Frontier Communications Inc. Distressed Debt

Frontier Communications is a broadband internet, cable, and telephone company, formerly known as Citizens Utilities Company until May 2000 and Citizens Communications Company until July 31, 2008. (Interestingly, Citizens Utilities Company of Minneapolis was formed from remnants of Public Utilities Consolidated Corporation created by Wilbur B. Foshay.) Citizens Communications acquired the Frontier name and local exchange properties from Global Crossing in 2001. In May 2008, they changed the holding company name to Frontier Communications Corporation.

They provide service in 29 states to 4.2 million customers and 3.6 million broadband subscribers at an average monthly revenue per customer of $88.45. Their customer count was down 8% from third quarter 2018 to third quarter 2019, which is brutal in a high fixed cost business, although revenue per customer was up 4% year over year. The result was that revenue was down 6%.

Is this kind of like the tobacco business, with falling customer counts but rising prices? Cable companies ought to have some properties of good businesses: lack of competition and stickiness. How many choices do customers have, and how often do people switch their phone, cable, or internet providers, even when they have a choice?

The fixed cost structure is bad when customers are leaving. That's not a problem that the tobacco companies have. However, Frontier was able to cut some costs. Network access costs declined 13% year-over-year in the third quarter. And their own "network related expenses" were down 3%. The third category of recurring cash expenses, SG&A, was flat. The result was that EBITDA for Q3 was $781 million, versus $852 million the prior year - down 8.3%. That is more than the revenue decline - thanks to operating leverage. The current EBITDA figure would be $3.1 billion annualized. At the current run rate, this year's capex will be $1.2 billion, for a projected FCF of $1.9 billion before allowing for further customer declines.

We have previously mentioned that Frontier's debt is distressed, and that hedge funds are prodding the company to file for bankruptcy. You can readily see the unsupportable leverage of Frontier by the market value of its equity (only $68 million) compared to its total liabilities ($21.7 billion in Q3 2019), or by the trading prices of its unsecured debt. The capital structure consists mainly of $10.9 billion of unsecured holding company debt (which is the fulcrum). Senior to that is $5.7 billion of secured debt, which consists of $2.45 billion of bank debt and then $1.65 billion of first lien secured notes (8% due April 2027) and $1.6 billion of second lien secured notes (8.5% due April 2026).

The total debt load is $17.5 billion. There is also $2.1 billion of pension, post retirement benefits, and other liabilities; and $1.7 billion of non-debt current liabilities, against $1.6 billion of current assets (excluding assets held for sale).

One thing you will notice is that the unsecured holding company debt maturing between 2021 and 2046 is trading solidly in the 46 range, with the exception of a couple tiny pieces and more notably with the exception of the two pieces that mature in April and September of 2020. It is a distress indicator when you have debt of higher and lower coupons all trading at the same price, based on an assumption of what the recovery will be. Even the fat 10.5% coupon on the September 2022 debt is not enough to budge the price from the same level that a January 2025 6.88% bond is trading at. Another good distress indicator is the fact that the $10.9 billion principal amount of unsecured debt trades at a market value of $5.1 billion - a $5.8 billion "hole" in the capital structure. The higher price for the 2020 debt suggests a small chance that the company will limp along for another year.

As Moody's commented on November 12:

Frontier's credit profile is supported by the company's large scale of operations, its predictable cash flow and extensive network assets. The rating is also supported by the company's improved ability to generate cash following the elimination of its common dividend in early 2018. Moody's expects Frontier to have adequate liquidity to retire the remainder of its outstanding unsecured debt maturing prior to 2022. Frontier has been meaningfully reducing its refinancing risk hurdles in the near term, including through a March 2019 refinancing of short-dated first lien term debt with a first lien bond offering. Though Frontier expects gross proceeds of $1.352 billion from the sale of western state operations in first half 2020 (subject to closing adjustments), the use of such proceeds remains undisclosed but will likely facilitate capital structure enhancement efforts.

They just sold their "Northwest Operations" (Washington, Oregon, Idaho, and Montana) for $1.35 billion, which represented 7% of revenues, but chose not to disclose what proportion of operating profit these operations represent. Considering that this would value the entire enterprise at $19 billion, it is likely that this company followed typical "circling the drain" behavior and sold one of its better divisions in order to buy time. It's always easier to sell a better division. 

It may be possible to use some of those $1.35 billion proceeds to pay the 2020 debt maturities and interest payments, which include something like $333 million on March 15 and $381 million on April 15). On the other hand, there are leverage covenants in their secured debt that apparently step down from 1.5x EBITDA to 1.35x EBITDA in Q2 2020. They have $4.1 billion of first lien secured debt, so the 1.35x limit would be iffy given the recent $3.1 billion of annualized EBITDA. So if the company decides not to restructure, it may need to take a good chunk of the proceeds to pay down first lien debt with covenants before it could use any to buy back unsecured debt at a discount.

So we can guess that this company will restructure in 2021 if not next year, and we know that the unsecured is the fulcrum security. The question is: what should the unsecured debt be trading for. In order to estimate that, we need to think about the value of the enterprise and the liabilities that are ahead of the unsecured debt. Frontier itself attempts to assess its enterprise value, as disclosed in its filings:

We use a market multiples approach to determine Frontier’s enterprise fair value for purposes of assessing goodwill for impairment. Marketplace comparisons, analyst reports and trends for other public companies within the telecommunications industry whose service offerings are comparable to ours have a range of fair value multiples between 4.1x and 7.6x of annualized expected EBITDA as adjusted for certain items.  At September 30, 2019, we estimated the enterprise fair value using an EBITDA multiple of 4.4x.

