Wednesday, October 27, 2010

Betting with Paulson

At times, investing in the gaming industry can be a gamble (/corny opening line). Not that it really has to be that way. Like any addiction, gaming produces quite stable cash flows once the business is up and running and a customer base and a location has been established.

The threats are there, of course, with the expansion of licenses from revenue-hungry governments and the ominous Internet. Still, “if you build it, they will come” has worked relatively well in the past, so who are we to question its future applicability.

That said, gaming is a place where high yield thrives, since, not unlike gamblers, casino operators love to “double down” with plenty of leverage.

Where there’s leverage, there’s “credits” (as the pundits like to call bonds these days) and opportunities for bond investors (somehow credit investors doesn’t sound right) to throw some chips into the fray.

Start with MGM Resorts International, which owns a good chunk of the Las Vegas Strip (Bellagio, Mandalay Bay, Monte Carlo, Luxor, Grand, etc.) plus casinos and resorts around the rest of the world. Lots of property with a ton of debt, and booking substantial losses. Still, it’s a name I like, since the cash flow is good, and the company has shown financial agility. They have sold property to raise cash and recently announced they would issue new stock to the market. That’s always good for bond investors. In addition, Hedge fund manager John Paulson picked up a 9%+ equity stake earlier this year. Not fresh cash, but it’s always reassuring to have a guy like Paulson below you in the capital structure.

For MGM bonds, there are a number of choices, ranging from senior secured (the least risky in case of default) or the subordinated, which may not fare well in such a case. I listed a few on the table below. Personally, I like the subordinated 2013’s, because you might as well go “all in” if you think bankruptcy is looking like a long shot. But in any case, all these bonds have rallied over the last year and the easy money is over.

Second up is Harrah’s Entertainment, which is a behemoth like MGM, only larger and with less concentration in Las Vegas and more property in Atlantic City (not a good thing). Harrah’s was taken private in 2006 by private equity firms TPG and Apollo, which then proceeded to load it up with debt. That’s standard procedure in these cases. It’s also standard procedure for these takeover specialists to screw over those debt holders if necessary and convenient. That’s also not a good thing. Still, as we stated above, this is a business that generates cash, apparently even in Tunica, Mississippi (where Harrahs has THREE casinos).

Still, it’s not enough to make a bondholder comfortable (not that we ever are). So, once again Paulson to the rescue. Paulson’s fund(s) recently picked up a nice chunk of Harrah’s debt (over $800 mm) and agreed to exchange it for equity. For bondholders that’s a good thing since it means some deleveraging, if not a whole lot. Harrah’s LT debt is close to $20 billion. The company is planning to go public with its shares shortly, and from the preliminary prospectus, it appears they will be selling an additional $575 million in shares to the public. That would be a good thing, since it would mean more deleveraging.

Still, count me as a bit skeptical on Harrah’s, and I’d prefer the secured bonds, which still are offering a very hefty yield. That would make it good for a couple of chips.

Here's a BST oldie to get you in the gamblin' mood.

Monday, June 28, 2010

Converting to Solar

Financial bubbles, not unlike supernovas, leave reminders of their explosions throughout the market Universe.
A bubble in alternative energy, and particularly Solar stocks grew quietly in 2006-2008 and burst pretty much in tandem with other bubbles such as the one in housing.

What were boom times have turned into dark times for solar companies, as competition is fierce and subsidies have been subsiding. Many of these companies are Chinese, so the Yuan’s recent revaluation has become a new concern.

But solar companies did take advantage of the demand for their stocks during the boom to raise capital and finance their activities, Solar panels may be shiny, but they don’t manufacture themselves.

During the brief boom, a very popular financing option for solar companies was issuing convertible bonds. Their stocks were on a tear, so the companies (wisely) decided to give up a bit of their potential stock upside for some cheap (low coupon) financing.

And so they did.

Fast-forward two years later and these convertibles are “busted”. That is, the market price of the underlying stock is so far away from the equivalent conversion price, that the convertible component of the bonds is practically worthless.

Nonetheless, they are still bonds, still pay a coupon and (fingers crossed) will repay principal at maturity. Now trading at discounts to par, the yields are enticing and these bonds have the added attraction in that a good portion of the total yield will come in the form of capital gains, which for many taxpayers implies a lower rate and pushing the taxable event a bit out into the future.

Here’s a table of some of the solar convertibles out there. Like always click to make it bigger.

With the exception of Trina Solar, whose convertible is in the money, the others are pretty much straight bonds now, so the main issue is whether or not they will be able to pay. In general, the prospects of that are not bad, since most of these companies are not excessively leveraged and could tap the markets for equity or new debt when time comes to roll over.
(As always do your own due diligence, and your mileage will vary).

