Tag Archives : MOMENT


New year updates 1

Disclosure: Long 777 HK, long ISIG, long MOMENT 4.69% 2022, short MOMENT 11.5% 2016, short EXAS, no position in GCVRZ, 

Happy new year! My apologies for the long hiatus from blogging. It’s been a busy couple months of holiday travel and a solid finish to 2014 thanks to the performance of several long positions in December. I’m looking forward to making a fuller report in a forthcoming quarterly letter. In the meantime, I felt some quick updates on ideas that have been discussed on the blog and elsewhere were overdue.


China trip and NetDragon (777 HK)

I will be visiting Hong Kong and parts of mainland China later this month. If I have any readers there and you would like to say hello, please drop me a line. If you are a fundamental investor with interest in joining any management meetings, I have a few opportunities for that as well.

The NetDragon thesis is largely unchanged following Q3 results, which were poorly received as expense growth for the education business ramps in advance of revenue generation. NetDragon now has more than half its R&D staff working on online education initiatives. Meanwhile, the core gaming franchise remains strong and has a potential new hit that has already recorded 240,000 PCU. The company repurchased 2.8% of shares outstanding in December.

 

Public commentary on Insignia Systems (ISIG)

ISIG remains a significant position for Cable Car despite an unusual activist situation in the marketplace. Given recent events, Cable Car has adopted a policy of not discussing the investment thesis publicly. However, I remain open to speaking one-on-one with other investors. If you are a shareholder and would like to discuss the company, please contact me directly.

 

Momentive Performance Materials reorganization

I was wrong about both the legal outcome and the potential downside for the 1.5 Lien notes, at least from a mark-to-market perspective. The plan of reorganization went effective in October and the former 1.5 Lien notes (now 4.69% second lien senior secured replacement notes) traded down to the low 80s context. At last trade, the replacement notes yielded 8.3% to maturity, much wider than other similarly capitalized industrial credits. I also failed to fully account for the impact of legal fees on the post-petition accrued interest, which remains in escrow pending a partial settlement (expected to be approximately 70% of billed fees, the same as the first lien notes). There is a further fee reserve against this amount to cover pending appeals. With the intercreditor action between the secured noteholders dismissed except for one narrow class of claims, cash recoveries under the plan as implemented are uncertain and appear limited.

That being said, I continue to find the risk/reward attractive, and arguably more so today. From a purely relative value standpoint, the replacement notes seem to be considerably cheaper than they should be. Interest rate risk and concern over high yield in general could negatively impact market values, but the notes are over-secured and the recapitalized Momentive is much more conservatively levered. Unfortunately, the ratings agencies are unlikely to rate the replacement notes unless someone pays them to do so, which may limit the number of natural buyers. The new notes should otherwise be investment grade. As mentioned before, comparable high yield issuers such as Berry Plastics have notes of similar coupon, duration and position in the capital structure that trade above par, despite what appears on the surface to be a worse financial position. I’m hard pressed to think of a good fundamental reason why second lien MOMENT notes should trade 300 bps wider than second lien BERRY notes, but perhaps there are technical reasons Berry is not comparable or greater concerns about Momentive’s underlying business than I have observed.

Furthermore, the terms of the replacement notes remain open to appellate review. At current levels, that certainly seems like a free call option. The Momentive bankruptcy raised some important questions regarding the proper determination of a market rate of interest for secured creditors. Both the coupon of the replacement notes and the original make-whole claims are the subject of an appeal currently before the district court. From a naïve, non-technical standpoint, the market outcome of the legal process to date—that senior secured creditors could recover anything less than par value while junior creditors received significant recoveries—is unusual enough to lead me to believe the appeals process has potential. From a legal standpoint, it is quite a bit more difficult to handicap the odds of success on appeal, but noteholders remain highly motivated to pursue the case. There remains an outside chance at a full recovery including the make-whole payment, which could result in nearly 50% returns from current trading levels. More likely in my view is an upward adjustment to the coupon on the replacement notes. Even if the court upholds Judge Drain’s reliance on Chapter 13 precedent for his basic methodology, in my opinion the small incremental increase to the interest rate already made at the end of the confirmation process belies the objectivity of the process. The chosen 4.69% coupon is essentially arbitrary and clearly did not reflect the full market value of the notes.

