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von Hedgefonds-Manager Kao.
Trump Trade or Chump Trade?
In recent months, the JPS have woken back up, presumably on Trump’s improving election odds. In conversations with bullish JPS holders, this is the gist of the Bull Thesis. I paraphrase, with my own comments in italics: Does Trump win? If so, the price goes up, simple as that. (Certainly what the market has been pricing lately, but there is a big difference between a Greater Fool Sentiment Trade and an actual Event-Driven outcome.) Does Trump actually want Recap/Release? If the answer is yes, they will have to deal with JPS. (I disagree. SCOTUS + other legal losses stripped JPS leverage away permanently.) How does that negotiation look? Since they don’t need to bring in new capital because earnings were retained (Disagree. They can’t just arbitrarily write down the SPS Liability and just keep the Retained Earnings Asset.), they will need to get SPS out of the Capital Structure (Agreed, and this is where the Escalating SPS Liquidation Preference is a problem.), so they could: Cancel SPS without touching JPS. Unlikely. (Agree — read further to see for why this is a virtual impossibility.) Convert everyone to Equity. Very likely. What would the conversion look like? Does SPS get 100% of Equity? No, because JPS would not agree. (Disagree, I think JPS have almost no leverage.) Does JPS get full par, as SPS takes a haircut on their Liquidation Preference? No, because UST would not agree. (Agree) SPS/JPS get Pari Passu Treatment, and everyone wins. UST gets massive pay day, and JPS also gets a potentially large payday. (Small possibility of Pari Passu Treatment, but read further to see why this will likely make little difference.)
Unfortunately, because the facts have changed, so too has my optimism, and I feel compelled to inject a harsh dose of reality into the equation.
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Undaunted by the reality of ever-worsening prospects, some JPS Perma-Bulls have opined that, “I have no doubt if JPS could have been wiped out by now, it would have happened already.” That is a false sense of security. We have all seen how bankrupt stocks can irrationally retain value for years. If you’re hoping for the Event-Driven Recap/Release Catalyst to finally happen, be careful what you wish for, because ironically, it’s usually the actual Restructuring event that finally crystallizes the zombie securities to zero. From a purely financial perspective in a Recap/Release, the Big New Money that must write a massive check to replace the Government’s SPS will get to dictate the terms of the Restructuring.As you will see, even under an unlikely Pari Passu Treatment scenario, SPS will likely command >95% of the Post-Reorg Equity because of COERCIVE CAPITAL RAISES.
Coercive Capital Raises
COERCIVE CAPITAL RAISES in Restructurings are frequent and are like Rights Offerings in which INVESTORS MUST PONY UP NEW MONEY OR FACE EXTREME DILUTION.
If the JPS layer miraculously gets Pari Passu Treatment with the SPS, here’s how I see the negotiations playing out.
Both SPS and JPS classes get presented with this ultimatum: “For whatever par amount you own, you need to put up equal amounts of NEW CAPITAL equating to your PAR to earn your Post-Reorg Equity.” Because the SPS is owned by Government (with unlimited pockets), it can choose to write any check size to keep whatever pro rata Post-Reorg Equity it wants to retain. It will then invite whomever can write the Big New Money check (Berkshire Hathaway comes to mind since Warren Buffett is the King of Sweetheart Deals) to fill in the Private Capital portion. For the JPS holders, they might be offered the same deal, but here’s the rub: ALMOST ALL JPS HOLDERS I KNOW ARE LOADED TO THE GILLS FOR A HAIL MARY GIFT WITH NO CAPACITY TO PARTICIPATE IN SUCH A COERCIVE CAPITAL RAISE, AND ONLY THOSE THAT PARTICIPATE COME ALONG FOR THE RIDE WITH THE SPS.
What will practically happen is that only investors at the SPS level will be able to afford to cough up the Big New Money, whereas very few JPS holders will be able to participate in a Coercive Capital Raise. The result is that JPS will get massively diluted, and SPS will end up with almost 100% of the New Post-Reorg Equity. This is NOT a theoretical concept. Coercive Capital Raises happen all the time in Restructurings — especially Restructurings that require large injections of Big New Money. I’ve had to navigate Coercive Capital Raises in my own career. From mid-2016 to late 2018, my firm was intimately involved in the Restructuring of Breitburn Energy for over 28 months. I had accumulated a large face amount of Senior Unsecured Notes at 4-6c on the dollar, thinking I had a free shot on the Post-Reorg Equity. After a long and contentious negotiation within our Senior Unsecured class as well as against Senior Secured Second Lien (2L) Noteholders, we Senior Unsecured Noteholders had to pony up almost the full PAR AMOUNT of our claims in NEW MONEY of almost $800 mm to protect our position and participate in the Post-Reorg Equity. I had to scramble and raise an SPV to fund the Rights Offering, and many investors who had similarly bought large face amounts of these Senior Unsecured Bonds had to subsequently dump them at a loss when they realized that they could not fund the Coercive Rights Offering. Note that my Breitburn example is Small New Money compared to the $330B (or perhaps $400B) of Big New Money required to Indy Switch the SPS Liquidation Preference! It is my belief that most holders of the $30B of JPS don’t have the financial resources to pony up in the event of a Coercive Capital Raise.
The result of Coercive Capital Raises is that HE WHO WRITES THE BIG MONEY CHECK GETS THE LION’S SHARE OF THE VALUE
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Back to the Restructuring math: If we round my best realistic case Recovery up to 50c, this would cut the Expected Value under even generous outcomes under a Trump win from 25c to 12.5c, which is still almost ~40% lower than what the market is pricing right now at ~20c.
Let’s put down those Rose-Colored Glasses now and recognize that when facts change, so must the Investment Thesis.
What is a more Realistic Scenario Expected Value? 55% Probability of Trump Win x 25% Recap/Release Makes The Agenda x 20% Pari Passu Treatment x 50c Max Payout due to Coercive Capital Raise = 1.375c!
For those hoping for an Event-Driven outcome, be careful what you wish for, because in this situation, it’s the final Recap/Release event that can crystallize the permanent impairment.
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