Using a 4.4x multiple on $3 billion of EBITDA would imply that the enterprise is worth $13.2 billion. Enough to cover all of the secured liabilities and structurally senior subsidiary debt of $6.6 billion, but not enough to cover the unsecured debt and other unsecured liabilities, which appear to total $13 billion. This would leave unsecured creditors with ~50 cents on the dollar, just north of where the bonds are trading right now. When was the last time we even saw a pre-bankrupt company with  unsecured debt that stood to recover something?

Of course, we should not take the company's EBITDA projection or multiple at their word. Here are some competitors in the space (CenturyLink, Cincinnati Bell, and Consolidated Communications Holdings) and their enterprise value multiples.

	Market Cap	EV	EBITDA (ttm)	EV/EBITDA
CTL	15,590	51,290	9,180	5.6
CBB	325	2,580	392	6.6
CNSL	263	2,630	462	5.7
FTR*		13,000	3,100	4.2

The FTR is for the enterprise value of the debt only, at approximate market values of the debt. Notice that CBB and CNSL have very small market capitalizations in relation to their enterprise values. As one analyst we read pointed out, "at some point, all industry players will not be able to service their unsecured debt and will need to restructure". That analyst also pointed out that the CBB and CNSL stocks are probably inappropriately valued:

Unsecured debt of CBB and CTL is being created at substantially higher multiples, compared to those of CNSL and FTR. The same pertains to the market creation of unsecured debt plus equity. Why? Just because these companies are paying dividends.

So here is how the FTR unsecured recovery would look for the following pairs of EBITDA and EBITDA multiples, and assuming that $6.571 billion of liabilities would be in front of them and they would share with $13 billion of total unsecured liabilities:

	4.25	4.5	4.75	5	5.5
2,400	28%	33%	37%	42%	51%
2,600	34%	39%	44%	49%	59%
2,800	41%	46%	52%	57%	68%
3,000	48%	53%	59%	65%	76%
3,200	54%	60%	66%	73%	85%

The big questions are: what is the EBITDA that this business will earn going forward, and what multiple would the enterprise be worth. On the EBITDA question, it is alarming how rapidly the company's business is shrinking. They went from 4.85 million customers at the end of 2017 to 4.2 million now, a 13% drop in under two years. With that level of customer exodus, the chart of historical EBITDA by quarter is not too pretty. 

The analyses that I have seen are pretty complacent about EBITDA. They take a >$3 billion level as a given and then assume that since CBB and CNSL's debt (which both trade close to par) create those enterprises at >5x EBITDA, FTR will do the same. The problem is that if the ice cube continues to melt, not only will EBITDA be lower, but it will probably be worth a lower multiple. In the 2x2 matrix of unsecured recoveries above, there's really only a line of realistic outcomes: low EBITDA, low multiple; or high EBITDA, high multiple.

Unless you can have reason to believe that the decline in customer losses is about to stop, there does not seem to be a margin of safety in the unsecured debt. If 13% of customers (net - more after figuring churn) left over the past two years, they probably went somewhere, since they are not likely just canceling their internet entirely. There must be competitors in Frontier's markets that are better or cheaper and are eating their lunch. For all we know, the most alert or savvy customers are the ones who just left and it is the beginning of an S-curve of the slower to react customers leaving too.

Distressed Debt Watch - November 2019

Previously in September.

• Approach Resources (AREX, EDGAR) bond due June 2021 traded at 30 cents for a yield to maturity of over 100%. They are still in forbearance with the lenders. The stock is down to 10 cents - a market capitalization of $10 million.
• Frontier Communications (FTR, EDGAR) bond due April 2020 is trading at 63 cents, a yield to maturity of almost 150%. At a $1 share price, the market capitalization is a bit over $100 million. The September 2020 bond is trading at 50 cents, a yield to maturity of over 100%. The January 2021 $1 put is offered at 60 cents and the $2 put is offered at $1.55. The Q3 results are supposed to be released after the close on November 5th. The big debt maturity ($2.2 billion) isn't for three years but some creditors are trying to get them to restructure early.
• J.C. Penney (JCP, EDGAR) bond due November 2023 trading at 58 cents, yielding 24%.
• Denbury Resources Inc. (DNR, EDGAR) bond due July 2023 trading at 43 cents, yielding 33%.
• California Resources Corp (CRC, EDGAR) bond due January 2020 is trading at 89 which is a ytm of 70%. The 2021 bond is trading at 36 cents which is a yield of 73%. The 2024 bond is trading at 29 cents. The market capitalization at a $9.61 share price is $471 million. Most recent quarter (Q3) their operating income was $148 million vs interest expense of $95 million. So far this year their capital expenditures are running ahead of depreciation, depletion, and amortization by $36 million. Long term debt and other LT liabilities of $5.6 billion is 9.4x the mrq's annualized operating income. There are only $100 million of the January 2020 notes and $100 million of the September 2021 notes. The biggest chunk of the capital structure is $1.84 billion of 8% notes due in December 2022. These are trading in the 40 cent range. (In Q3 they repurchased $153 million face value of the 2L notes for $90 million in cash.) The Second Lien Notes require principal repayments of $290 million in June 2021, $58 million in December 2021, $61 million in June 2022 and $1,429 million in December 2022. So, there is not much debt maturing prior to the second half of 2021. The Jan 2021 $10 put has increased to ~$5.30. The Jan 2022 $5 put is $2.60.