I expect the appeal to survive a motion to dismiss on equitable mootness grounds, since it would be relatively straightforward to adjust the coupon. I expect the senior unsecured notes, which I am still short, to fail to clear that hurdle.

 

Exact Sciences (EXAS) and Cologuard reimbursement

Despite my public comment, CMS retained its original crosswalk to codes 81275, 81315, and 82274 in its 2015 payment determination for code G0464. The ultimate payment rate was the subject of some drama over the past few weeks, as the rates document was initially published on December 19 with a lower reimbursement level before being retracted. The reimbursement rate in the document was approximately 74% of the crosswalked values, an adjustment that normally only applies to tests prior to 2001. This was corrected, but several localities in the revised document have significantly lower payment rates than the National Limitation Amount (NLA), which is itself slightly lower than the sum of the three crosswalked codes. For example, reimbursement in Jurisdiction K, which contains populous states such as New York, is 45% lower than the NLA. Medicare reimbursement is based on the lower of the amount billed, the NLA, or the local payment amount. Some market commentators and even Exact’s own press release seem to imply that the NLA is the only reimbursement amount for all Medicare patients, which is not the case. It is a maximum.

Expect a further post discussing this in more detail. I am still looking into the reasons for the lower local reimbursement amounts, and Cable Car has a pending FOIA request for the other public comments on the CLFS in order to respond to potential justifications for a higher reimbursement level. I still intend to submit a reconsideration request, which could potentially impact the 2016 reimbursement level.

As a reminder, Cable Car is short EXAS primarily on the basis of lower-than-expected uptake. I believe setting a lower reimbursement rate is a public health imperative that could actually encourage wider screening.

 

Lemtrada approval and GCVRZ

Sure enough, not long after discussing why I was unwilling to bet on Lemtrada approval, GCVRZ had one big day after the drug was approved. It didn’t quite triple, and it now trades about 50% above the price the day before approval. I stand by the reasoning in the post and increasingly suspect I may have dodged a bullet. The price reflects considerable uncertainty over the timing and success of the US launch. My post did not address in detail the risk that Lemtrada has a slow launch in the US. However, there is a distinct chance that Lemtrada fails to achieve the $400 million first-year sales milestone even with contribution from the US. Due to the number of alternative MS treatments on the market, Lemtrada’s status as a last-line therapy emphasized on the label, and the time required for physician acceptance, US sales might not be sufficient for the milestone in the first year even if the drug is ultimately a blockbuster. In the absence of US data so far, the picture of the pace of sales from Europe does not look encouraging.

Although bound by the terms of the CVR not to deliberately interfere with sales, Sanofi’s incentives are at odds with CVR holders as well. The company could conceivably justify a slower launch, focusing on building physician relationships over meeting near-term sales goals in order to maximize the long-term value of the product. That they might avoid a ten-figure payment to CVR holders would be a nice bonus. If the $2 milestone appears more likely once sales data begin to come in, I would expect Sanofi to buy back CVRs or conduct another tender offer. Unless and until they do so with the benefit of internal sales data, I view the likelihood of GCVRZ paying more than zero to be low.


Thank you for following along last year. I look forward to many interesting investment opportunities and conversations with you in 2015.


Quick update on MOMENT 2

Disclosure: Short MOMENT 11.5% Senior Subordinated Notes (60877UAM9), Long MOMENT 10% 1.5 Lien Senior Secured Notes (60877UBA4).