Even Evergreen Solar, which appears to be the most vulnerable on the list, has a positive tangible equity in its books. Of course, ESLR has yet to make a profit, so keep that in mind.

My personal favorite is LDK Solar, which has been reporting profits and whose convertibles have a put provision that can shorten maturity by two years. Trading around 85% makes for a 26% yield in less than a year, if you exercise that put. Not very liquid, but if I managed to find some (and I did), they can’t be that scarce.

Energy Conversion Devices is another that looks “overlooked”. The company took a huge (non-cash) write-off recently, which affected the stock and general perception very unfavorably (some analysts consider their technology outdated). But there are believers and the company recently did some private debt/equity swaps with the convertibles (below the strike price, obviously). Although such an action is dilutive (and not great news) for stockholders, the more of those they do, they better chance bondholders have of collecting ultimately.

Of the others, JA Solar would seem to be the least risky and Suntech Power, the best value.

So, there you have it, a “green” alternative to my previous oily suggestions. May the daystar shine radiantly on your portfolios,

Sunday, June 13, 2010

Spill Bonds

It seems the whole planet has been watching the Gulf of Mexico oil spill. The world cup may provide a much-needed distraction from that unfolding disaster but in any event, analysts and traders are fast at work trying to find ways to make money in the oily turmoil, without appearing to be too oblivious to the plight of shrimp fishermen and seabirds.

Most of the work has centered on stocks, but like always, there is a bond angle to this also. Let’s “explore” and “drill down” to details.

First: the good guys, those trying to clean up this mess. Clean Harbors (CLH) is a name that comes to mind. Its stock is up over 20% since the spill. Its 2016 bonds, on the other hand, have traded flat. If you’re happy with a 7% yield on a BB- rated bond of a company whose prospects were fine and just got a lot better, there’s an idea for you. Clean and simple. The issue is a bit small ($300 mm), but it does trade (Reg S 144A only for now).

Now. the evil enviro-killers. BP jumps out first, of course, While much has been make of BPs stock slide, its bonds have sold off also. Here’s graph of the yield on BP’s 5.25% , 2013s as an example.

BP is still rated AA- by S&P, although we’d expect a downgrade at some point. In any case, the possibility that this spill will send BP into bankruptcy has to be extremely remote. The highest clean up cost estimate out there is $15 billion, which is huge amount of money. But BP can afford that, the company made $20 billion in profits last year.

At the bottom of this post there’s a list of oil spill bonds including some BP USD issues. BP also has issued bonds in Euros, Yens and Sterling, so the whole world can get clean up on what appears to be a temporary bargain.

BP may be the main target of the “spilling fields” disaster, but not the only one. Transocean (RIG) owns the Deepwater Horizon rig, which is leased to BP. Transocean will probably have a bill to pay in this fiasco too, but they too can afford it.

RIG bonds have been submerging also. Here is the yield on the 5.25%% 2013s. Quite a spike.

And there has been substantial “collateral damage also”. A company like Hornbeck Offshore (HOS), which doesn’t drill itself but operates supply vessels to the rigs has seen its stock and bonds hit. Several clients are reneging on their contracts alleging “force majeure” in the offshore drilling moratorium, but HOS isn’t buying that and is countersuing. The bonds have sold off and there is a nice buying opportunity, since the company’s balance sheet is still quite acceptable.

Then there are cases like McMoran Exploration (MMR) and Energy XXI (EXXI). These companies have operations on and offshore in the Gulf area, but the offshore ops are “shallow water”. Shallow water is a whole different animal when it comes to oil spill risk and the ban has been lifted for shallow water already.

Sunday, May 9, 2010

Yet Another Update on My Wife's Junk

Last year I blogged about the junk bond portfolio that my wife put together all by herself (mostly). LINK. I also ran an update on it later in the year. LINK.

This is what that portfolio looked like last time I updated: (click to enlarge)

A few things have happened since. First and foremost, everything went up. A lot. The portfolio gained 45% in 2009 and is up around 5% so far this year. Not that my wife was keeping count. She’s content to just clip coupons. I’m the one doing the counting.

Second there were corporate actions. Starwood Hotels (Sheraton) made a tender offer (accepted) and Jo-Ann Stores called its bonds.

In addition, the Alcoa and Seagate Bonds rose enough in price to trigger the “mortgage” sell signal. That signal basically states that if the bond pays less than our (tax-adjusted) mortgage rate, sell it and either buy something else or pay down the mortgage.

