clearlake's stalking horse bids) they were going to receive was the $10M promissory note which seems to have been pulled away. If any of the parties involved (so far EA, Warner Brothers have been named in court) bid for all or just some of the titles, there is a chance bond holders could see a recovery here. Exact bid procedures have yet to be filed so I do not have a good assessment on how bids will be evaluated.
For instance, what happens if two studios are purchased for an aggregate consideration more than Clearlake's bid but the remaining studios need to be wound down? That may actually drain resources from the estate for wind down expenses.
For what its worth, when I first saw Clearlake's bid I wanted to be an LP in their fund because they would make a fortune off their purchase price. Given the way cash flows will begin to pick up (and possibly roll in if they are successful, not to mention cash already overseas) at THQI after their two releases in the first half of this year, with which a lot of developmental costs have been already spent, the return to Clearlake would have been impressive.
A few questions remain: Where are the massive swings in potential unsecured liabilities (from the first day affidavit) from Europe arising from? No one has given me a good answer on that. Why hasn't bond holders (or strategics for that matter) stepped up with their own DIP?
As we get more answers, we will update readers, especially after new items hit the docket.
1.04.2013
THQI Reconvening on Monday (more coming later)
After an very, very long hearing, Judge Mary Walrath, a favorite of mine, did not approved the DIP motion or bidding procedures motion in the THQ case. She instructed parties to discuss and work out their issues over the weekend and set a new hearing on Monday. I will be writing a more thorough post this weekend on the day's events.
1.03.2013
Distressed Debt: What I Will Remember About 2012 and a look to 2013
As investors, we are bombarded with information. Whether it be macro news, political turmoil, or earnings releases (just to name a few), its oftentimes hard for investors to filter out the noise from things that actually change the intrinsic value of securities. With so many things happening through the year, the one thing I'll remember about 2012: equity recoveries in bankruptcy.
Do not get me wrong. When I tell friends or family about what stocks I am invested in, most of them think I am speculating on some pump and dump scheme of a failing company. Maybe I monitor Twitter or Yahoo message boards for the next stock that's going to EXPLODE. Look at most of the stock message boards for companies entering the Chapter 11 process and you may go blind and/or cry.
2012 was different. In 2012, there were huge returns to be made by diligent investors invested in the bankrupcies of certain equities. During 2012, I was invested in (and in many case still invested in via the liquidation trust)
If Europe imploded, or China went into a deep deep recession, maybe my returns would have been lower than what they printed at for the year. But probably not terribly different because at the end of the day, the macro news (noise) had little effect on the intrinsic value of these securities.
I do not remember a year when there was so much money to be made in bankrupt equities and seriously doubt 2013 will come close to the sort of opportunities that were presented. There have definitely been years prior (2009) where buying incredibly stressed, levered equities was the most profitable trade out there (Dollar Thrifty anyone?).
Comically, there are a number of trades I still missed despite being deeply knowledgeable about the players, docket, and companies that had filed. In fact, one of the most profitable trade I've seen in my life is right in front of me but I haven't been able to buy the stock for 3 months. Frustrating to say the least.
The distressed cyle in general in 2012 was in line with what people had expected. I am hearing numbers all over the place for fund returns for 2012 with some eye popping numbers barbelled with some generally poor numbers and a number of funds in the mid single digits - low teens. This relative to a low double digit return for high yield is frustrating to funds that hedged rate and only picked up spread tightening which would contribute a far less return. If you were long housing (via homebuilders, subprime mortgages, Ambac etc) you did very well. Some on and off the run situations that I spoke about in the blog were all over the place (Petroplus dropping to 10 then quickly doubling, MF Global grinding to 60+, etc).
2013 inevitably will be a harder year for funds to generate absolute returns but probably an easier year to generate better returns than their benchmarks. If you were long S&P vs short funds in 2012 you are now counting your money. I don't think that will be the case this year for a variety of reasons. I really do think this year will be a stock pickers market where money will be made in catalyst driven opportunities on the long side (when financing is cheap, event driven things pick up...think M&A, spin offs, IPO of business units) and on the short side simply because valuations are stretched for a number of industries especially if you consider a sub optimal growth tragectory for the U.S. and abroad. Commodities are interesting from the short perspective given the supply outlook for a number of materials in the 2014-2015 time frame.
The stars were definitely aligned for distressed equities in 2012. Here's to hoping a few more come down the pipe in 2013.
