Investing in Equity Stubs

[Hubris]

I've just joined the board recently.

 

You all have provided so much insight into so many companies I thought I might humbly contribute insight into a profitable area of investment I feel might be overlooked by some:

 

I think equity stubs might be very interesting and can provide outsized returns. I can emphasize more on picking your spots here.

I'm hoping this thread leads to some idea generation.

 

My current list of ideas which I'm working through:

 

Lee Enterprises (LEE)

McClatchy (MNI)

Caesar's (CZR)

Radio One (ROAIK)

Rite Aid (RAD)

Cenveo (CVO)

DexMedia (DXM)

Gentiva Health Services (GTIV)

OI SA (OIBR)

 

These are all highly levered equity stubs. I think they will serve as fertile ground for research.

 

Note: CZR is going ahead with a rights offering to spin-off its World Series of Poker intangible assets and its stake in two casinos. So its stub value + rights value. (Non-transferrable rights)

 

Endo Health (ENDP) used to be part of this list however MV has gone up quite a bit and is a nice turnaround at this point.

 

[SharperDingaan]

Once you realize how toxic these are, who created them, & why; you will have a very different view. You are also competing against junior debt tranches (C tranches on securitization financings), & put/call options on real companies. Ultimately, do you really want to be buying from a GS (or equivalent), & who do you think is most likely to have the better experience.

 

SD

[Hubris]

Once you realize how toxic these are, who created them, & why; you will have a very different view. You are also competing against junior debt tranches (C tranches on securitization financings), & put/call options on real companies. Ultimately, do you really want to be buying from a GS (or equivalent), & who do you think is most likely to have the better experience.

 

SD

 

Hi I do realize the risks entailed. For example Buffet and GS own the junior debt in Lee while Apollo and TPG created CZR and are participating in the rights offering and fully subscribing. I just think at a certain prices these are investable with outsized returns. I've been very comfortable in this area for a while now. Some of these were trading at over 50% FCF last year. You really have to make a judgement against the business going forward. I'm saying this is an area of big winners and big losers the key is telling the difference. Just sifting the world for a mis-priced bet!

[SharperDingaan]

Different strokes for different folks, & we wish you luck; but a story for you .....

 

When XYZ junior is trying to raise funds for their next project, the UW will get paid a 4-7% commission; & to get the deal done the UW will often agree to take all/part of the fee as stock, at a deep discount (40%) to the issuing price. That 10M share offering at $1/share may result in the UW taking their 600K fee as 1M shares. The UW was paid to support the issuance & did it by keeping 10% of the new shares (their fee) out of the market, & agreeing to initiate/maintain coverage of the stock for a minimum period of time (1 yr). During the next 4 quarters the UW will sell off their inventory, using each report as marketing. They are clearing inventory, & have that inventory only because they could not get paid in cash - & you are buying it.

 

And this is a relative benign example .... securitization C tranches are orders of magnitude more toxic & abusive.

 

How lucky do you feel.

 

 

 

[Saidal]

If you invest in equity stubs, then you must read the credit agreements and fully understand the Company's covenant position, cushions and ancillary items (equity cures, sweeps,etc). A company can spew FCF, however if their going to breach a covenant, and the lender group isn't full of commercial banks, you'll have a rough situation.

[gary17]

I was wondering if someone could explain to me what a equity stub is.

Sounds to me like it's investing in companies with a lot of debt and the share is a 50c dollar - therefore it's calculating the risk of whether it goes to zero or not.  ????    thanks Gary

[ERICOPOLY]

Different strokes for different folks, & we wish you luck; but a story for you .....

 

Are multiple people sharing your account?  Just asking...  this isn't the first time you've referred to yourself as "we".

 

[Guest wellmont]

I was wondering if someone could explain to me what a equity stub is.

Sounds to me like it's investing in companies with a lot of debt and the share is a 50c dollar - therefore it's calculating the risk of whether it goes to zero or not.  ????    thanks Gary

 

where the debt is a large part of the enterprise value. it's your job to figure out if the equity is a 50c dollar or not. :) but these can be rewarding if you are right. I own fsl.

[Packer16]

There are two filters I apply to invest in these types of situations: (1) trend of cash flow up and (2) equity management/control incentives.  I also use coverage ratios to see if the debt is sustainable and can be paid off in 10 years with FCF (unless the other businesses in industry can support high debt loads).  Of your list, the only one I would look at is OIBR.  I have done a top level review of the others and have passed because the CF trend was down, the debt was too large or management incentives were not there.  I would be careful of the situations where an investor holds the common and debt because depending upon how much they hold of each, they may not be averse to a BK filing and it may turn out to a LVLT situation where the debt holders get a majority of the CFs and the equity is just an option.

 

Packer

[gary17]

Does one generally hold equity stubs for the one gain from 50c back to a dollar, then sell; or long term hold - that the company going forward can be profitable? Thanks!

[Guest wellmont]

Does one generally hold equity stubs for the one gain from 50c back to a dollar, then sell; or long term hold - that the company going forward can be profitable? Thanks!

