A Wave Of Equity For Debt Restructurings And Common Stock Offerings Are Coming, by Bruce Berger, author How To Create Wealth Investing In Turnaround Stocks, full bio below
By now every investor understands that the high yield markets have cracked. The frenzy of high yield bond issuance is over but the hangover and consequences are now starting for not just bondholders but common stock owners.
As a turnaround stock Investor I can tell you that the frenzy of debt issuance will have a profound impact on common stock holders. After 30 years of investing in beaten up common stocks typically down over 75%, I have never seen so few clean balance sheets among small cap stocks.
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With rates at zero percent clean balance sheets were frowned upon by investors demanding stock buybacks with cash on hand or from issuance of debt. One example among hundreds is Resolute Forest Products. Despite continuing declines in its business, the company used $60 million in precious cash to buy back stock at prices averaging $12 a share that are now $4. The company thought it had a solid balance sheet but with a recession on the horizon and falling pulp prices and demand they are now faced with the prospect of raising capital in a harsh environment with collateral values falling fast.
Then take a look at all the oil service and oil companies. Out of hundreds of public companies you will be lucky to find any with a debt to equity capitalization of less than 30%. In years past oil and oil service companies made sure they had solid balance sheets given the cyclicality of oil. However, the pull of high yield was so strong management teams trashed the notion of conservative balance sheets.
I believe the reason share prices for small caps have fallen so quickly is not the economy, but because balance sheets are so weakened. The prospect of Falling EBITDA is not a welcome development for a company with even a debt to equity capitalization of 50%. As a consequence the markets are pricing stocks with leveraged balance sheets for possible equity dilutions from common stock offerings, as banks demand more equity to relax debt covenants.
If we are going into a recession investors must now price in the effect of equity offerings and equity for debt exchanges. For example, I think Tidewater corp is a good investment at its current share price of $5 a share. At first glance it appears ridiculous that the stock is $5 while book is $50, especially considering their large market share in the offshore vessel supply industry and ability to stabilize vessel rates from stacking boats. However, Tidewaters interest to ebitda ratio has plunged. Ebitda has fallen from $400 million in 2013 to what I estimate will be $125 to 150 million in 2016. This is forcing the company to reach out for covenant relief and renegotiation of their bank facilities. TDW debt of $1.5 billion against book equity of $2.4 billion for a debt to equity ratio of 55% and vessel values of $3.6 billion is not horrible at first glance. However, equity does not pay the bills, interst expense and principal payments. In Tidewaters case, I believe the equity holders are ok because the banks and bondholders are unsecured. Tidewater has the ability to negotiate a reduction in its untapped revolver from say $600 mil to $300 or $400 mill by giving collateral to its banks and bondholders. My recent purchase of shares at $5 also assumes the dilution possibility from the company having to issue $100 million in equity. I believe the stock price reflects this possible dilution. In fact its possible the share price may not sink when an offering is priced as the fear of a restructuring goes away allowing investors to believe they will be getting the the present value of future cash flows and not the creditors.
What has happened to Tidewater was unimaginable just one year ago. Equity investors need to be credit analysts now. If your company has declining ebitda and debt to equity of over 50% and god forbid over 70% you need to seriously consider the equity dilution possibilities from a debt for equity restructuring and large common stock offerings. You should be especially concerned if goodwill and intangibles account for a large percentage of total assets. Banks give zero value to goodwill on a balance sheet when considering asset based loan and revolver borrowing bases.
What has happened to the stocks of leveraged natural resource stockholders may be coming to other industries such as paper and pulp, technology, trucking and many others that require larger debt to equity capitalizations.
Over the next year pay particular attention to the stock price action of your company. If you see sudden declines in a stock price that breaks long-term historical lows this may be a warning signal of problems ahead. Investors should learn some basic technical analysis to help them notice these warning signals. A share price weakening significantly with no news may be from Investment Bankers and bondholder committees with loose lips spreading information of upcoming equity offerings or worse debt for equity exchanges.
Turnaround and value investors also need need to put earplugs in when listening to corporate managers in regards to possible future equity offerings. This week I was shocked while listening to the Teck Resources conference call. The ceo was adamant that under no circumstances would he issue equity. I think he will eat those words. He is living in denial. Don’t listen to a CEO when they announce that there will be no equity offerings. When Teck and other companies go back to their banks to renegotiate broken covenants on revolvers and term loans they will be hit in the face with the equivalent of a 2 by 4 as their once friendly bankers turn into loan shark collection agents. At that point CEOs will fold like cheap suits and call their investment bankers to raise equity.
After this wave of stock offerings and debt to equity restructuring it will be safe to come out of the dark and buy up stocks. However, if you believe that a company’s share price is so low and is still cheap when factoring in a possible dilution like tdw, I suggest you scale in and not take a full position waiting for the offering.
Keep checking in with my website www.turnaroundstockinvesting.com as i will be following all the equity and debt restructurings throughout 2016 searching for bargains.
A Wave Of Equity For Debt Restructurings And Common Stock Offerings Are Coming by Bruce Berger
Mr. Berger serves as a founding Member at Recapitalization Partners, LLC. Prior to Recapitalization Partners, Mr. Berger was a General Partner and Co-Founder of Lindenwood Capital Partners, LP, a New York based private equity fund that invested in underperforming companies. Over it’s 6 year lifetime, Lindenwood returned to it’s investors an annualized return of 35%. Before Lindenwood, he founded and was President of White River Partners, Inc., a wholly-owned subsidiary of White River Corporation (NASDAQ-listed) specializing in the acquisition and restructuring of troubled businesses. Mr. Berger served in this capacity until June 1998 when it was sold to Harvard Capital Management. He served in a similar capacity while with Fund American Enterprise Holdings Inc. (NYSE-listed), being responsible for the analysis and management of distressed companies.
Mr. Berger has served as Chairman of the Board for various companies and as a director of a number of other companies.
Mr. Berger is a graduate of Rutgers University and is a Certified Public Accountant , Certified Fraud Examiner and a Certified Valuation Analyst.