Monday, September 28, 2009

Hertz: “We’ll come and get you” ®

Sorry, for the interruption in the middle of my multi-part AIG analysis, but I just had to write this up.

Reuters is reporting that Hertz has decided to file a defamation suit against an Independent Research Firm, for suggesting that it might go bankrupt. This has to be the most outrageous thing I’ve read all year.

Hertz was included in a list of “Twenty companies most likely to go bankrupt” which was published and circulated by Audit Integrity, Inc, an independent research firm.

The outrage is not that Hertz may go bankrupt, (I have no idea) but that Hertz actually files this suit and considers it an “appropriate response”.

So now every time an analyst states something a company may not like, the “appropriate response” is to sue? Wow. Just Wow. (Any lawyers out there willing to represent me on the cheap?).

A research report is an opinion. Like…first amendment protected? Remember that? Opinions are an integral part of the market, without them we would not have two sides to a trade. Shut that down and we can say goodbye to any remnants of transparency. It was bad enough when everyone had to be “hush, hush” last year about the collapsing banks due to “public interest”. Now we can’t state an opinion about a car rental company’s prospects?

As for the report, I haven’t seen it, but Seeking Alpha has the list. I obviously don’t agree with it, since I own credits for a number of the names on the list (no not Hertz).

That is not the point. Obviously. I can only hope (because if I predict, I get sued), that Hertz gets this thrown out and Audit Integrity countersues and takes Hertz to the cleaners. Maybe it will throw the company into bankruptcy. LOL. (That was a joke, Hertz people).

I certainly KNOW which rental car company I won’t be using EVER AGAIN. I think that is an “appropriate response”.

Bailout Bonds or The AIG Trifecta (Part I –AIG)

I got a ping on my Blackberry from a colleague/friend: “What do you think about AIG?” He was talking, of course, about AIG stock, which has been a trader's delight for much of 2009, from the short and long sides.

He might as well have asked me to tell him how general relatively is explained by string theory.

AIG is an analyst’s nightmare. Take one look at those financial statements and you can understand why the black hole that lurked within the company went undetected until it was too late.

Nowadays, even post-bailout, AIG’s 10-K (annual SEC report) is 344 pages long and its latest 10-Q (quarterly) is 221 pages strong. That’s without getting into the supplementary statements. To make matters worse, you can go through those reports with a comb and STILL not come away with an understanding of the company and much less a valuation of it.

You see, AIG is a holding company with different operating companies, all mainly in the financial area. To BEGIN to understand and value it, you’d have to go through all the main subsidiaries and drill down THEIR portfolios (now that we’re not sure of the value of anything) and businesses and add all that up.

Sorry, amigo, don’t have that kind of time. It also brings up the analyst’s conundrum: by the time the analyst has done the work, figured it out and written it up, the market has probably gone way ahead (perhaps on insider knowledge). So it’s not worth it. And as far as I have been able to find, there hasn’t been any deep research done on the company this year. Goldman Sachs, often fingered as the beneficiary of the AIG bailout lists the company as a “Not a GS-followed company”. (If someone can find a good report, send it my way, please).

I can’t say I blame them. I wouldn’t have an analyst spend time on unraveling the mysteries of the AIG universe, either.

Of course, you can read the WSJ and the Internet blogs. You’ll find outrage, opinions, conceptualizations, but very little in terms of hard numbers.

As frustrating as it may seem, sometimes you have to make use of less than perfect information and make some assumptions when investing. AIG and others like it, just stretch that reality a bit further than most.

With all those caveats, luck has it that that sometimes you can find tidbits of information that are particularly useful. Earlier this year I had been browsing through that mountain of AIG data, and I found this. LINK. Open it in a new window. Look it over, it’s important.

It is AIG’s post-bailout capital structure, explained by AIG itself. I know it may seem like Chinese to some, but basically this is the “pecking order” of AIG’s creditors, and bonds and shareholders.

First in line is the Federal Reserve Bank of NY, which basically has the first dibs on the sale/spinoff of several of AIG’s insurance businesses. AIG owes FRBNY over $40 billion.

Second is Senior Debt. Yes, Bonds. AIG has a number of senior debt issues outstanding.

Number three on the list is Junior Subordinated debt. Also bonds. A couple of these caught my eye. Will explain further down.

Four and Five is government bailout money and last on the list is the common stock.

So here’s how it works: if you were to value all of AIG’s assets (something I’m not going to do) and assign the value to the stakeholders in order of preference, there would certainly be enough for Level One. Also probably Level Two and probably Three. Levels Four or Five, not so sure. What’s more, we hear all the time that the government isn’t certain that they’ll get their money back. LINK. Well, until the gov is paid, there is nothing for level SIX.