Distressed Debt Watch - September 2019

See previously: the August Distressed Debt Watch.

• Approach Resources (AREX, EDGAR) bond due June 2021 trading in the 20 cent range (small pieces), ytm's of  over 100%. Market capitalization at 18 cent share price of $17 million. Net debt of $400 million on about $2 million of EBITDA the most recent quarter. They keep rolling their forbearance agreement with their lenders, one week at a time, negotiating a restructuring. The January 2020 $1 put options are usually 80 cent bid and 85 cent offered.
• Frontier Communications (FTR, EDGAR) bond due April 2020 trading at 63 cents, ytm of over 100%. Market capitalization at $0.81 share price of $87 million. Net debt of $17 billion on $1.5 billion of operating income. There are restructuring talks, with some creditors favoring a Chapter 11 (in-court) restructuring. Shareholder equity is $1.5 billion, but that includes $6.4 billion of goodwill and $1.4 billion of other intangibles. The January 2021 $2 put options are $1.35 bid and $1.55 offered. On the second quarter earnings conference call (where they didn't take questions), the CFO closed by saying, "I want to touch briefly on our capital structure. The Finance Committee of the Board of Directors is evaluating Frontier's capital structure. This includes considering, evaluating and negotiating capital markets and/or financing transactions and/or strategic alternatives. Frontier remains committed to reducing debt and improving its leverage profile." There is also a September 2020 8.875% bond trading at 55 cents, a ytm of 80%. Moody's downgraded in mid-August: "Frontier's decision to write down $5.45 billion of goodwill in the quarter reflected, in part, concerns regarding the long term sustainability of the company's capital structure and reduced expectations for the overall wireline industry. The company's potential to improve weak fundamentals in advance of sizable debt maturities beginning in 2022 remains difficult given a shortening runway to stabilize business trends. The potential for distressed debt exchanges in the next year or so is further elevated based on these operating results and other developments, including recent appointments of new Board members with restructuring and bankruptcy experience. Moody's continues to anticipate a heightened focus on potential capital structure optimization efforts given the mixed evidence of sustained progress from ongoing operational improvement initiatives." They just sold their "Northwest Operations" (Washington, Oregon, Idaho, and Montana) for $1.35 billion, which represented 7% of revenues, but chose not to disclose what proportion of operating profit these operations represent. Often when a distressed company is  selling assets, it is an adverse selection process where the best stuff can find a buyer (like real estate at a failing retailer) and what remains with the company becomes more and more concentrated sludge.
• J.C. Penney (JCP, EDGAR) bond due November 2023 still in the 40 cent range, ytm of over 30%. Market capitalization at 77 cent share price is $241 million. From the second quarter results: "For the quarter ended Aug. 3, 2019, total net sales decreased 9.2 % to $2.51 billion compared to $2.76 billion for the quarter ended Aug. 4, 2018. Comparable sales decreased 9.0 % for the quarter." Book value has declined to $963 million, but I would subtract $657 million of "other assets" like capitalized software and intangibles, and further the $392 million of capital expenditures in 2018 for things like "investments in our store environment and store facility improvement," leaving an adjusted equity value that may be negative. The capital structure subject came up on the quarterly call: "First, our capital structure. Since my arrival to JCPenney, we have been very focused on reviewing the overall dynamics of our capital structure. We have outlined key tenets that we will abide by when evaluating our capital structure. First, we will continue to maintain more-than-adequate liquidity to fund the operations of our business. Second, we will proactively manage our existing outstanding debt maturities. And third, we will maintain flexibility in how we fund the business and options we have to ensure sustainable and profitable growth. With that, we are taking positive and proactive measures to improve our capital structure and the long-term health of our balance sheet." The January 2021 $1 put options are about 52 cent bid and 63 cent offered. 
• Denbury Resources Inc. (DNR, EDGAR) bond due July 2023 trading at 35 for a 38% ytm. Market capitalization at $1.13 share price of $516 million. For the first half of 2019, they had $213 million of cash from operations less $158 million of capital expenditures, for a net of $55 million of free cash flow, which would be $110 million annualized. Against that, they currently have $2.5 billion of debt outstanding. The January 2021 $1 put options are 45 cents. 
• California Resources Corporation (CRC, EDGAR) bond due Setember 2021 is trading at 58 for a 37% ytm. Market capitalization at $10 share price of $489 million. Total net debt outstanding at the end of the second quarter was $5.1 billion. For the first half of 2019, their operating income was $179 million. The DDAX was $239 million but capital expenditure was $170 million. This suggests that "cash flow" is something like ~$500 million annually, which is small compared to the $5.1 billion of debt. Interest expense is like $400 million annualized now. The January 2021 $10 put is ~$4.50.
• Mallinckrodt plc (MNK, EDGAR) bond due April 2023 trading at 25 cents, ytm of 56%. "The company has been implicated as a major contributor to the prescription opioid scandal around the over-prescription of oxycodone in the United States." The January 2021 $3 put is $2.15 (with the stock at $1.87). Moody's just downgraded: "Mallinckrodt's liquidity will be weak over the next 12 months as it faces a large upcoming notes maturity of $700 million in April 2020. It also reflects Mallinckrodt's full draw on its $900 million revolver, using up all of its committed external liquidity. Mallinckrodt's liquidity benefits from substantial cash (exceeding $550 million at the beginning of September 2019, inclusive of proceeds from its full revolver draw) as well as good free cash flow. Moody's believes that Mallinckrodt would likely be able to meet the April 2020 maturity with available cash and cash flow. However, given the sizeable debt maturity, there is minimal cushion to absorb any litigation or other required payments. For example, there is risk that Mallinckrodt would have to make up to $600 million in retroactive payments to Medicaid related to Acthar. Even without this payment, Mallinckrodt faces considerable uncertainty around the timing and amount of possible opioid related cash outflows. In Moody's view, risks stemming from Mallinckrodt's exposure to opioid litigation are high, in both its branded and generics businesses, potentially posing a challenge to capital market access."