In any case, she decided not to pay down the mortgage, but rather to buy some more junk.
What to buy?

For starters, she selected SmithField Foods, a company I blogged about around Thanksgiving. That’s good because it means she actually reads my blog. When I mentioned that she already had two food companies in Dole and Chiquita, she said “What do Pineapples and Bananas have to do with Turkeys?” OK. Point Taken. Of course, coming from a vegetarian, who knows?

She did take my advice on her next purchase. I thought she could have an energy company in the portfolio, so I showed her several options. There are quite a few smaller oil and gas producers and refiners with bonds in the market at attractive yields. She chose Clayton Williams Energy, an oil and gas company with operations in New Mexico, Texas and Lousiana. Hopefully, for my sake, that well doesn’t come up dry.

Finally, she got motorized with her last two picks. First, Ford Motors, which has been doing much better lately and is benefiting from the troubles that Toyota is having. Ford bonds were huge winners last year, but still could have room to run.
Second, Avis-Budget Rent a Car, which is a highly leveraged situation, but my wife figures if they try harder they’ll pull through.

Here’s what the portfolio looks like now:
Click on the table to enlarge:

It’s a bit junkier, longer in duration and the overall yield is lower.

Only averaging about 7.56% now. But confronted with the alternatives: bank CDs at under 1% or taking her chances on the stock market, she says she’ll stick with her junk for now. She’s happy just to collect the interest. Market crashes? She's like "What me worry?"

That being the case, she should be able to sit tight and just clip coupons for another year and a half until her next bond matures. We’ll see what the world looks like then. Maybe it will be time to pay down the mortgage.

As for the photo. Yes, that is my wife. I married up, I know.

Thursday, April 22, 2010

Getting up to speed

I haven’t blogged for a while, so I thought we’d catch up on some things written about over the past year or so.

First, bonds in general. LINK. There is no doubt that corporate debt has been the asset star of the last year or so. While stocks have made their way back and are closing on their high-water marks, most bond portfolios and funds are hitting new highs.

The category is still very much in favor and there is some value still to be found. Don’t get too greedy and you’ll be ok. There are a lot of new issues coming to market both in the developed and emerging markets, so there is quite a bit to choose from. The big gains are over now, its coupon-clipping time.

As for more specific issues, our friend Borat must be happy. LINK. Kazakstan’s sovereign risk is now lower than many Eurozone countries. Not only Greece (duh), but Hungary , Portugal and almost Spain. The fact that Kazakh debt trades better than California’s was widely remarked in the press. LINK.

In Ukraine, things have calmed down. Elections were held in January/February and the pro-Russian candidate Victor Yankovych won a close second-round victory over Yulia Tymoshenko, despite her good looks. LINK. And so the “Orange Revolution” was reversed. Tension between Russia and Ukraine which contributed to the “gas war” between Gazprom and Naftogaz has come down dramatically and there are even talks of joint ventures. LINK. Russia has agreed to give Ukraine a price break on the gas it consumes, while Ukraine will extend Russia’s lease on its Black Sea Naval ports. LINK.
Naftogaz bonds, which defaulted briefly in October (swapped for new issue- LINK) are now trading at 108%. I remember an analyst stating that he “wouldn’t be surprised if the new Naftogaz bonds were trading above par in less than a year”. Oh wait, that was ME.
Isn’t it nice when neighbors get along?

As for corporate issuers: AIG and its subsidiaries are still current with their bonds all of which have rallied sharply. LINK. LINK. LINK. An important “turning point” was reached when airplane-leasing subsidiary ILFC returned to the bond market, thereby reducing the refinancing risk of its outstanding bonds. LINK.

Herrtz quietly dropped the suit against an analyst who had named the company as a possible bankruptcy candidate. They figured out it would only get them bad publicity. Took them a couple of months to figure that out. LINK.

Despite my skepticism, Kodak’s bonds and stock have rallied, as the company raises cash selling or licensing some patents and is trying to raise more by suing the likes of Apple and Research in Motion. I could have held on…oh well. LINK. LINK.

The price of Gold has stagnated, ruining a speculative gold trade I had set up, Sometimes investors DON”T go bananas. Especially when you expect them to. LINK.

Venezuelan bonds have rallied of late, but still yield much more than their credit rating would suggest. What good are the numbers if you can’t believe them? LINK.
Analysts are looking at a $1.5 billion bond maturity in August, as Central Bank reserves drop.

Blockbuster and Netflix continue their lopsided battle. The Hollywood studios have realized that Blockbuster’s survival is in their best interest. How much they will help keep Blockbuster away from bankruptcy remains to be seen. Anyway, the four trades proposed back in February are winners at this point. LINK. LINK.