Do not get me wrong. When I tell friends or family about what stocks I am invested in, most of them think I am speculating on some pump and dump scheme of a failing company. Maybe I monitor Twitter or Yahoo message boards for the next stock that's going to EXPLODE. Look at most of the stock message boards for companies entering the Chapter 11 process and you may go blind and/or cry.
2012 was different. In 2012, there were huge returns to be made by diligent investors invested in the bankrupcies of certain equities. During 2012, I was invested in (and in many case still invested in via the liquidation trust)
- CDCAQ
- CDCSY
- AGUNF
- TRIDQ
- CAGAQ
If Europe imploded, or China went into a deep deep recession, maybe my returns would have been lower than what they printed at for the year. But probably not terribly different because at the end of the day, the macro news (noise) had little effect on the intrinsic value of these securities.
I do not remember a year when there was so much money to be made in bankrupt equities and seriously doubt 2013 will come close to the sort of opportunities that were presented. There have definitely been years prior (2009) where buying incredibly stressed, levered equities was the most profitable trade out there (Dollar Thrifty anyone?).
Comically, there are a number of trades I still missed despite being deeply knowledgeable about the players, docket, and companies that had filed. In fact, one of the most profitable trade I've seen in my life is right in front of me but I haven't been able to buy the stock for 3 months. Frustrating to say the least.
The distressed cyle in general in 2012 was in line with what people had expected. I am hearing numbers all over the place for fund returns for 2012 with some eye popping numbers barbelled with some generally poor numbers and a number of funds in the mid single digits - low teens. This relative to a low double digit return for high yield is frustrating to funds that hedged rate and only picked up spread tightening which would contribute a far less return. If you were long housing (via homebuilders, subprime mortgages, Ambac etc) you did very well. Some on and off the run situations that I spoke about in the blog were all over the place (Petroplus dropping to 10 then quickly doubling, MF Global grinding to 60+, etc).
2013 inevitably will be a harder year for funds to generate absolute returns but probably an easier year to generate better returns than their benchmarks. If you were long S&P vs short funds in 2012 you are now counting your money. I don't think that will be the case this year for a variety of reasons. I really do think this year will be a stock pickers market where money will be made in catalyst driven opportunities on the long side (when financing is cheap, event driven things pick up...think M&A, spin offs, IPO of business units) and on the short side simply because valuations are stretched for a number of industries especially if you consider a sub optimal growth tragectory for the U.S. and abroad. Commodities are interesting from the short perspective given the supply outlook for a number of materials in the 2014-2015 time frame.
The stars were definitely aligned for distressed equities in 2012. Here's to hoping a few more come down the pipe in 2013.
1.02.2013
Distressed Debt News: Objections in the THQI Bankruptcy
I have been following the THQI bankruptcy very closely over the last few weeks since its filing in Delaware on December 19th. Pursuant to the first day motions of CEO Brian Farrell, the company is to be sold to Clearlake Capital (Clearlake) for an aggregate contribution of approximately $60.5M, comprised of cash, assumption of liabilities, and promissory notes. In addition, Clearlake, along with pre-petition lender Walls Fargo will provide financing to THQ during its bankruptcy process. What surprised me was how fast the process was going especially given the potential large values of THQ's IP.
Clearlake is the stalking horse bidder in THQ's sale. According to the sales motion on the bankruptcy docket, Clearview will acquire substantially all of the Debtors' operating assets. The exact sale consideration that Clearlake is offering is as follows:
i) Fund payment in full of secured claims, including repayment of the DIP facility, projected to be approximately $29M
ii) Pay $6.65m in cash at closing
iii) Assume certain liabilities estimated at approximately $15M
iv) Deliver to the debtors a promissory note for $10M (at a 2% rate) due in 7 years for the benefit of creditors
for a total consideration, on paper, of approximately $60.5M. I view it lower than this due to the fact that a 2% note would be worth far less than 100 cents on the dollar. The DIP here, with 2.5% fee for a January 18th maturity (and a 15% PIK rate to boot), looks overly punitive given the short window here.