I would guess that common stocks of companies that mention "capital structure" on their conference calls underperform. I am pretty sure that common stocks of companies with debt yielding more than 30% underperform.

Distressed Debt Watch - August 2019

• Approach Resources (AREX, EDGAR) bond due June 2021 traded at 10 cents, ytm of 200%. Market capitalization at 27 cent share price of $25 million. Net debt of $400 million on about $2 million of EBITDA the most recent quarter. They are currently in a forbearance agreement with lenders (that's been extended a couple of times), negotiating a restructuring. The January 2020 $1 put options are 80 cents.
• Frontier Communications (FTR, EDGAR) bond due April 2020 trading at 78 cents, ytm of 50%. Market capitalization at $1.32 share price of $139 million. Net debt of $17 billion on $1.5 billion of operating income. There are restructuring talks, with some creditors favoring a chapter 11. Shareholder equity is $1.5 billion, but that includes $6.4 billion of goodwill and $1.4 billion of other intangibles. The January 2021 $2 put options are about $1.20.
• J.C. Penney (JCP, EDGAR) bond due November 2023 trading at 40 cents, ytm of 35%. Market capitalization at 75 cent share price is $238 million. Net debt of $5 billion on $68 million of EBIT last fiscal year. (And EBIT for mrq was negative $93 million.) Book value is $1 billion, but I would subtract $664 million of "other assets" like capitalized software and intangibles, and further the $392 million of capital expenditures in 2018 for things like "investments in our store environment and store facility improvement," leaving an adjusted equity value that may be negative. There is a $50 million debt maturity in 2019 and $110 million in 2020. The January 2021 $1 put options are about 50 cents.
• Denbury Resources Inc. (DNR, EDGAR) bond due July 2023 trading at 40 for a 33% ytm. Market capitalization at $1 share price of $475 million. Net debt of $2.8 billion on $569 million of operating income. The January 2021 $1 put options are 45 cents.
• GNC Holdings (GNC, EDGAR) bond due August 2020 trading at 90 for a 12% ytm.

Eddie Makes a Sears Restructuring Proposal $SHLD

Eddie put out a presentation today called "Transforming Sears Holdings - A Proposal from ESL Investments, Inc." as a 13D exhibit. Some highlights:

• Sears must act immediately to have sufficient runway to continue its transformation. To obtain this runway, Sears must extend near-term debt maturities, reduce its long term debt and eliminate the associated cash interest obligations.
• We continue to believe that it is in the best interest of all stakeholders to accomplish this as a going concern, rather than alternatives that would substantially reduce, if not completely eliminate, value for stakeholders.
• Sears now faces significant near-term liquidity constraints, including a $134mm maturity for Second Lien Notes due October 15, 2018.

The proposal to the second lien loan and noteholders is to choose between options A and B. The first option gives them new mandatorily convertible, zero coupon debt that would mature December 2021 instead of July 2020 for the 2nd lien loan and October 2019 for the 2nd lien notes. It would be convertible at the higher of $1 per share or the 20 day VWAP. The second option only applies to the 2nd lien notes, giving them the option to re-strike the conversion price to be equal to option A plus $1.25. Under option B, they get PIK interest at their existing rate. The maturity is pushed out until December 2022.

The unsecured debt holders also get two different options. (Actually, there are only two options for the holders of the cash unsecured notes, who did not accept Eddie's earlier exchange into PIK notes.) Option A is to exchange into mandatorily convertible, zero-coupon unsecured debt. The strike price would be $1 above the secured debt conversion price, and the conversion would take effect in December 2021, same as for the 2nd lien debt. Option B is that they can get taken out for 25 cents on the dollar.

So that is funny - zero coupon debt that is mandatorily convertible into equity is not really debt, it is just equity with a three year waiting period. There would never be any interest payments or cash flows for any secured or unsecured debtholders who exchanged into this. 

Eddie also proposes a "Real Estate Transaction". This is an odd one where a "Consortium" including ESL would refinance the debt encumbered real estate portfolio that Sears is currently marketing for sale. The members of the consortium would convert their loans to a PIK at an interest rate of 12.1%.

Overall, debt would be reduced from the current $5.6 billion to $1.2 billion (excluding the mandatorily convertible, zero-coupon debt). The result, if it takes place, is huge dilution of the current equity by the current 2nd lien debt and unsecured notes.

In the most recent quarterly report, there was a section called "Actions to Address Liquidity Needs".

The following actions, which are intended to fund liquidity needs over the next twelve months, are in various stages of completion as of the date of this filing. We believe these actions, some of which we expect, subject to our governance processes, including the process being overseen by the Special Committee, to include related party participation and funding and, in the case of Sale Assets that are sold to ESL, subject to approval by a majority of the disinterested stockholders of Holdings, if completed, would be sufficient to satisfy our liquidity needs for the next twelve months from the issuance of the financial statements.

