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.

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,