Yesterday, Judge Drain ruled against the vote change motion. While that was obviously disappointing, the relatively muted market reaction since the ruling has validated the risk/reward tradeoff discussed in my original post (so far, at least). Last trade was 91.25 and the 1.5 Lien bonds are currently bid 92/94. At 92, yield to maturity is just under 7%, which I continue to view as attractive on a relative basis. Though a quick cash payout would have been nice, several causes of action remain, including appellate rights and potential recoveries from the Second Lien noteholders after plan confirmation. As a passive holder, I still like the tradeoffs here and look forward to the next step in the legal strategy.


This magic MOMENT: while the risk/reward is fine 3

Disclosure: Short MOMENT 11.5% Senior Subordinated Notes (60877UAM9), Long MOMENT 10% 1.5 Lien Senior Secured Notes (60877UBA4).

The 1.5 Lien Notes last traded at 93. If they prevail at a hearing on September 9, noteholders will receive 104.17 in cash. If not, replacement notes are still unlikely to be worth less than current trading levels.

If you’ve gotten past the pun in the title and are still with me, read on for what I think is a compelling and actionable near-term opportunity in the Momentive Performance Materials (MPM) bankruptcy cases. Spending some quality time with the MPM docket has been a bright spot in an otherwise challenging quarter for Cable Car. Barring a successful appeal by the Subordinated Notes trustee, which I think unlikely, I’ll have the chance to discuss the success of my short position in the Subordinated Notes in Cable Car’s next quarterly letter. I have been following the case closely in support of that position, and in the process decided to invest in the Senior Secured Notes following the sell-off from last week’s make-whole decision. The remainder of this post discusses the 1.5 Lien Notes. A similar opportunity with slightly less appealing pricing (but more liquidity and lien priority1) exists in the 8.875% First Lien Senior Secured Notes (55336TAC9).

Cable Car focuses primarily on equity securities, but I occasionally find value elsewhere in the capital structure. For a number of structural reasons, reorganizations often present interesting opportunities to invest in debt securities. Institutional ownership restrictions, the prevalence of relative value frameworks, and legal complexity can often lead to mispricing. Distressed debt often has a potential return profile similar to equity (both long or short), even when it is not being explicitly equitized.

As a non-lawyer (though I am the proud son of a mediator!) and passive investor, I have a deliberately limited approach to bankruptcy cases. Unlike many specialist distressed debt investors, I will generally only even consider participating after a plan of reorganization has been proposed, which after some analysis I believe is likely to be confirmed. I am content to let larger players do the heavy lifting of negotiating a prepack or a restructuring support agreement, for which they are often well compensated by the right to provide exit financing on preferential terms. Even after a plan has been put forward and controversies have been fully briefed, securities prices may not yet reflect the proposed distributions under the plan, or the reasonable range of outcomes in the legal process (subject to interpretation, of course). I’m a firm believer that potential outcomes can be bounded and questions of interpretations assessed, even by the non-specialist. There’s something very appealing about quantifiable outcomes for value investors with a probabilistic approach. With extensive public bankruptcy docket updates nearly in real time, reorganizations present a rather delightful reading comprehension exercise—at least if there’s something wrong with you and, like me, you kind of enjoy poring over a bond indenture. From experience, I can say it at least beats reading critical theory.

In any case, all that is a very long-winded way of saying that while I think I have a handle on this situation, I am not a distressed debt expert. So if you are, and you’re reading this, please don’t be shy about pointing out where my analysis may be flawed. Or just say hello!


MPM is a quartz and silicones producer that was purchased for $3.8 billion in a leveraged buyout by Apollo in 2006. The bankruptcy proceedings formally value the enterprise at just $2.2 billion today. For a detailed discussion of the Debtor’s business and the proposed plan of reorganization, see the plan disclosure statement. The details of the operating business are not important to rehash here, except to note that MPM will benefit from restructuring. Although hopelessly overleveraged at 16x last year’s (possibly cyclically depressed2) EBITDA, MPM is a leader in its business and generates enough earnings to comfortably support a more realistic capital structure. The proposed plan reduces net debt by about $3.2 billion, including a $600 million equity injection. If confirmed, MPM will emerge with about $1.2 billion of net debt against $300 million in EBITDA. Using management’s 2015 EBITDA forecast, the pro forma entity would have about 4.5x Total Debt/EBITDA and 3.8x EBITDA/Interest coverage. These metrics are roughly consistent with an issuer rated BB or B.