[List:] Sales of properties securing the remaining principal amount of the Secured Loans to fund the repayment of such Secured Loans; Additional borrowings under the Mezzanine Loan Agreement, Term Loan Facility and the Consolidated Secured Loan Facility; Monetization of the Sale Assets; Extension of maturities beyond September 2019 of Line of Credit Loans under the Second Lien Credit Agreement; Additional borrowings secured by real estate assets, borrowings under the short-term basket, or other borrowings; Amendments to the terms of certain of our financing arrangements, including to allow interest on some of our debt to paid-in-kind; Further evaluation and right-sizing of our store base, including evaluation of our business categories; and Further restructurings to help manage expenses and improve profitability, including additional store closures and the accomplishments of our planned cost savings initiatives.

While we believe that completion of these actions would be sufficient to satisfy our liquidity needs for the next twelve months from the issuance of the financial statements, these actions have not been fully executed as of the date of this report and certain of the actions have not received necessary approvals (including but not limited to approval of the Special Committee and approval of a majority of the disinterested stockholders of the Company in the case of certain proposed transactions with ESL), and/or are at too early of a stage in the process to be considered probable of occurring under applicable accounting guidance as of the date of this report. Accordingly, because we cannot at this time conclude that these actions are probable of occurring under such accounting standards, substantial doubt is deemed to exist about our ability to continue as a going concern. The Company continues to move forward with these proposed actions, including the process being overseen by the Special Committee, and discussions with lenders, in order to complete these actions. The Company believes that completion of these actions, or in some cases substantial progress towards such completion, would alleviate or eliminate the substantial doubt. The Company will continue to reevaluate this assessment.

The PPPFA contains certain limitations on our ability to sell assets, including the Kenmore brand and related assets, which could impact our ability to complete asset sale transactions or our ability to use proceeds from those transactions to fund our operations. Therefore, the analysis of liquidity needs includes consideration of the applicable restrictions under the PPPFA and the ability to utilize related party borrowings to provide liquidity when there are short-term delays in the closing of transactions.

The success of the foregoing actions is subject to various risks, uncertainties and other factors, including market conditions, interest in specific assets and our ability to close the sales of assets at valuations and within time frames that are acceptable to us, our ability to effectively and timely execute the above actions to improve the operating performance of our businesses and, in certain cases, the approval and participation of third parties, including our creditors and the PBGC.

If we continue to experience operating losses and we are not able to generate additional liquidity through the actions described above or through some combination of other actions, then our liquidity needs may exceed availability under our Amended Domestic Credit Agreement, our second lien line of credit loan facility and our other existing facilities, and we might need to secure additional sources of funds, which may or may not be available to us. A failure to secure such additional funds could cause us to be in default under the Amended Domestic Credit Agreement or other financing agreement. Additionally, a failure to generate additional liquidity could negatively impact our access to inventory or services that are important to the operation of our business. Moreover, if the borrowing base (as calculated pursuant to our outstanding second lien debt) falls below the principal amount of such second lien debt plus the principal amount of any other indebtedness for borrowed money that is secured by liens on the collateral for such debt on the last day of any two consecutive quarters, it could trigger an obligation to repurchase our New Senior Secured Notes in an amount equal to such deficiency. As of August 4, 2018, our borrowing base was below the above threshold, and if our borrowing base is below the above threshold at the end of our third quarter of 2018, it would trigger an obligation to repurchase or repay second lien debt, in an amount equal to the excess of our funded debt secured by liens on our inventory as of November 3, 2018 over the borrowing base. If we fail to make such repurchase or repayment, we would be in violation of our covenants under our Second Lien Credit Agreement and the indenture relating to our New Senior Secured Notes.

On August 4th 2018, Sears only had $193 million in unrestricted cash. The October 2018 debt maturity that is being talked about is "$134 million during October 2018, in addition to $668 million of other debt maturing in the next twelve months."

Here is something I do not understand about Eddie or Elon Musk. They each made a serious entrepreneurial mistake over a decade ago and have been dealing with the miserable consequences ever since. Why keep prolonging it?

Distressed Debt Watch - April 2018

• FTR (Citizens Communications Co) 7.875% due January 2027, trading at 54 ytm ~19%.
• EGLT 5.5% due April 2020 trading at 36 ytm 70%
• XCOOQ (in bankruptcy) both notes trading 13-14 cents
• Sears 8% due December 2019 trading at 35 yielding ~90% to maturity
• Windstream Corp 6.375% due August 2023 trading 57 cents yielding ~19% tm
• GNC 1.5% due August 2020 trading 73 cents ytm 15%

Distressed Debt Watch - January

Bankrupt

• Exco Resources (XCOO, EDGAR) bond due Sept 2018 trading at 7 cents; filed for bankruptcy today. 
• Cobalt International Energy (CIEIQ, EDGAR) bond due Dec 2019 trading at 32 cents; filed for bankruptcy.

Not Yet Bankrupt

• Iconix Brand Group (ICON, EDGAR) bond due March 2018 trading at 82 cents, YTM of 137%.
• Bon Ton Stores (BONT, EDGAR) bond due June 2021 trading at 25 cents, YTM over 65%. Missed interest payment due December 15 and entered forbearance agreement today.
• Egalet Corp (EGLT, EDGAR) bond due April 2020 trading at 46 cents, YTM over 47%.
• GNC Holdings (GNC, EDGAR) bond due August 2020 trading at 49 cents, YTM of 32%.
• Frontier Communications (FTR, EDGAR) bond due April 2022 trading at 73 cents, YTM of 17%.