Now that we’re up to date on these trailing issues, maybe we can move forward and I can get around to blogging more consistently.

Monday, March 22, 2010

Life After Japanese

Not breaking news, but I wanted to mention that Japan’s population is shrinking. This is hardly unique in the world, since a number of other countries are also suffering from population decline, mainly in Eastern Europe. What makes Japan different and has demographers all over the world (all 25 of them) drooling in anticipation, is that they were expecting this, and there is really isn’t much Japan can do to avoid a dramatic depopulation in this century on a scale not seen since the bubonic plague ravaged Europe in the 1300s.

Here are the projections. It’s a really great graph, so click on it, put it in a big window and take some time to look it over.

The estimate is that by the year 2105, the population in Japan will have plunged from its current 127 million to around 45 million. A 65% drop for those keeping score. The action has only gotten started. Last year, the population decline was a modest 75,000, but by the end of this decade the yearly decline should be in the 500,000-1,000,000 range.

Driving the pop- drop is a fertility rate that has been in a steady decline for about 35 years, when it slipped beneath the “replacement rate” of 2.1 births per woman. It currently stands at 1.34, but even if it were to rise again, population decline would still occur since there are fewer and fewer women of childbearing age.

The social reasons behind the fall in fertility are basically that Japanese women don’t want to get married and much less have children. And who can blame them as one Internet poster put it:

“Fewer Japanese women having babies because they don't want to get married to childish Japanese men. Also, babies are expensive, and why bring a child into a world with a looming threat of Godzilla?”

Working women come home after 12- hour workdays to wait on their husbands and kids. Grandparents could babysit, if they weren’t busy taking care of their own parents.

For years, the central and local governments have been extending financial incentives for women to procreate. But you have to question the commitment when it wasn’t until late 2008 that childbirth was even covered by medical insurance (it’s not an illness).

Naturally, not everybody sees depopulation as a bad thing. Japan is still one of the more densely populated countries in the world and when they sought to “reach out” into the world for a little elbow room, the results weren’t pretty.
Still, the process is going to leave the country with a disproportionate number of elderly, and many are worried about that.

Immigration has been the answer for other societies in this pickle. But the Japanese seem to love their monoethnicity and a massive immigration program is unlikely to garner popular support.

Cruel and insensitive internet posters have suggested remedies such as subjecting Japanese males to “tenderization”, by forcing them to watch Sandra Bullock romantic comedy marathons Or spiking the water supply with ExtenZe. Very funny, guys.

Why am I blogging about this? It’s interesting and something to be considered when investing. When Japan’s population is headed for a fall off a cliff, one can hardly expect the Nikkei to bounce back to its 1989 highs (almost 40,000 then, it’s standing at 10,800 now). I know I’ll think twice about buying Toyota stock. (/Investment Theme Justification)

Rural Japan is already feeling the effects of depopulation. If you’re into this kind of thing, here’s a fine blog called “Spike Japan”, depicting the desolation setting in on the countryside. Great depressing stuff.
It’s almost like a preview from the series “Life after Humans.”

Saturday, March 13, 2010

Too Puny to Succeed

Now that banking reform is beginning to be discussed in Washington, much of the conceptual discussion about new legislation surrounds “systemic risk” and “too large to fail” institutions.

Left behind is another structural challenge that faces regulators: “too puny to ever succeed”.

The FDIC puts out quarterly banking statistics, which are quite a good source for stat buffs like myself. LINK.

Here’s a tidbit: as of December, there were 8,012 banks in the US, with over $13 trillion in assets.

I know large numbers are difficult, so I’ll say it again: EIGHT THOUSAND BANKS.
That’s a lot of banks. I mean, how many banks do you really need? Obviously something very wrong happened on the way to industry consolidation.

The UK consolidated its banking industry in the early 20th century. Other countries, like Germany (with over 2,000 banks) have yet to see the shakeout. The US is on its way, with the total slowly coming down from over 14,000 in the 80s. But there is still a long way to go.

Here’s a pie chart with the banks by size.

What stands out here is that there are 2,845 banks with under $100 million in assets and almost 4,500 with under $1 billion. I know a billion sounds like a lot, but in terms of the total market, it represents less than 0.01%.

So we’re talking about a market where 92% of the market players are puny. Individually, they are tiny, minute, and perhaps insignificant. As a group, however, they control 11.5% of the system’s assets, including 17% of the real estate loans. (Can you say “systemic risk”?).