Elements of the plan have been contentious. The First Lien and 1.5 Lien trustee unsuccessfully argued that the notes were due a significant make-whole payment in addition to the par value of the notes and accrued post-petition interest. Votes for or against the plan were due prior to the adjudication of the make-whole dispute, and they offered Senior Secured noteholders something of a Hobson’s choice: either vote to reject the plan and accept replacement notes with or without the make-whole, or vote to accept the plan and receive payment in cash, but give up the right to pursue the make-whole adversarial proceeding. Unsurprisingly, both classes of Senior Secured voted to reject the plan. I will come back to that decision in a moment.

In principle, any replacement notes should have a net present value equal to the value of the Senior Secured claim. In practice that is not such an easy number to pin down. The court heard testimony, unfortunately filed under seal, from fixed income experts who opined on the proper choice of discount rate. Depending on the terms of the new notes, prevailing market conditions could result in replacement notes having a market value other than the value of their claims. Indeed, after Judge Drain issued a bench ruling denying the make-whole claim, disappointed Senior Secured noteholders drove the price down to its current low 90s context.

If the plan is confirmed as currently proposed, then we can calculate exactly what the 1.5 Lien holders will receive. Assuming for convenience a September 15, 2014 effective date, the notes are due 5 months of post-petition interest, or about 4.17 cents on the dollar, which would be capitalized. The notes trade flat, so paying 93 points for 104.17 in principal is equivalent to buying 100 face value of the new bonds for 89.28. The new bonds have a proposed maturity of March 15, 2022 (7.5 years) and a coupon of 275 basis points above comparable Treasuries. The nearest Treasury maturity currently has a yield of about 2.2%, so the new bonds would carry a coupon of approximately 4.95%.

By my math, that works out to a 6.8% yield to maturity. Even at the current ask of 96, the yield to maturity is 6.28%. While not very appealing in absolute terms—I wouldn’t be terribly excited to earn 6.8% in my portfolio for the next 7.5 years—it is an attractive yield on a relative basis. It is worth examining where similar securities currently trade. As everyone knows, “high” yield debt is not currently yielding very much right now.

The court’s choice of 4.95% is at least one view of the “right” yield for reorganized MPM notes. At the moment the market appears to disagree, but selling may have been exaggerated by disappointment over the make-whole ruling. Institutional buyers that are restricted from buying debt in bankruptcy may find the notes appealing after emergence.

While there isn’t a neat benchmark for 7.5-year senior secured industrial paper, there are a few comparisons that suggest the replacement notes should yield something less than 6.8%, and in any event not more. According to FactSet, as of September 4, a BAML index of B-rated industrials yields 4.935% with 5 years to maturity and 6.333% with 10 years to maturity. A 7.5-year MPM note could be reasonably interpolated somewhere in between. BB credits yield between 4.288-5.736%. Furthermore, the 1.5 Lien notes have the benefit of being partially collateralized by their junior security interest, while the index includes unsecured and subordinated debt. The notes would be the most senior part of the capital structure of reorganized MPM other than an undrawn ABL revolver. The nearest maturity, similarly structured bond I could find in a comparable industry is part of another Apollo LBO, Berry Plastics. BERRY 5.5% Second Lien Senior Secured Notes due May 15, 2022 (085790AX1) are B-/Caa1 rated and yielded 5.62% on their last trade.