Distressed Bond Watch

XCO Sept 2018 maturity - 240% ytm.
CIE Dec 2019 - 153% ytm.
EGLT 2020 - 40% ytm.
BONT 2021 - 43% ytm.

Junk Bonds Are a Creature of Falling Interest Rates

Man, Gundlach is a lot smarter than Bill Gross.

Thoughts About Failing Businesses

I was just looking at the list of companies we've blogged about as potential failures that either did fail or else essentially wiped out shareholders in a restructuring:

• STP (182)
• RSH (131)
• GMXR (93)
• WLT (58)
• MCP (46)
• ESLR (40)
• AONE (39)
• GBE (39)
• DSL (38)
• GNK (37)
• GGC (36)
• JRCC (34)
• EXXI (33)
• KV-A (32)
• BTU (22)
• ENER (22)
• NIHD (19)
• DNDN (17)
• RMIX (17)
• GDP (16)
• BKUNA (12)
• ACI (11)
• cfc (10)
• ATPG (9)
• LDK (8)
• LINE (8)
• NEW (8)
• USU (8)
• ANR (7)
• YRCW (6)
• CORS (5)
• LEH (5)
• KWK (4)

First I looked at them in terms of industry categories. The biggest category was coal/mining, with 7 companies. Molycorp was what you call a science project stock, funded with expensive debt, not too hard to see poor equity returns coming there. But the six coal companies were on top of the world in 2011. Much cheaper natural gas came out of nowhere and destroyed them.

To have rationally invested in those coal companies, you needed to know what coal prices would be many years in the future. But that means knowing about the prices of coal's competition for electrical generation (natural gas, solar, etc.) which is tough.

The next category is oil & gas, where there were six failed companies. This is pretty similar to the thoughts on the coal companies; in fact the oil & gas glut is in a sense what caused all the coal failures. Once again, there were very explicit oil price assumptions that were necessary for the success of the companies' capital expenditures and for the success of equity investments in those companies.

Financials had six failed companies but they were all 2007-2009, there haven't been any recently obviously thanks to reflation. Maybe what's noteworthy is that they were extremely levered, which magnified the effect of bad investment decisions.

Next category is solar and alternative energy, with five failed companies. The alternative energy ones were once again science project stocks. Maybe it's a bad idea to invest in public companies with 9+ figure enterprise values that don't yet have a product that they can sell for more than it costs to make. And then the photovoltaic solar companies were dealing with a product where the underlying technology was rapidly improving but they had sunk huge capital into manufacturing plants. Also, there's the theory that the Chinese PV solar firms were a deliberate bust-out to take advantage of naive American investors.

Two of the firms were pharma - those fit the science project category again. Then two were shipping and two were building materials: firms that run with a lot of leverage to make up for low margins that come from undifferentiated products.

One thing that would be interesting to look at is how much these companies spent on capex in the final years of their lives when the businesses should've been in runoff mode. For example, Radio Shack was remodeling stores and buying "Super Bowl" ads right up until the end.

It's also remarkable how quickly the change from extreme best-ever success to failure can happen. In fact, it's almost as though those extreme levels of success can signal big change ahead.

2016 Begins with Ultra Distressed Energy Companies on the Brink

Judging by the bond prices, many of these are likely to file in 2016:

• ZINC, the July 2017 3.8% note trading at 20 cents; ytm 155%
• GDP, the 8.875% notes traded at 8; current yield >100%.
• EXXI, the 3% notes traded at 6; current yield 50% and ytm 145%
• TC, the 7.375% notes traded at ytm of 134%
• SD, the 8.75% notes traded at 12; ytm >100%
• PVA, the 7.25% notes traded at 13; ytm>100%
• BTU, the 6% notes traded at 18.2; ytm 88%
• CLF, the 5.95% notes traded at 28; ytm 88%
• LINE, the 8.625% notes traded at 16; ytm 78%
• XCO, the 7.5% notes traded at 27; ytm 72%
• SSE, the 6.5% notes traded at 16; ytm 54%

Energy and resources. These companies have a combined market cap of $1.67 billion. In all likelihood based on the bond prices, that is illusory. Maybe in 2016 lots of illusory wealth will be revealed as worthless.

What if FB ad revenue that is funded by VC equity contracts, and the multiple contracts, and much of that $300 billion market cap is revealed as illusory? What if the Amazon flywheel runs in the opposite direction (both AWS, as an expression of the VC bubble, and the traditional business, as an expression of consumer spending), and some of that $317 billion market cap is revealed as illusory?

What if the replacement cycle on Apple devices lengthens, or consumers get tired of paying 100% markups for memory, and some of that $587 billion market cap is revealed as illusory wealth?

Well, then, we'd have a bear market.

Low low distressed debt trades

• RadioShack bonds traded last week with a 5 handle.
• The Walter Energy 8.5s traded at 6.25; massive current yield!
• The EXXI 3s traded in the high 20s - low 40%s ytm.
• Molycorp secured debt moved down about 15 points into the high 40s - around 30% ytm. People had gotten way too optimistic before earnings.
• The Molycorp 6s unsecured and the 3.25s unsecured are both single digit now. The 3.25 ytm is over 400%!
• Goodrich bonds have come down into the mid 40s again. That's a ytm inthe mid 30%s.