So what? You may say. More competition is great and it leads to greater efficiency. The fact is that in an efficient marketplace, these banks have no chance of long-term survival in their current form. Just think of the characteristics of the industry:

Retail banking has commoditized/standardized products and services. A checking account is still a checking account (even if people don’t write as many checks anymore).

Economies of scale exist. Processing two hundred transactions or whatever costs less per transaction than processing one hundred.

Technology has not only drastically reduced transaction costs (enhancing economies of scale), but is destroying the geographical barriers that protected the small fries. Let’s face it, do you really need to go the bank (branch) anymore? If a bank’s competitive advantage is being “close” to the consumer, how much closer than a click on your computer screen?

Close to 100,000 bank branches operate throughout the US, but although their number continues to grow (slower now), branches are shrinking in size and staffing. Last year, the WSJ reported that Bank of America was going to close 10% of its branches. The report was later denied by the bank, but you have to believe that the issue has been discussed in the bank.

BTW, just to get an idea, there are about 30,000 supermarkets in the US. Three bank branches for every one supermarket, seems a bit much, IMO. LINK

In any case, industry consolidation is now accelerated by the credit crisis. The FDIC can’t shut down these micro-banks fast enough. Of the 30 banks closed by the FDIC this year, 25 have total assets of less than $1 billion. Their challenge has been finding “less puny” and financially stable banks to absorb the operations of these failing banks.

So long Waterfield Bank, Marshall Bank, Evergreen Bank and Charter Bank (etc etc).
We hardly knew ye. You were too puny to succeed.

Sunday, February 21, 2010

Whither Junk?

The beginning of 2010 hasn’t been quite as smooth as most of 2009 was for the junk bond market. Some fear here and there, a pulled deal or two and risk spreads have widened a bit.

However, there is nothing really dramatic in this pullback. So far this year the FINRA-Bloomberg High Yield index is still up about 0.2%, but it’s 1.6% off the high achieved on Jan 11th. Compare that to some stock indices, a few of which (Spain) are down double-digits for the year and you’ll see junk has suffered only a “mild setback” in comparison.

Naturally, after a year that saw this index rise 44%, expectations might be a bit exaggerated not only from those riding the wave, but also from those anticipating a fall from those perceived “heights”

Still it’s always good to reassess one’s position. And mild or not, a setback is a loss and nobody wants to lose. So what now?

After thinking it over for about two minutes , I’ll be sticking with my junk for now thank you and here’s why:

1. The alternative is nothing. Not saying that there is no alternative, but if you’re
looking for something “safe” a 12-month FDIC insured CD at Bank of America is paying 0.80% APR. Two years: 1.11%. It’s quite ridiculous. Sure, bonds (and junk) aren’t really ‘safe”, but do you really want to give your money away to the big bad banks?

2. Money continues to flow into bonds. The Investment Company Institute tracks money flows into money market and mutual funds. During 2009, the net flow into bond funds was $374 billion dollars vs. a NEGATIVE flow of $9 billion for equity funds (which is pretty much a wash). Where is the money coming from? Money market funds (down $566 billion in 2009) and bank CDs (see point 1). Some money market funds are paying 0.01% because they can’t pay “negative” interest.

3. The boomers are getting older. The oldest boomers will be 64 this year and the youngest 46. E*Trade took a survey in 2008 (before the crash) and a majority of investors believe they are underweight in bonds and should be looking at allocating more. LINK.

4. Deleveraging continues. Despite the fact that credit is becoming easier, companies are looking to reduce debt, either by issuing equity or other means. LBO activity, which normally has the opposite effect (new issuing of debt to retire equity) has been very light.

Money flows and lack of attractive alternatives. This clip probably sums it up.

Monday, February 8, 2010

Internet Killed the Video Store

The Internet has been a major disruptive force in business ever since Al Gore invented it a couple of decades ago (Al just can’t seem to remember exactly when it was).

Of course, of the assumptions we all made about it back then, many didn’t pan out, but others did, not necessarily in the immediate, cataclysmic fashion expected, but gradually and in some cases definitively.

In any case, battles between the “new” (Internet-based) and “old” (Bricks and mortar) abound and are ongoing, some having lasted for well over a decade now.

Today on the History Channel: The war between Intenet-based mail-order movies for home viewing and the video store. Netflix vs. Blockbuster.

This one, in particular has been raging for over a decade.