How much is level SIX worth? No idea. If there are enough in assets and/or ongoing businesses to satisfy ONE through FIVE, level SIX is worth something. If not, it’s worthless. Right now, Mr. Market says that level SIX is worth $6 billion. Maybe it is. Maybe it’s worth 10 times that. Maybe zero.

I told my friend to trade the stock technically, if he was into that. What else can you say?

However, there is a lot to be said about Levels Two and Three. (Yeah, bonds). These guys collect BEFORE the government with its preferred stock. And so far, AIG has been making its debt payments on time and in full.

Not that this is secret to the bond market. Last year in the midst of the crisis, AIG senior bonds maturing in one year later (i.e. now) was trading at 50 cents on the dollar. Those brave enough to get in there, made their double. (Compare to those who dared to buy stock). (No, I wasn’t that brave).

Today AIG senior bonds are trading with yields mostly below 10%. They have been on a tear lately, since yields were in the high double digits only a few months ago.

Better returns are still available in the Level Three bonds, the junior subordinated ones. I’ve been able to get my hands on two different issues, the A-6, which matures in 2058 and the A-1, which runs through 2087.

The A-6 bond pays 8.175% coupon until 2038, when it changes to Libor plus 4.195%. Currently yielding about 14% until my kids inherit and something variable thereafter (which my grandkids might enjoy).

The A-1 is set up similarly, 6.25% until 2037, Libor plus 2.0568% thereafter until 2087. Trading around 50% currently, there’s some good interest payments left in those bonds until my great-grand kids collect the principal.

I was fortunate enough to get those bonds at a lower price, but would still consider buying them. AIG got its bailout, here’s a way get a bailout of your own.

As for the other two flavors of AIG. Next post. This is long already.

The Picture? Wayne Rooney. AIG used to be the sponsor of the Manchester United side. Ah, the good old days.

Sunday, September 20, 2009

Update on My Wife’s Junk

In one of those routine wanderings that people do while on the net pretending to be working, I waltzed over to Bank of America’s web site to check their CD rates.

One month: 0.30%
6 months: 0.50%
12 months: 0.95%


It only gets a bit better when you go out two to five years. (2 to 3%). Yes, FDIC insurance is included but only up to only $250,000.

BTW, notice how “interest checking” is accruing all of 0.01%. Seriously, how does BofA pay 0.01% and still call it “interest checking”?

Getting back to the rates, it’s got to be a tough pill to swallow if you’re a retiree or simply saving for something down the road and don’t want to risk it on the stock market.

Investors are moving into bonds. Can you blame them?

I’ve been harping on the issue for a while, I know. A few months ago, I ran a post describing my wife’s junk bond portfolio. It’s not the idea that those investments are specific recommendations. This was simply to show that a person with limited financial knowledge could put this together with a little help. So, other people can, too. (Notice I don’t say “anyone”, some people can’t or simply don’t care enough…but that’s for another post).

Here’s the link to that post. It’s not a long read.

My Wife’s Junk

Also, here is a table of what her portfolio looked like back then:


A few things have happened between then and now. First of all, none of these companies has gone bankrupt (despite all the talk of “default rates”). Second, most of these bonds have moved up in price and there has been some corporate action. Third, my wife has made some necessary changes.

First she sold her Home Depot bonds (number 6 on the list) The yield on these came down to well under 3% and that is the “mortgage threshold” in this household (might as well pay down the mortgage). I had mentioned that she was thinking about doing this.

The Corrections Corp bond (number 4 on the list) was called. For the bond newbies (like my wife): some bonds have a provision that allows the issuer to pay them back before maturity. That one did. They paid back two years ahead of time. It doesn’t matter if you tell them nicely to keep your money. They still pay you, even if you don’t want them to.

The Owens-Illinois bond got a tender offer (see my post about At 104%, for a bond with a year left, it was an offer she couldn’t refuse.

Here's the portfolio as of today. Click on the image to make it larger (and readable).

The new additions were as follows. The theme, is “flawed but fair”, as it should be with junk.

Interpublic 2014 6.25%. Interpublic is large global advertising company, whose claim to “shame” is being GM’s ad agency. The balance sheet checked out ok and, let’s face it, GM STILL needs to run ads. Now more than ever.

Dole Food 2013 8.75%. Food is stable business of course, but Dole was part of a leveraged buyout so it’s heavy on debt. But there is talk of taking the company public once again, which would improve the company’s balance sheet (and make the bonds less risky). S&P downgraded. Go Figure.

Continental Airlines 2011 8.75%. With this one, my wife kind of jumped right into the “risky” waters. Airlines are notorious for their tendency to go into bankruptcy and Continental has been in there –twice. But my wife figured, “hey, its only two years, Continental’s not doing that badly” and she has profits to fall back on. It’s always easier to take some risks when you’re already sitting on profits. S&P recently downgraded to CCC+ (from B-). The bond subsequently rose from 66% to 87%!