"These Shale Companies Will File For Bankruptcy First: Goldman's 'Best And Worst' Shale Matrix"

From ZH:

Group 4: Weak balance sheet/weak assets

This group includes companies with leverage above 2.5x and assets we rate “B-“ or lower. Names we highlight are Approach Resources (NC), Exco Resources (NC), Goodrich Petroleum (NC), Halcon Resources (IL), Magnum Hunter (NC), Midstates Petroleum (NC), Rex Energy (NC), Sabine Oil & Gas (U), Samson Investment (NC), Sandridge Energy (IL), and Swift Energy (U).

We view management teams in this group as facing the most difficult decisions. Given the general lack of “core” assets, we believe strategic interest from a larger acquirer is less likely than for Group 3. Furthermore, with the bonds in this group generally trading below $80, we believe 101% change of control provisions act as de facto “poison pills” for acquirers.

Given high leverage and the lack of strategic interest, we believe many companies will need to seek alternative sources of capital. While the options here will vary case by case, we note that most of these names have secured debt baskets that can be used to bolster liquidity. Based on the phone calls we receive, investor interest in this type of security remains high, which suggests to us we will see robust second-lien issuance as soon as the conclusion of 1Q earnings. The bottom line is that, for now, we think investors should tread lightly in this group, despite the average bond yield of 19% (excluding obviously distressed names Swift Energy, Samson Investment, and Sabine Oil & Gas).

Dividends and Share Repurchases When Companies Are Approaching Insolvency

Here's an interesting subject for distressed investors to think about: the legal boundaries regarding dividends and share repurchases when a company is approaching insolvency.

One good paper is "Wrongful Corporate Cash Distributions Under Delaware and Georgia Law" [pdf]. Some highlights:

A Summary of the Key Formula
Title 8, sections 160 and 170 of the Delaware code allow a corporation to purchase its own stock or issue dividends, provided that such transactions do not result in an impairment of the corporation’s capital. If the amount calculated is less than the amount distributed, then the transaction is unlawful, and directors who willfully or negligently conducted the unlawful redemption are jointly and severally liable. Del. Code, tit. 8, §§ 160, 174.[...]

Section 174 of the General Corporation Law makes directors personally liable for their willful or negligent conduct in connect ion with the repurchase of stock or the payment of an unlawful dividend. The director s are liable to the corporation, and in the event of dissolution or insolvency, to its creditors, at any time within six years from the date of the unlawful stock repurchase or the payment of the unlawful dividend, for the full amount of the payment. However, Sections 141(e) and 172 of the General Corporation Law provide protection to directors who in good faith rely on the books of the corporation or on reports of officers or outside experts selected with reasonable care in determining whether there are sufficient funds legally available for a stock repurchase or payment of a dividend. [...]

The purpose of the limitations on the sources of funds for effecting valid stock repurchases contained in Section 160 and permissible dividends contained in Section 170 are to protect creditors (and in some cases stockholders as well) from fraud. Therefore, it appears that the reference to 'value' in Morris must be read as a reference to fair market value of assets and liabilities because it is only fair market value that represents a potential fund from which creditors' claims may be satisfied.

This article points out some other potential causes of action if directors or management improperly deprive creditors of value through dividends or share repurchases: breach of fiduciary duty, fraudulent conveyance, and state law provisions such as Section 14-2-640 of the Georgia Business Corporations Code.

Another good article is "American Corporate Law: Directors' Fiduciary Duties and Liability during Solvency, Insolvency and Bankruptcy in Public Corporations" [pdf]:

"A check-list for [corporate directors to avoid] personal liability to creditors for their actions when the corporation is or may be in the zone of insolvency includes: [...] Consider retaining financial advisors to evaluate whether contemplated transactions are fair to the creditors of the corporation; [...] Assure that decisions are defensible on the basis of good faith judgment - generally, it is prudent to avoid dividends or stock redemption while in the zone of insolvency; Be prepared to demonstrate, based on reports and outside advisors, reflected in the records of the board's deliberations, that any awards of executive compensation were reasonable and necessary..."

Last article worth mentioning is "Protecting Directors and Officers of Corporations That Are Insolvent or in the Zone or Vicinity of Insolvency: Important Considerations, Practical Solutions" [pdf]:

"[C]ourts may judge in hindsight whether the corporation was insolvent at the time that the corporate decision in question was made, 'notwithstanding contrary presentations made in the company's audited financial statements or made to its board of directors.' Accordingly, it is prudent for directors and officers to adopt a conservative approach in their evaluation of the corporation's solvency and to assume that the corporation is insolvent or within the zone of insolvency if there is any reasonable question about the corporation’s solvency."

These rules for directors to follow result in two important signals of corporate insolvency: ceasing dividends and hiring financial advisors. Debtwire is a subscription service that costs a fortune but delivers valuable scoops about what companies have hired restructuring advisors or counsel; investors then know to unload those companies shares.

Public Companies Where CDS Protection Costs More Than 10% Annually

CZR, JCP, RSH, SHLD

Current Distressed Universe

Public companies with distressed debt.

