Friday Workout

Micro Bets Big, Macro Effects Small, but Yellen is Telling

By Chris Haffenden | Editor | chris@9fin.com

We’ve highlighted in previous Friday Workouts the contradiction between current economic uncertainties, and the unwavering confidence in and the pricing for perfection for risk assets. Emergent Macro risks such as the resurgence of inflation and significant supply chain issues are having little effect. This is despite split opinions on whether these are temporary or become permanent, a direct consequence of unprecedented fiscal measures and central banks actions. 

Janet Yellen is now telling that inflation will be above 3% for most of this year, before (hopefully) falling in 2022. She said it would be ‘healthy’ for interest rates to rise and normalise, “If we end up with a slightly higher interest rate environment it would actually be a plus from society’s point of view and the Fed’s point of view.” This has led some observers to read the Fed will soon taper its Treasuries purchases. So, why did 10-year Treasuries drop below 1.50% on Weds? Perversely, a higher print for US CPI yesterday saw yields fall 6bps bps to 1.44%. 

Fans of dead Austrian economists say that the huge increase in money supply would directly feed through into inflation and spiral out of control, whereas others believe it has been diverted into financial assets, and recent rises in inflation are related to temporary structural issues from reopening and will dissipate. But is this due to cost push (higher input costs) or demand pull (excess savings, pent-up demand).  Huge reverse Repos from the Fed this week ($503bn), undoing 4.2-months of QE, suggests banks are awash with liquidity. 

I agree with Bill Blain, that there is now a massive game of chicken within markets, with an explosion of speculative investment in zombie companies, SPACulative vehicles, meme stocks and cryptocurrencies. 

“Fiscal carpet bombing has worked saving the economy, but debt has ballooned. But what do we hear from the Right? That all that debt is crushing confidence in fiat money, that state handouts are causing lazy workers to withdraw their labour, and the devaluation of currencies will cause the collapse of the west. It’s become the clarion call of Libertarian Cryptocurrency supporters – who perceive that their mythical digital asset’s being free of government control is its major advantage…”

It was certainly a turbulent week for Bitcoin and its peers. An initial sharp sell-off on concerns on further Chinese crackdowns, and the recovery of the $2.3m Colonial Pipeline cyberattack ransom (wasn’t Bitcoin meant to be secure and untraceable?) saw prices collapse on Mon/Tues. It was reversed by El Salvador adopting it as legal tender, and the Basel Committee on Banking Supervision issuing capital rules for banks holding cryptocurrencies, which HODLrs took as a sign the asset class is entering the mainstream – without any apparent irony.   

So, what does this all have to do with LevFin and HY? 

Over the past couple of weeks (apologies for last week’s Friday Workout absence, the author was struggling with effects of the second AZ jab) we have seen meme stocks, SPACs and now Bitcoin, spilling over into HY. 

Micro Bets Big

The Basle Committee has decided this week that cryptocurrencies should have the same risk weighting for banks as the riskiest High Yield bonds. 

Stablecoins such as Tether would only qualify is they were fully reserved at all times, with banks having to monitor this was “effective at all times.” This is a blow to Tether, whose one pager is unlikely to suffice, its purported $30bn holdings makes it the 7th largest Commercial Paper investor globally, seemingly without most participants noticing their presence.  

What happens if a HY issuer is mostly holding Bitcoin, what risk weight should be attached for underwriters?  Is this the nearest thing we could get to a HY-squared?

We now have a practical example to ponder. Microstrategy was one of the strongest performing stocks of the past year, with Michael Saylor, its CEO and founder one of the biggest cheerleaders of Bitcoin. The business intelligence software firm owns $3bn of the cryptocurrency. After raising over $1bn via two convertible bond issues in December and February to buy Bitcoin, on Monday it turned to the HY market for more of the same. 

The Feb converts have a zero coupon, with a 50% premium conversion strike price at $1,432 per share. As you can see below. their embedded equity option is well out of the money. 

Owen Sanderson, who we are delighted to reveal  is joining 9fin at the end of the summer, points out while a convertible makes some sense – Issuing a bond to buy bitcoin? C’mon!

The timing of the deal was interesting. Microstrategy released its 8K this week to take a $284.5m impairment in its second quarter numbers, losing 78% of total stockholder’s equity. Its average purchase price is 24.2k. It writes down asset values to the lowest level that Bitcoin trades in any quarter – held in its Macrostrategy subsidiary, outside the restricted group. (The holdings are considered indefinite-lived intangible assets, leading to regular impairment charges if they decrease below book value.)

The new Bitcoin purchases, however, will sit in the restricted group. Amazingly, given the volatility of the underlying collateral and the poor performance of the underlying business Moody’s still gave it a Ba3 rating. But it only got a B- from S&P Global which doesn’t count the crypto assets as liquidity, given “it’s significant volatility and regulatory risk.” 