I led with the relative value discussion because I think this is a situation with very limited downside risk. Because the coupon is based off a spread to Treasuries, there is no market interest rate risk until the plan is confirmed, after which of course a rise in market interest rates would be the most significant ongoing risk factor, barring an unexpected collapse of the entire restructuring process and forced liquidation. However, there are multiple ways in which an investment today could generate very attractive returns in a very short time frame:

  • Most straightforwardly, if 4.95% is the correct market rate of interest for the bonds, they should trade to par after emergence.
  • Alternatively, trading in line with the BERRY notes would result in a gain of about 7 points.
  • If plan confirmation is delayed for any reason, the notes continue to accrue post-petition interest at 10%, increasing the eventual recovery.
  • The Senior Secured trustee could appeal the make-whole decision and win (very unlikely).
  • Apollo could call the replacement notes for cash as a goodwill gesture or if financing on better terms becomes available.
  • The Senior Secured noteholders could prevail in their Rule 3018 motion to change their votes to accept the plan.

It is this last possibility that I think most interesting, and it is a key motivating factor for the investment. In conjunction with the plan confirmation hearing on September 9, a requisite majority of both classes of Senior Secured notes has petitioned to change their votes to accept the plan. The market is giving investors a free option on the success of the motion and setting up a compelling risk/reward tradeoff: if the motion succeeds, noteholders will be paid in full in cash, earning more than 11 points on their investment in 2 weeks. If the motion fails, investors are unlikely to lose much, if anything, if my reasoning above holds.

While, again, I am not a lawyer, I think there are reasons to believe the judge may be sympathetic to the motion. The legal standard for a 3018 motion is to show “cause,” which commentators have suggested is a lower standard than “good cause.” To change its vote, a party in theory needs to persuade a judge only that doing so would not result in a harmful outcome. I think it will be difficult for the Debtors to argue that in this case, confirmation of the plan as written is harmful to the Debtors. They are left with a public interest argument that allowing a change of votes would somehow constitute a “do over” that might unfairly prejudice future restructuring processes. Given the unappealing voting options available to the Senior Secured classes, I’m skeptical of that argument. Past cases have hinged on whether or not the goal of the party trying to change its vote was to unfairly benefit its own interests by blocking confirmation of the plan. Although the Senior Secured creditors opposed confirmation of the plan as written, they are not attempting to block plan confirmation through the change of votes. In this case, changing votes to accept the plan would result in the acceptance of the plan as it was first proposed.

Here I would like to take a moment to pick on a stranger on Twitter. I joined “Finance Twitter” only a couple months ago, but I already have found it indispensable in at least one regard. For bench rulings, and in particular the Momentive ruling, two excellent reporters provided breaking news on Twitter. Their quick takes actually preceded newswire headlines on the rulings, which was pretty cool.

Nevertheless, I think Maria has it wrong when she writes:

During the last confirmation hearing, Judge Robert Drain expressed frustration that the parties had not come to a negotiated settlement, stopping the proceedings several times to encourage Apollo and the Senior Secured holders to settle the make-whole dispute. Prior to ruling, Judge Drain was quoted by Bloomberg as saying: “This is a bunch of lawyers standing around avoiding an obvious solution [...] You know most people when offered payment in cash take it.” That is just what the Senior Secured noteholders are now trying to do. Judge Drain demonstrated a strong preference for a consensual solution to the restructuring process. Denying the Rule 3018 motion could motivate the Senior Secured noteholders to appeal, lengthening the restructuring process and adding costs to the Debtors.

I think there’s a good chance the motion is granted and noteholders recover in full in cash. I would welcome your thoughts.

 

1 If you’ve been following the case, you’ll understand why I specifically wrote lien priority, as opposed to seniority in right of payment!
2 A more nuanced view of the silicones cycle is necessary to evaluate the Second Lien notes, which will receive equity in the reorganized entity. Some commentators have suggested that the current level of earnings represents a cyclical trough and Apollo put together a sweetheart deal. That may be true: I have not done more than the superficial analysis needed to give myself comfort that the business is at least not falling off a cliff.