 

these can be extremely rewarding stocks to hold a long time. because once they turn the corner and it becomes obvious they can service their debt, a positive feedback loop begins and things can get better and better for the holder of the equity. this is a great place to look for ideas. but you have to be very careful. be careful of the debt. watch for when the debt comes due. and don't put every last penny in these things. treat them like options. :)

[Packer16]

It depends upon what they are when you sell.  If they become compounders you treat them as such if they are ordinary businesses then you sell when they approach $1.

 

Packer

[SharperDingaan]

Are multiple people sharing your account?

 

We are a private investing partnership with direct family & relatives. It is 1 of 3 partnerships, each is run by a family member specialized in the areas their partnership can invest in, & I am the FCSI holding GP of the Cdn partnership. The other partnerships are in the UK, & Iceland.

 

The partnerships exist to make money, train nephews & family members in investment, & provide funding for new ventures. Same sort of operating structure as the mob, but without the blood & guts. As GPs we would see it as a failure if our nephews end up as fund managers. No disrespect to others!

 

Works very well, we are always in areas where we have local expertise, & it allows us to spread our risks.

 

SD

 

[gary17]

So what criteria do you normally use to evaluate if it makes more sense to invest in the shares or the bonds?

thanks

[finetrader]

One of the best exemple of investing in common in a leverage company is SCI. In early 2000 they went on crazy acquisition spree, overpaying, etc.. and leveraging themselves. Then they started having problem servicing their debt. But is you looked at the cash flow statement you could see that they had lots lots of FCF. They sold a few cemetary and lowered their debt. I bought the common at around 1,75$ at that time and sold at 2,75$ a few months later. Was very proud of myself until I looked at it again lately...

[finetrader]

Rite Aid results are improving but I'm afraid the stock price is fully valued right now.

It also look quite expensive on an EV/EBITDA ratio.

[ERICOPOLY]

Are multiple people sharing your account?

 

We are a private investing partnership with direct family & relatives. It is 1 of 3 partnerships, each is run by a family member specialized in the areas their partnership can invest in, & I am the FCSI holding GP of the Cdn partnership. The other partnerships are in the UK, & Iceland.

 

The partnerships exist to make money, train nephews & family members in investment, & provide funding for new ventures. Same sort of operating structure as the mob, but without the blood & guts. As GPs we would see it as a failure if our nephews end up as fund managers. No disrespect to others!

 

Works very well, we are always in areas where we have local expertise, & it allows us to spread our risks.

 

SD

 

That's a terrific idea.  Thanks for sharing.

[Hubris]

There are two filters I apply to invest in these types of situations: (1) trend of cash flow up and (2) equity management/control incentives.  I also use coverage ratios to see if the debt is sustainable and can be paid off in 10 years with FCF (unless the other businesses in industry can support high debt loads).  Of your list, the only one I would look at is OIBR.  I have done a top level review of the others and have passed because the CF trend was down, the debt was too large or management incentives were not there.  I would be careful of the situations where an investor holds the common and debt because depending upon how much they hold of each, they may not be averse to a BK filing and it may turn out to a LVLT situation where the debt holders get a majority of the CFs and the equity is just an option.

 

Packer

 

Thanks Packer! I also like LEE although BRK and GS own the common cash flow has been steady for four years and their repaying debt at a pretty steady pace. There has been a recent insider buy by the CFO and the CEO took I think around half her pay in equity which has doubled since then. The CEO has also some higher cost basis shares which were repurchased prior to their prepackaged bankruptcy.

[Hubris]

Are multiple people sharing your account?

 

We are a private investing partnership with direct family & relatives. It is 1 of 3 partnerships, each is run by a family member specialized in the areas their partnership can invest in, & I am the FCSI holding GP of the Cdn partnership. The other partnerships are in the UK, & Iceland.

 

The partnerships exist to make money, train nephews & family members in investment, & provide funding for new ventures. Same sort of operating structure as the mob, but without the blood & guts. As GPs we would see it as a failure if our nephews end up as fund managers. No disrespect to others!

 

Works very well, we are always in areas where we have local expertise, & it allows us to spread our risks.

 

SD

 

That's great best of luck to you guys! We have a similar arrangement while where some of them are in PE and others are in banking. It's much more common here in the Middle East/Asia to have such arrangements.

[Hubris]

I think we can now add JCP to the list here as well...  ;D Its amazing how some turnaround can't turn...

[CorpRaider]

GTIV keeps popping up on my magic formula type screens, but I haven't been able to get comfortable with it.  I offer the following analysis regarding GTIV:  There are a crapload of old people in America.  Nursing homes are like the fifth ring of hell.  Disclaimer when it comes to leveraged interprises: I went down with the ship on CHTR some years back.

[Packer16]

This business will get squeezwed between rising wages and declining reimbursement (as most of the reimbursement is via Medicare).  Add in the debt and not a very good combo unless you think reimbursement is going up.

 

Packer

[CorpRaider]

Yeah, seems like its a shitty business unless there is some future scenario where the home healthcare providers are advantaged in reimbursements over full-time "in-patient" nursing care.

[Hubris]

If its in magic formula and an equity stub so it's never easy to own. I don't know about reimbursements but I think quite a few within space are trading at depressed valuations. How is their business replaceable though?