As for the rest of the portfolio, here is what it looks like now:

Advanced Micro Devices: This bond was downgraded from B to CCC+ by S&P in April. The bond has risen from 57% back then, to around 87% today. Thank you, S&P! In S&P’s defense, they are only assessing default risk, and not considering if the bond should rise in price. But seriously, do we really expect AMD, the world’s second largest microprocessor company, now with the backing of Middle East money, to go under?

Alcoa: Price is up, yield is down. Still beats the “mortgage benchmark”. So it stays.

Chiquita: Won’t go Bananas and sell now. S&P upgraded to B.

Davita: Has been stable, as expected. That’s why she bought it! (Dialysis Centers)

Jo-Ann Stores. This was upgraded to B- by S&P. This bond is going to a problem for my wife, because I believe it will probably be called next March. It’s hard to find, but if you want an easy 7%+ yield for about six months, I would recommend buying this (try to get it under par).

Seagate and Starwood. Nothing to say here. Just clipping coupons.

There it is, still short duration (average 3.35 yrs to maturity), still a decent overall yield (8.59%). A little riskier, perhaps (in S&P’s opinion). But my wife is still happy with it. And if she’s happy…well…you get the idea.

Note: comments now open to anyone. The death threats have waned. Just keep it on topic, ok?

The picture? Not my wife, but Ukrainian-born Olga Kurylenko, the latest “Bond Girl” (pun intended).

Thursday, September 17, 2009

A Kodak Moment in Junkland

Sometimes you make an investment and you feel uneasy about it almost immediately.
I had such a moment, a “Kodak” moment, back in January when I picked up some Kodak bonds.

These were 7.25% 2013s, yielding around 17% at the time and price of purchase. I had checked out Kodak’s financials and though they weren’t pretty, figured that the cash balance of over $2 billion would buy the company some time to get its act together. And it wasn’t a large investment. I was buying a lot of bonds at the time and trying to “spread it around”.

Yes, I was aware of Kodak’s problems. Bonds don’t get the “junk” label if they aren’t somehow flawed. But c’mon, it’s KODAK, the camera Dad used to take my baby pictures.

Then the First Quarter 2009 results came out (ugh) and later the second quarter performance was just as ugly. The cash balance was now down to $1.1 billion. Not unexpected, I guess, since there IS a recession going on (in case anyone on Wall Street forgot). This wasn’t just the recession, though; Kodak has been spiraling downwards for over a decade and now very sharply over the last five years. Sales for 2009 are likely to be approximately half what they were in 2004. Cash flow was negative. No tangible equity left on the books.

Consumer Digital Imaging Sales (i.e. Digital Cameras for us consumers) were down 33% Q/Q in Q2 09. And that’s the business that’s supposed to be a “keeper”. Kodak’s attempts to regain market share have been futile.
This was bad upon bad.

Despite a booming high-yield bond market; my Kodak bonds were floundering about where I had bought them. I pondered selling them, but the market was so good…maybe they’d catch up anyway.
But they sat there until about a week ago, when they jumped from the 65-70% range, to close to 80%.

Today I found out why. KKR will buy up to $400 million in SECURED senior bonds with warrants attached (maturity 2017) and Kodak plans to issue an additional $300 million in convertibles. This money comes at a hefty price. The KKR bonds haven’t priced yet (as far as I could see), but Kodak will pay KKR a 3% placement fee (for selling the bonds to itself, I guess) and the coupon is set at 10-10.5%. The details of the other issue (the convertible) haven’t been disclosed yet, but expect the financial cost to be high.

First order of business for these $700 million will be to pay off Kodak’s 3.375% 2033 convertibles, which have a put option (holders can and WILL sell them back to Kodak) in October 2010. That totals $575 million. Those bonds are trading close to par now (logically) after this announcement. LINK

So KKR’s deal bought Kodak some time and perhaps brought some frustration to stockholders who resent the possible dilution. Bondholders were mostly happy with the development (I sure was).
Who knows? Maybe Kodak will get its act together or develop some radical technology it can capitalize on. Or just survive to pay those 2013 bonds (all $500 million worth). These “maturing” companies sometimes decline gracefully. More often, they don’t, but still seem to find some nostalgia-filled white knight to give them a second, third or fourth lease on life. Not that KKR fits that bill, but…

I won’t hold my breath. My plan with most bond purchases is to hold until maturity and junk investors are optimists almost by definition. But when you make what you think is a mistake and you get a chance to correct it –at a profit- you have to take it.

So, with the bond trading up into the high 80s today, I’ll be looking for a chance over the next few days to sell these and let someone else enjoy a Kodak moment. Say CHEESE!