To give you a sense of the valuation, here is the Debtor's projections per the first day filings:
This afternoon, Roberta DeAngelis, U.S. Trustee overseeing the THQ bankruptcy filed an objection to the Motion Of Debtors For Entry Of (I) An Order (A) Authorizing And Approving Bid Procedures In Connection With The Sale Of Substantially All Of The Debtors' Assets, (B) Authorizing And Approving Stalking Horse Protections, (C) Authorizing And Approving Procedures Related To The Assumption And Assignment Of Executory Contracts And Unexpired Leases In Connection With The Sale, (D) Scheduling Auction And Sale Approval Hearing, (E) Approving The Form And Manner Of The Notice Of The Sale Hearing And (F) Granting Certain Related Relief.
In her objection she states the following:
The note holders objection is embedded below. Its a fascinating read that deserves its own post. Looks like the main argument here, which I've heard from talking to parties involved: "a requirement that prospective purchasers bid on the Debtors “as a whole” rather than on a “piecemeal” or “title-by-title” basis". Here's a great snippet:
Here is the noteholders' objections.
THQI Noteholder Objection
It will be interesting to see how this plays out. If you are following the case, feel free to give me a shout to discuss.
Clearlake is the stalking horse bidder in THQ's sale. According to the sales motion on the bankruptcy docket, Clearview will acquire substantially all of the Debtors' operating assets. The exact sale consideration that Clearlake is offering is as follows:
i) Fund payment in full of secured claims, including repayment of the DIP facility, projected to be approximately $29M
ii) Pay $6.65m in cash at closing
iii) Assume certain liabilities estimated at approximately $15M
iv) Deliver to the debtors a promissory note for $10M (at a 2% rate) due in 7 years for the benefit of creditors
for a total consideration, on paper, of approximately $60.5M. I view it lower than this due to the fact that a 2% note would be worth far less than 100 cents on the dollar. The DIP here, with 2.5% fee for a January 18th maturity (and a 15% PIK rate to boot), looks overly punitive given the short window here.
To give you a sense of the valuation, here is the Debtor's projections per the first day filings:
This afternoon, Roberta DeAngelis, U.S. Trustee overseeing the THQ bankruptcy filed an objection to the Motion Of Debtors For Entry Of (I) An Order (A) Authorizing And Approving Bid Procedures In Connection With The Sale Of Substantially All Of The Debtors' Assets, (B) Authorizing And Approving Stalking Horse Protections, (C) Authorizing And Approving Procedures Related To The Assumption And Assignment Of Executory Contracts And Unexpired Leases In Connection With The Sale, (D) Scheduling Auction And Sale Approval Hearing, (E) Approving The Form And Manner Of The Notice Of The Sale Hearing And (F) Granting Certain Related Relief.
In her objection she states the following:
- The timing of the sale is on too short of a window to let interested parties participate in the sales process. In fact she goes on to point that the rush to get the sale process through was a result of the secured lender's actions (who are intended to be paid in full)
- The break-up fee and expense reimbursements ($1.75 and $500k respectively) are excessive when measured against the cash portion of the purchase price ($29M + $6.65M in cash)
- The overbid procedures "may chill bidding". Currently, the minimum overbid must equal $2.75M despite such a small cash component.
- Break up fee is contemplated to be treated as a superiority admin expense. She states "The granting of superpriority status to a break-up fee is not authorized by the Bankruptcy Code."
- The current bidding procedures only allow a small subset of people to attend whereas the Local Rule in the court states that "the auction be conducted openly and all creditors will be permitted to attend.
- Silverback Asset Management
- Third Avenue Focused Credit Fund
- Wolverine
The note holders objection is embedded below. Its a fascinating read that deserves its own post. Looks like the main argument here, which I've heard from talking to parties involved: "a requirement that prospective purchasers bid on the Debtors “as a whole” rather than on a “piecemeal” or “title-by-title” basis". Here's a great snippet:
"During August and September, 2012, Centerview and the Debtors’ management began a so-called marketing “process” focused on finding an investor to either: (i) fund the Debtors’ business plan or (ii) acquire the Debtors’ entire business (as a whole). During this “process,” the Debtors and their advisors focused their attention on contacting “growth-oriented” financial investors (i.e., venture capital and private equity firms) and, by marketing the company as a whole, effectively precluded strategic investors from participating in a sale process. The financial investors that the Debtors and their advisors did approach included only a few firms known for “distressed” investing, which likely further hindered the process."
Here is the noteholders' objections.
THQI Noteholder Objection
It will be interesting to see how this plays out. If you are following the case, feel free to give me a shout to discuss.