The 7NC3 bond priced at 6.125% being upsized to $500m from $400m. Unusually it has a make whole call @50 – it can redeem the bond early (at any time) before the first call, by paying back the NPV of remaining cash flows discounted by the benchmark + 50bps. According to Efficient Market Hype as long as bitcoin is 21.5% higher by the first call date, they would have broken even (ignoring discounting).  

We suspect that many of the new bonds are in the hands of Bro’s, as the minimum denominations were an unusually small 2k apiece. Shockingly, it looks like the Fed now has some crypto exposure too:

In any event, the earnings calls will be interesting, if this performance at last weekend’s Miami crypto bash is anything to go by!  

Price to Meme ratio

AMC management have played a blinder in recent weeks, taking full advantage of their Meme stock status to raise over $800m in funds, by channelling their inner Steve Wynn: 

He famously responded to an analyst question as to why Wynn issued equity at $154 at the end of September 2008 and then paid a dividend of $6/share on December 10th. (Wynn shares had traded in the $80s in June and at $120 on the day of the call).

“It is the job of the board of directors and especially of the CEO to take advantage of the market when that market movement is extreme. When a company increases its value by 100% in 60 days, that’s an unnatural movement of value and the market also goes the other way sometimes. These unnatural movements in value, no company gets to be worth twice as much in 60 days as it was before to any intelligent person, so when that happens, we take advantage of it. If everybody is so hungry for shares, we let them have some. If the shares go down, we buy them. And that, that is a statement of policy in this company, period.”

One quarter later he was true to his work at repurchased 2.4m shares. 

“Look, we issued 4.4 million shares for 660 million and promptly distributed it, which was really nice for us shareholders. And a return of capital. We have now bought back at 50 or $60 a share [cheaper] those shares that we issued.”

Despite Mudrick making a quick $41m from its $230.5m AMC stock purchase in a same day trade at printed at $27.12 per share, and then stating they were out, with the shares fundamentally overvalued, the Meme traders were having none of it. They rallied themselves to buy on Reddit, with the results that the shares surged to $72.62 that Wednesday (it has an average analyst price target of $5.11!). 

The next day management announced an ATM equity raise, pocketing another $587.4m at $50.85 per share. It’s 10.5% Senior Notes due 2025 yield 7.8%, the stock if you were wondering is at $43.90, on Thursday close. Yesterday, S&P improved its rating by two-notches to CCC+saying that if it uses the funds to reduce debt and refinance expensive debt raised during the pandemic, it will materially reduce its interest burden, cash burn and leverage. 

Take your PIK for Refi

Speaking to restructuring advisors in recent days, it’s clear that most stressed mid-to-large companies have already accessed the HY market to refinance. This leaves some more difficult names left to clear, such as Lowen Play, 4Finance, McLaren, Matalan and Haya Real Estate. 

We think that some will try to follow Douglas and include HoldCo PIK as part of the solution. 

My former colleagues at Debtwire reported last week that McLaren is looking to use proceeds of a HoldCo PIK to push equity into the OpCo as part of a wider refinancing. Using LTM March 21 EBITDA of £92m, the supercar maker only has capacity to issue around £450m of new debt if it wants to get OpCo leverage down to 4.5x. This means a huge c.£300m PIK issue. Timing is soon, a £150m one-year HoldCo loan to National Bank of Bahrain looms (signed 29 June 20). 

Earlier this year, our deep dive on Lowen Play highlighted the potential difficulties facing the German gaming company, citing regulatory uncertainty, and elevated refinancing risk, especially if further lockdowns delayed reopening. Last Friday, Moody’s downgraded Lowen Play to triple-hook saying it “reflects the increasing refinancing risk with debt maturing in August 2022, the uncertainty of future EBITDA levels under the new regulatory regime and the deterioration of liquidity in the last twelve months as a result of longer-than-expected restrictions due to the coronavirus.” 

Reorg Research reported this week that bondholders are talking to a number of advisors, in the event that Rothschild - hired by the company in a debt advisory role - cannot get a deal away. In conversations with advisors tracking the name, most believe that a refinancing is possible, But Lowen Play needs more certainty on reopening and regulatory impacts first. Sponsor Ardian may need to write a small cheque to smooth the deal, but many we spoke to were unconvinced that they would do so.  

4Finance management in their latest earnings call spoke about their plans to refinance the rump of its May 2022 dollar bonds, by issuing new Euro-denominated bonds, potentially in conjunction with an exchange for its existing 11.5% February 2022 euro-notes. 

CEO, Kieran Donnelly said “I would just add in whatever technical form, the idea would be to refinance in a way that would, of course, extend, right, so not necessarily extend that existing bond, but to – perhaps to exchange it– to do a new transaction which existing holders would have the opportunity to exchange into, or just because the bond is callable as your question earlier at par. So, we have a number of options.” 