Essentially the war is over. Netflix won. In their latest quarter, the company reported excellent results and has accumulated over 12 millions subscribers. Netflix put together two things that worked relatively well: the Internet and the postal service, and with low overhead, provided a model that was hard to beat. More info HERE.
Check out the stock performance:

On the other hand, Blockbuster has had to deal with a model, which is outdated, but still has its followers. They operate over 7,000 stores in 25 countries. It used to be over 9.000 but reality has forced a round of closings and more are expected. They tried to beat Netflix at its own game with a mail-based system, but faltered and apparently are now losing subscribers. The estimates out there have them at between 1 and 2 million, far behind Netflix. And they have had to contend with a second battle front, from automated “kiosks” which rent out recent release DVDs for $1 per night. (Operated by Coinstar CSTR). To fight that, Blockbuster has set up some kiosks of its own (Blockbuster Express), but it’s a $1/day rental vs. a $4.99 2-day rental (what Blockbuster offers on new releases at the store), so that’s not going to be good for margins in the short run.
Here’s an interview with the CEO. Prepared to be unimpressed. LINK.

Don’t be sad, everyone dies sometime. With Blockbuster, it’s not a matter of “if”, but “when”. A competitor, Movie Gallery, operator of over 2.000 stores under the “Hollywood Video” brand, filed for bankruptcy last week, for the SECOND time in two years. LINK.

This was supposed to be good news for Blockbuster. I’d call it mixed at best, but most likely ominous.

With all that said, here come the investment ideas, starting with the winner: Netflix.

Idea # 1: Netflix bonds. In November, Netflix issued $200 million of 8.5% unsecured bonds due in 2017 (8 years). When you can find them, they trade somewhere around 102-104%, to yield around 8% to maturity. They are callable at par in 2015. This trade looks easy. Nice yield. S&P rates the issue at BB-, which is “junk” but only “a little junky”.
One concern perhaps is that the trend towards direct downloads could grow, overtake and overwhelm Netflix. Probably. But when? These things take time. Habits do not change overnight. The horse and buggy did not disappear once the car was invented. AOL STILL has dial-up Internet subscribers, people still buy magazines and so on. The bonds look safe to me for the next 5-7 years (which is all it will take). Netflix as a business, probably hasn’t peaked yet, so let’s not worry about its demise. YET.

Idea #2 Netflix puts. Instead of the straight equity play (buying Netflix stock), I prefer a more conservative approach. The stock has traded up a bit recently and the market isn’t looking so great. So the idea is to SELL Netflix puts 6 or more months away and at strike price lower than the current price (out of the money) The stock is at 61 right now, but you can get $2 or more for a Jun 50 put or $3.50 for a Sep 50 or $5 if you want to take it to Jan 2011. What this means (I know not everyone is an expert), is that if the stock goes below $50, which is 20% less than today, you will be assigned the stock (i.e. you must buy it at $50). If the stock doesn’t go under $50, you get to keep the premium. Sure, this is not an idea with a great upside and if NFLX goes to $100, you’ll still only get your $2-$5 in premium. So be it, I’m not greedy.

Now, lets go check out the unburied corpse (Blockbuster). Without getting too “numbery”, lets point out that the company last October issued $675 mm in new SECURED 2014 bonds to pay down its credit lines. At the end of the year, the company was said to have $247 million in cash. Leading us to…

Idea #3 Blockbuster secured bonds. Now trading around 71%, those secured bonds with a 11.75% coupon, yield over 27% to maturity…IF they pay. That of course, is the question. If and “how much?” or “how long?”. These bonds have an additional advantage, if you will, that they are a “sinking fund”, paying 3.33% back in principal each quarter.

If Blockbuster manages to stay out of trouble, you would have your 71 cents back in about three years counting interest and principal. Any payments after that, be it the result of normal operation, restructuring, reorganization or bankruptcy would be profit. There would still be 60 cents worth of principal outstanding on the bonds at that point.

Before you say, “they won’t last that long”, just look how long they HAVE lasted. And there are options for companies in these downward spirals: asset sales, cost-cutting, etc. I’m often amazed how long they can go on. Sometimes they even manage to “reinvent” themselves. Heck, Businessweek pronounced Apple dead over a decade ago. LINK.

There is a lot at stake, namely the CEO pulls in over a cool million a year and the top execs all over half a mill. I wouldn’t personally give that up without a good fight.

Bringing us to…

Idea #4 for the greedy and the optimistic. No, not Blockbuster stock. That’s for the foolhardy. This one is Blockbuster UNSECURED 9% 2012 Bonds (Maturity 09/01/2012), currently trading around 22% of par for a YTM of 93%. I guess it’s obvious that the market doesn’t expect these bonds to be paid in full and on time. Being unsecured, they are behind the secured bonds in a reorg or a bankruptcy and could come out of such an event with nothing.

