Q&A - High Yield/Distressed Debt Sell Side Analyst
2nd year analyst at a boutique broker-dealer from a non-target state school. Also a CFA Level 2 candidate, working under multiple sector analysts with decent exposure to Oil & gas, metals & mining, and retail. We publish mostly on high yield/distressed debt situations but also some special situation equities (spin-offs, risk arb etc..) I want to do a Q&A to see what interests the WSO monkeys out there. Many students aren't exposed to the debt markets while in school which I believe is a shame considering the credit capital markets are significantly larger than equities. Ask away...
I was surprised also, not sure if its because this is my first post it doesn't get attention.
I got my job similar to others from non targets, an alumni works here and offered me a 2 week non-paid internship over winter break. I basically worked on the trading desk and came up with a couple trade ideas. I pitched my best ideas to the CEO and Head of Research (very small shop, i am on a first-name basis with everyone including the CEO), and they basically offered me a full time position on the spot.
Hi, thanks for doing this. Do you get much experience looking at chapter 11 situations and work-outs or it is more performing/stressed high yield names you look at? Also, how much due diligence do you do on each name? I see a lot of sell-side research where guys just throw a multiple on EBITDA and waterfall the EV through the capital structure and present a recovery value to support their view. Do you guys do a lot of work on the business model or focus more on the financials? Thanks.
The easiest way to answer this is to go through our research process from beginning to end. Some of the companies we cover are names our analyst is well established in, but others are special situations that our clients ask us to take a look at, and if the company has a lot of debt outstanding (different classes of debt so Sr. Secured, Unsecured, Convertible notes etc) we'll do a bottom up analysis. Generally this will start with going through the K's and Q's and determining the structure of the industry, the major competitors, going through earnings transcripts and speaking with clients who are involved (aka own some of the debt). Throughout this process we will build a model and project rev/EBITDA/cash flow, meanwhile compiling the best comps to determine a range of multiples.
So I would say its a rather lengthy and detailed process, including speaking with management and doing on-site research (touring a retail store for instance). If the company is on the verge of bankruptcy we will do full chapter 7 & ch. 11 analysis, which essentially turns into a waterfall but under different scenarios. Sometimes we'll do a waterfall even if we have a Buy rec just because most buy-side distressed guys will want to know the down-side framework. The biggest difference in HY/DD research and equity research is going through the Indentures to determine the companies ability to incur more debt, sell assets, what call schedule is there, and everything else that could occur in a bankruptcy. The analysts I work under have a very strong back-round in court-law, even down to the different judges in Delaware to determine the probabilities of different outcomes.
In regards to the sloppy sell side research you allude to, a lot of that is because the big banks are obliged to cover dozens of names due to their banking relationship. Being a boutique we're much more selective in the names we cover, so analysts will generally cover 8-12 names on a primary basis, and maybe another 10 on a secondary basis. The difference between primary & secondary is secondary we don't have a recommendation on, so its much less involved and we won't publish on every earnings. The bulge bracket research is watered down because they have analysts covering 20+ companies on a primary basis, and its simply not possible to stay on top of them. Most of what you see is their junior analyst tweaking a model to maintain their "Buy" rec. There are numerous exceptions to this but from what I see this is what usually happens.
Thanks for the AMA, sending you SB your way. I had the below questions, sorry if they're retarded:
1) How do you value distressed debt?
Obviously I know the theory about expected coupon payment etc. but I see a lot of names out there where the underlying bonds are trading in the 80s while they seem (to me) to be 2 inches away from default / full bankrupcy and I don't understand why they're not dropping much lower....
2) What is the right way to go about about your recovery analysis?
I'm thinking of these various European issuers who may not have the luxury of chapter 11 protection and always wondered how it's working when the music stops and the secured lenders are getting only a portion of their $ back and the unsecured bondholders end up being completely fucked
Also I presume you only have access to public info no? So how do you know how the various debt instruments link together (e.g. cross-default threshold, cross acceleration etc.)
3) Who are your clients and how do you make money? Distressed debt investors? Do they pay for research or is a portion of trading/brokering income coming back to you?
4) Do you have access to management? I presume distressed companies are not going to be friendly when they have tons of investors smelling blood around them