Tuesday, September 15, 2009

The Long and Short of Naftogaz

Ukraine’s state-owned gas company is not usually at the top of the business news here in the Western Hemisphere. But there is a story to it, and like usual in this blog, an investment opportunity.

So here’s the short story and the long story.

The Short Version

Naftogaz, 100% owned by the Ukraine Government, is not in the finest of financial conditions these days. But as a government entity, the Ukraine government by way of subsidy or capital infusion has bailed it out, time after time.

The company has a series of loans and other debt obligations coming due over the next two years, which it wishes to reschedule. The total is $1.7 billion. The interesting part (for us) of these obligations is a $500 million bond issue coming due September 30. Two weeks from now.

All summer long, Naftogaz has fueled speculation about whether it would pay these bonds on time. At one point, it seemed they would pay. And then they’d be back in the “restructuring” mood.

Two weeks ago, they hired Credit Suisse to help them with the process, so the “restructuring” seemed to back on. LINK. Yesterday it was announced that talks with bondholders were beginning. Some tentative terms were leaked to the press. LINK.
Not everyone is happy with this, and there is a dissident group trying to block the efforts and make Naftogaz pay up on time. LINK.

Naturally, all this has bondholders quite nervous and that 2009 bond (with a 8.125% coupon) maturing in two weeks is trading at 85-86%.

The terms “leaked” about the restructuring are a coupon of 9.5%, an additional five years, an explicit government guarantee and possibly an upfront “consent” payment. If that’s it, sign me up.

Certainly, Ukraine is not an easy place to invest, and there is a rocky road ahead. But it’s not easy finding double digit yields anymore, not even in the emerging markets. This is a risk I can stomach. This isn’t Ecuador, who thumbed its nose at the international financial markets, recently. LINK.
Ukraine has a $16 billion program with the IMF established last year in the midst of the global crisis. You don’t sign on with the IMF, if your plan is to default a few months later. (You default FIRST, and THEN go to the IMF)

Now the LONG version
(more interesting…but well, LONGER)

The Ukraine and Russia have had a complicated relationship going back centuries. I’ll let you wiki that if you will, but here’s how it all relates to gas.

Russia has gas, with 25% of the worlds known reserves. Europe needs gas, since it gets cold in the winter (and at other times also) Since the 1970’s, the Soviet Union has been exporting gas to Eastern and Western European countries through a network of pipelines.

Here’s a great map of those pipelines. LINK. (Don’t you just love maps?)

I did write “Soviet Union”, but the USSR is no more and the main trunkline of the pipeline now goes straight through now independent Ukraine. That pipeline now belongs to Naftogaz. But the gas belongs to Gazprom (Russia).

If this sounds like fertile grounds for conflict, it has been. Through the 1990s, Ukraine and Russia quibbled about these issues and in particular gas debts, since Ukraine had the habit of getting behind on payments for the gas it consumed.

Not surprisingly, things really started to get testy after the Ukrainian “Orange Revolution” of November 2004-January 2005, from which a pro-Western government emerged with talk of joining the European Union and (OMG) even NATO.

So at that time, Gazprom figured out that it was about time to look at the easy terms (below “market”) that Ukraine was enjoying for the gas it consumed, and of course, Ukraine wanted more money for “transit fees” through its territory. Naftogaz admitted to “turning the valves” its way (diverting gas for domestic needs).

The dispute culminated with Gazprom turning off the gas for EVERYONE on Jan 1, 2006. The Europeans, not really enjoying the prospect of freezing in January, helped broker a deal and supply resumed. A similar spats over debts and prices resulted in a disruption in supply earlier this year, again with some Western European intervention.

At the moment, Naftogaz is current with its payments to Gazprom, but that probably doesn’t leave a lot of room for other creditors (hence the proposed restructuring). Add to this the fact that Naftogaz still subsidizes local gas consumption heavily (something the IMF isn’t particularly happy about) and Naftogaz’ financial situation is still suspect. But, as stated above, there is an “implicit” government backing and frankly for all practical purposes, Ukraine can not cut Naftogaz loose.

If all this weren’t convoluted enough, Ukraine is scheduled for presidential elections in early 2010. The incument president (Yushenko) AND primer minister (Tymoshenko) are expected to run, as well as former president (and loser in the “Orange Revolution”) Victor Yanukovych, (Putin’s favorite., BTW)

If all this is a little too complex for your stomach, well, maybe investing in the emerging markets is not your cup of tea. Personally, I love this stuff, especially when I’m sitting 6,000 miles away. I’ll take the Florida heat over the Ukrainian winter (with or without gas) anytime.

PS. The picture is of Prime Minister Yulia Tymoshenko, who has the Princess Leia look down pat. She appears to be Yanukovych’s (the pro-Russia ex-prez) strongest opponent in the upcoming elections. Incumbent President Yushenko, the Orange Revolution “Victor”, is nowhere to be seen in the polls.