But then again, 22% is pretty close to nothing already. There are many possibilities, not excluding the company tendering for these bonds (say at Ford did early last year) or some sort of discounted swap. If Blockbuster can buy back or somehow write off part of its obligations at a deep discount, it can make the remaining debt more payable.
These kinds of maneuvers are what make investing in distressed assets interesting, and this is distressed for sure. Expect it to be interesting, in the Confucian sense (apparently he never said that…).

Ok, so there it is. I blogged a long blog this time. For those who didn’t bail halfway through: a thought. Think about these wars and those like them. The winners, the losers and the implications. Keep it in mind next time someone offers you some commercial real estate, a bookstore or a bank or gives you a DVD for Christmas.

Here’s a classic clip from “The Holy Grail”. Quite Appropriate.

Friday, January 22, 2010

My Neighbors’ Mortgage

My neighbors are gone. They left several months ago. I didn’t realize exactly when, since I didn’t know them that well and frankly I don’t pay attention to those things.

There is a sticker on the front door, placed there by the homeowners association stating that “We have determined that this residence is abandoned and have contacted your mortgage lender”.

My curiosity was piqued. “What happened to these people?” A lost job, perhaps, or some other misfortune. Is the property for sale? Can I buy it dirt cheap? and so on.
I remembered that the property was up for sale for a short while, but then taken off the market again.

Well, the interweb is a wonderful and scary place and the answer was there. I looked up the county records and voilá:

I believe the table explains itself quite clearly, but in any case: they bought the property in 2002, with 20% down financing $205k for 30 years. Three years later, they refinanced for $342,400, probably at a better rate and pulled about $140k out. And then, only one year later, refinanced again with a $414,000 first mortgage and an $86,000 second mortgage tied to a revolving credit line (which I can only assume they used) and got themselves another cash-out for about $160k.

So basically, my neighbors bought their house with about $50k down, and pulled roughly $300k out of it in four years. We all know what happened to the real estate market and now the house is listed at with a value of approximately $340,000, but no way it goes for anything like that in an auction.

I guess my neighbors just “walked away”. Can’t say I blame them. Sure their “credit score” will be shot, but that’s just “joining the club”. There are millions of Americans in the same boat. And it’s perfectly legal.

They will be liable for some taxes once the bank forecloses on the property and sells it (owner is liable for the difference between the loan value and the sales prices), But who knows when that will be. I went to the bank to find out about the house. I figured it would a nice way to add an extra bathroom (or two or three) or have a place to put my mother-in-law when she comes for a long visit (totally worth it) or simply make a deal.

From what I could gather, though, the bank has no idea the house is probably theirs, and very little interest in getting rid of it. They have not listed it in among their properties and I guess its not going to be on the market for a while.

So it sits there, deteriorating. The homeowners association mows the grass and cleans up the garden. The paper is still delivered and usually winds up on my driveway. The crack dealers are moving in (just kidding!).

One can only wonder how many more neighbors’ houses are still out there. Abandoned, but not foreclosed, sitting in residential real estate purgatory.

Time to sell my Bank of America shares.

Wednesday, January 20, 2010

It Ain't Me, Babe.

Sorry to interrupt this blog, but I've been getting inquiries about the Venepirámides blog, which I have linked under "Blogs I read". It's not my blog. I don't write it or know the person who does. I read it, find it interesting and whoever runs it was kind enough to link this blog also and send some traffic my way.

When I was writing about Stanford, Venepirámides translated some of my posts into Spanish and published them there, for which I was and am grateful. I've also commented some of the posts there (using my name).

Recently, Venepirámides has been blogging about the Venezuelan financial system, which I lost track of like half a decade ago, and that has a number of bankers either nervous or upset or simply wondering about their classification in the rankings.
And they're calling and emailing me.

So to all the bankers, their friends and associates who are wondering...let me paraphrase Dylan.

But it ain't me, babe,
No, no, no, it ain't me, babe,
It ain't me you're lookin' for, babe.

I'm kind of partial to the Turtles' version (check out the go-go girls!)

Tuesday, January 12, 2010

Not a Prophet in Venezuela

Analyzing Venezuelan bonds as an investment is a very sticky topic. On one hand, it’s very hard to be dispassionate about the issue, given the fact that I spent so many years in the country. On the other, there’s potentially good money in it, so one has to be practical and try to leave one’s emotions aside.