GENCO SHIPPING & TRADING LTD, 5s of 08/15/2015, 58 cents.
JAMES RIV COAL CO, 10s of 06/01/2018, 12.6 cents.
JAMES RIV COAL CO, 7.875s of 04/01/2019, 16 cents.
JAMES RIV COAL CO, 4.5s of 12/01/2015, 30 cents.
JAMES RIV COAL CO, 3.125s of 03/15/2018, 24 cents.
PENNEY J C INC, 7.125s of 11/15/2023, 65 cents.
PENNEY J C INC, 5.65s of 06/01/2020, 68 cents.
RADIOSHACK CORP, 6.75s of 05/15/2019, 60 cents.
USEC INC, 3s of 10/01/2014, 36 cents.
Verso Paper Holdings LLC, 11.375s of 08/01/2016, 69 cents.
Verso Paper Holdings LLC, 8.75s of 02/01/2019, 55 cents.

Best guess is that GNK, JRCC, JCP, RSH, and USU are all going to zero in the next few years. Verso was supposed to merge with NewPage, but the deal was contingent on Verso bondholders agreeing to an exchange offer that would basically give them a 50 percent haircut.

General Maritime: Past Example of Loan-to-Own a Shipping Company

This is from 2012:

"Tanker operator General Maritime Corp, which emerged from bankruptcy seven months after going under, does not expect to go public again until at least 2014 as the company is yet to come out of the woods, its chief financial officer said.

Private equity firm Oaktree Capital Management invested about $175 million as part of General Maritime's restructuring.

Oaktree had lent General Maritime a $200 million loan in May last year prior to the company's Chapter 11 filing. That loan was converted into equity once General Maritime emerged from bankruptcy. Oaktree now owns about 98 percent of General Maritime's stock."

Crazy Deals Being Done In The Restaurant Industry!

This just popped in to the inbox.

"It is a great time to be in the restaurant industry. Publicly held stocks are trading at high multiples. IPOs have been all the rage. The success of the Potbelly and Noodles & Company IPOs and the dramatic increase in share price that followed reminds us of the hype around the Facebook and Twitter IPOs. Additional restaurant chains will be coming to market soon. Money is flowing to the industry from lenders and private equity investors faster than a roaring river, with many lenders financing large chains at rates under 5% with minimal covenants.

Private equity is investing like they never have before. Some sophisticated PE shops are investing in very small startup chains in the Fast Casual space. One example is the rush of money to the fast pizza segment, with service systems similar to Chipotle and 800-degree ovens that can bake a pizza in under three minutes. There are at least ten startup chains with PE backing rushing to become the first national player in this segment. Private equity is also willing to own large franchisees. There was a time several years ago when private equity would not own a franchisee at any price. Now, word on the street is that one of the large franchisees of a YUM Brands company sold for seven times EBITDA and a lender financed five times EBITDA. These dynamics are unheard of in recent history for the restaurant industry – they are certainly higher than anything we saw in the 2005–2007 timeframe.

These financing and investing trends are happening despite headwinds of almost no positive traffic growth in the casual dining segment, low single digit traffic gains in the QSR and Fast Casual segments, higher commodity prices (especially beef), and higher labor costs coming in the form of minimum wage increases and Obamacare."

A correspondent writes,

"Still no soft-serve IPO. Wings IPO (own financing of franchisees, what could go wrong?) (Tyson wings business tracking stock?). Better burger IPO."

"A Mail Steamship Company in Ruins; Motion for Receiver and Injunction"

A New York Times article from 1860!:

"They aver that the judgment is still unpaid, and that the Company has been insolvent for the last year, and is still incapable of paying its debts. The plaintiffs further state that some of the other creditors of the Company have threatened to bring actions against them for bills outstanding to their credit, and owed to the Company. The prayer of the complaint is that the Company may be declared insolvent; that a Receiver be appointed, and that the assets of the Company be sold and applied to the satisfaction of its debts."

The case was Isaac Grey et. al. vs. The New-York and Liverpool United States Mail Steamship Company et al..

Receivership is old fashioned medicine for insolvent companies.

"Post-Judgment Remedies in Reaching Patents, Copyrights and Trademarks in the Enforcement of A Money Judgment"

Excellent article in the Northwestern Journal of Technology and Intellectual Property, "Post-Judgment Remedies in Reaching Patents, Copyrights and Trademarks in the Enforcement of A Money Judgment" [pdf],

"Confronting a recalcitrant debtor, the judgment-creditor should recall Winston Churchill’s description of Russia 'as a riddle wrapped inside a mystery inside an enigma.' To unravel the enigma of a debtor’s inventory of secreted, hidden, and concealed assets, post-judgment remedies compel the judgment-debtor to appear in court and disclose assets and liabilities by testimony and documents through an Order to Appear ('ORAP'). ORAPs are in personam proceedings that compel the judgment-debtor to physically appear for an examination and disclose assets and liabilities. The judgment-creditor has great latitude in compelling the disclosure of information necessary to discover assets available for enforcement. An ORAP also provides the judgment-creditor with the right to compel the judgment-debtor to turn over assets and subject the debtor to direct enforcement under the power of contempt.

The procedure to reach the judgment-debtor’s property through an ORAP is straightforward. At the conclusion of the ORAP, the judgment-creditor can seek an order compelling the judgment-debtor to transfer or assign property to the sheriff or receiver under Cal. Civ. Proc. § 708.205(a), who would then take the property into possession and provide for an orderly sale. If the asset is a patent, the court may order the judgment-debtor to execute an assignment of the patent in favor of the receiver but not the sheriff."

Debtors try to stiff their creditors all the time. There are plenty of tools that creditors can use to try to get paid.