Their presentation to BCP Securities Investor conference outlines the challenges:

In brief

Fire and Ice - Frigoglass has lost a significant amount of its capacity to produce commercial coolers, following a fire at its manufacturing plant in Timisoara, Romania last Saturday (June 5). According to Moody’s the plant represented a “significant portion of the company's total commercial coolers production capacity and, thus, had a material impact on the overall performance of the Ice Cold Merchandise (ICM) segment, which generated around 50% of the company's reported EBITDA in 2020. It may take several quarters to restart production in Romania,” noted the agency who put its B3 ratings on watch for downgrade. The 6.875% SSNs due 2025 bonds fell two points this week to 91.5.

DTEK Energy’s Scheme of arrangement was sanctioned earlier this week. Gazprombank had challenged the Scheme on the grounds that it had arbitration awards and freezing orders and therefore should be treated differently to other bank creditors. Their lawyers added there are doubts of recognition in the EU and in Singapore for the Scheme, therefore its sanction would be an act in vain. But the judge, Sir Alistair Norris disagreed, adding that there was no blot on the Scheme, his full ruling is available here

Following reports in the Spanish media, NH Hotels confirmed it was in advanced negotiations to sell the Barcelona Gran Hotel Calderón, “for an approximate amount of around 125 million euros and under a sale and leaseback structure, so that NH will maintain the hotel operation on a long-term lease basis…” 

Management told investors on their Q4 earnings call of their plans to raise €200m from sale-and-leasebacks to pay down debt. A €896m 2023 maturity wall has been built-up thanks to pandemic-induced government-backed loans and an RCF extension, in addition to the existing SSNs. 

Another week and another Amigo Loans holding announcement. 

The guarantor lender saw its Scheme rejected a fortnight ago. It said “without an appropriate scheme of arrangement to deal with the complaints, the value of Amigo's assets are less than the amount of its liabilities, resulting in an insolvent balance sheet. Amigo continues to engage with the Financial Conduct Authority ('FCA'), to identify an appropriate way forward. This could result in a revised scheme of arrangement or insolvency.” Our money is firmly on the former.

Intralot has airbrushed any mention of its planned restructuring from its first quarter release.

Which is odd, as management seemed bullish on their FY20 conference call on 10 May. 

“There is a lot of work going on in the background, including documentation, which Intralot is seeking to deliver in the most efficient way. “We have the tools available and a path to deliver.” When asked about engagement with an ad hoc group of 2024 holders, management said there have been a lot of discussions between all groups and we are committed to a deal for all stakeholders. This is a very complex deal, we are looking for the best common denominator, they added, declining to comment on the timeline. 

What we are reading this week

News on supply chain issues is arguably getting worse.

Manufacturers are now saying that chip shortages will last until mid-2022. Many are blaming the shortage on bitcoin miners, which is pitting miners against gamers. Three weeks ago, Nvidia intervened to stop its graphics cards being used for mining

Finally, a potential useful application for blockchain – in Hong Kong censorship avoidance 

As the Delta variant raises concerns about reopening in the UK, its toll in India may have been severely underestimated – journalists there are pulling together the numbers. An outbreak in China could disrupt its ports and have a greater effect on global supply chains than Ever Given, notes ShippingWatch. 

As the SPACtacular returns fail to materialise, the New Yorker has a long-read on Chamath Palihapitiya – the Pied Piper of SPACs

His most famous SPAC investment is Virgin Galactic, which unveiled its second piloted space plane – the VSS imagine – but the business which has burned through over $1bn and failed to meet several deadlines, is still light years away from commercial flights. In the meantime Virgin Galactic faces a class action over false and misleading statements according to the claim

I personally don’t see the attraction of paying $250k to spend a few minutes on the edge of space to see the curvature of the earth, with fleeting weightlessness. But, meanwhile, Jeff Bezos is likely to beat Richard Branson into space, booking a Blue Origin flight – albeit for just three minutes – on July 20. 

Some motivational words:

Our CTO prefers Live, Laugh, Leverage.

We will leave you with Steve Wynn’s thoughts on EBITDA:

“We report and talk about these EBITDA numbers with our chest puffed out as far as we can get it as an industry. I suppose it tells you how much money you can afford to pay in interest. But the public needs to understand that the profitability, the real profitability of these businesses are much, much less than these puffy EBITDA numbers. Interest expense is very large. And depreciation, I know office building guys and shopping center guys and apartment guys, they get to spend part of the depreciation. But, believe me, in my 40-year history and in the history of every other gaming company here, Kerkorian would agree with me. We spend depreciation. It is a real expense.” 

TLDR: Why value a capital-intensive business on metrics that exclude any measurement of capital intensity?