I will start with some advice: if you live in Venezuela or conduct a good amount of business there, you should probably NOT invest in Venezuelan bonds. Doing so would violate Dalmady’s first law of portfolio diversification: “Never put you nest eggs in the same basket as your cojones”. While this law may be a slight contradiction to Lynch’s axiom: “Invest in what you know”, ask any Enron ex-employee, who found himself simultaneously jobless and penniless (their 401ks invested in Enron stock), which precept is the more important one.

This is not to say one shouldn’t participate in the opportunities for participating in new offerings and quickly flipping these bonds for a profit, many of which have been good trades in the past few years. Those are arbitrages though, not really “investments”.

As for the rest of you (or us…but mainly you), here’s my take. Veni bonds have been on a tear lately, as you can see in the graph below of the benchmark Ven 27 bond (click on it to get a larger picture). In the last 30 days, that bond is up from 67% to around 83%.

There are a few explanations for this. First of all, Venezuelan debt was lagging in the credit market rally that began in late 2008. And it was lagging so badly that it was surpassed by the likes of Argentina and other lesser credits (not mention countries like Georgia, El Salvador, etc…which enjoy still much much better credit terms).

That fact wasn’t lost on the analyst community, which picked up on what they believed to be a bargain. Deutsche bank issued a note with a buy recommendation on PDVSA bonds several weeks ago and other analysts also gave their nod to Veni bonds. An analyst I spoke to at Credit Suisse was also very bullish on the bonds (while I shook my head in wonder). Analysts cite indicators, such as a relatively low Debt to GDP, Export Volumes, Substantial FX reserves, etc…which all seem to point out that Ven debt wasn’t as bad as its market price was indicating.

After Friday’s devaluation, even S&P got in the act, revising Venezuela’s credit outlook to “stable” from “negative”. JP Morgan upgraded the bonds yesterday also. So there is a lot of momentum riding on this trade and it could tick up even higher from here. If you’re riding this wave, congratulations, if you’re looking for some action there may still be some here. Double-digit yields are becoming an endangered species in the credit world and Venezuelan bonds still offer those.

Longer term, however, caution is the word. Although it’s hard, if not impossible to be a hometown prophet, I must point out the danger, Will Robinson. Buying Venezuelan debt is like lending money to a wealthy, eccentric and partly insane uncle. You kind of figure he’s good for it, but there’s a good chance he’ll blow his fortune buying real estate on the moon or something and leave you hanging out to dry.

That is the kind of uncertainty you must deal with if investing in Venezuela. Chavez regime’s economic policies are entirely idiot-logical (i.e. only make sense to an idiot). Electric shortages are fixed by shutting down shopping malls, agricultural policy proposals include “vertical chicken coops” on rooftops in poor barrios and consumption of scarce products and services is dissuaded by keeping their prices low. If money is tight, just take some dollars from the reserves at the Central Bank and/or devalue. What’s more, when devaluing the currency, book an exchange gain and spend that, too. What? still not enough? Nationalize a bank or two or ten. Ponzi banks? Bail them out and take them over. Need more money? That’s why we have the “Casa de la Moneda” (currency printing plant).

Corruption, deliberate misinformation and ineptness merge together to form an incomprehensible mess. There isn’t an official figure that can be trusted without an independent third-party verification. Inflation, unemployment, sure every country plays with those numbers…but also more basic, fundamental numbers are suspect in Venezuela. The “embellishment” of oil production figures has been well documented. But it could go deeper still. For example, the Central Bank puts FX reserves at $35 billion. Really? I’d need to see every single greenback to be convinced that that is the case. (Who audits the BCV? Think about that.)

I know what some of you may be thinking: “Dalmady’s just another Chavez-hater who wants the Venezuelan economy to fail and Chavez to fall with it”. Nah. I’m afraid Chavez is a given, he’s not going away anytime soon, so I’d much rather the country did well than not. Less than a decade ago, Brazil was considered a greater credit risk than Venezuela. Now it’s “investment grade”. Venezuela, on the other hand, competes with the worst of the worst. It’s disappointing, sad and no “trend change” is in sight.

It’s not like analysts aren’t used to uncertainty and contradiction, especially when dealing with government policy. Sure, measuring risk vs. expected return is how we handicap the game. In the case of Venezuela, IMO, there are just too many unknown variables and possibly disruptive scenarios to make an educated estimate. Expect the unexpected would have to be my best assumption. How do you put odds on that?

So, invest and play the game of chicken with fate, hoping to be able to bail out before the inevitable collision (Oh, yes…it WILL happen) or sit on the sidelines just for the satisfaction of watching the accident and saying “I told you so”. You could be waiting a long time for your shot at schadenfreude.

It’s a lose-lose proposition. I prefer to play some other game.