Appropriate hedge in turnaround situation
Hi Monkeys,
I'm looking at Newell Brands as a potential turnaround story as the company seems to have a few catalysts that I view as likely to push the stock back into normalized territory over the next few years if the narrative plays out, however, as everyone knows there is risk in attempting to time a "falling knife" position. So to help limit extreme losses I looked at hedging with derivatives but ruled this out as they are priced to perfection, so I took a look at the bonds, specifically, the senior unsecured notes yielding 3%-4% maturing in 2023+ and was intrigued as I estimate that if things turn for the worst and the company goes into default (worst case scenario) the bonds would drop to 30%-50% of face value as there wouldn't be much due to the tangible assets being worth significantly less than net debt.
I would love to understand someone's perceptive on the situation if they have experience putting on a similar trade.... long common with a bond short.
I would only long equity / short debt if you expected a very explicit transfer of value from debt to equity in a short amount of time. Generally I like bond shorts but you have to have a defined catalyst and short time frame due to cost of carry.
Agreed, not sure if you're familiar with the company but there is a fair chance the share price will continue it's death spiral, maybe even 50% lower from it's current share price in an extreme worst case scenario, but I still like the risk reward and wouldn't mind giving up some carry and a some basis points to hedge a bit of the risk.
Never shorted bonds before, so this is completely theoretical until I come to a decision to pass or pull the trigger.
Curious - has anyone shorted PIK notes before?
if company defaults won't cds print $$?.. the mispricing you see in the senior unsecured won't matter at that point.
if this is an RV trade then hedging with derivative that's well priced is totally fine, since you're trying to capture the mispricing of that note.. if it's outright then might as well buy the protection and forget about arranging repo/funding
CDS... I've watched The Big Short one to many times and the whole premise of swaps makes me cringe. By the way... the short would be a hedge against long common position.
that's why i told you to buy protection.. at any rate you should listen to the comments below
What do you think the upside on the equity is?
Base case 2-2.5x, Bull case 3x+ if earnings stabilize in 2-3 years. I have confidence in starboard and icahn to get this puppy back into normalized territory. It's a consumer defensive with peers trading at 25-30 FCF (Cash from ops. - Capex). The company's normalized FCF I'm projecting will be in the $600m-$800m range in 2-3 years once assets have been divested and debt has been paid down.
It's difficult to estimate a margin of safety as there is no tangible book and earnings are in a death spiral - hence looking for a hedge.
Wait so basically your strategy is to have confidence/follow other HFs for your catalyst? I am not saying that everyone's strategy shout be contrarian investing but I am not sure your catalysts are here.
how are you valuing the bond drop?
Well, I believe there is little chance the bonds will default, as mentioned early (extreme worst case scenario), remember this is a turnaround story where I am seeking a hedge not a bond short. Lets say everything goes to shit and the company gets thrown into bankruptcy, the bond holders are going to run for the hills and the distressed guys aren't going to pay anything close to par because the tangible assets on the balance sheet are worth less than the liabilities, and only a fraction at that, thus coming to the conclusion that distressed/bankruptcy funds would most likely only pay 30%-50% of par. (Bonds are currently trading above par).
I think you should focus more on your equity long thesis and forget about the bond short.
I don’t really understand the purpose of your hedge. You are better off controlling risk through position sizing here.
Problem with a hedge it eliminates some risks but introduces new ones. If they pay off debt with cash flow and cut the dividend. Suddenly you owe 4% a year on the bonds (as their credit improves) and get no dividend and the stock might go down. Realistically you have to short $2 in bonds for every $1 in equity for the hedge to hedge out the bankruptcy risks if you assume the bonds in bankruptcy trade 50 cents.
Meanwhile leading up to bankruptcy you’ve paid coupons of 8% a year for every $1 of stock price. If that occurs in two years and dividend was cut your down 16%.
Or a worse case scenario bonds don’t trade to 50 cents on the dollar. They trade 75 cents. Your down 50% on the equity after hedge and down 16% per year in coupon payments.
You very much need to know the capital structure to make that bet. My opinion size down the position and just own the equity. There’s a lot of ways long equity short bonds can hurt you in a distressed situation. I think most people doing things like that are short the equity and long the bonds.
Did a quick look at their brands. Seems like operating cash flow is a round a billion a year now. Some decent brands. Debt is $6 billion. Do you really think those bonds ever go to 50 cents on the dollar or 6 times current operating cash flow?
If I thought they had a good bankruptcy chance I’d be looking to buy the bonds to potential convert to equity.
a little familiar with it. wouldn't hedge with bonds. Options are probably cheaper now after earnings
I hear you, took another glance at the long dated puts, still expensive relative to shorting the bonds at a carrying cost of 4%-5% (guesstimate) annually vs. the puts selling at approx. 18% annually. Putting the hedge on hold for the moment.
Thanks for the feedback.
Puts are hedging at ev $12 billion
Bond hedge wouldn’t start to hedge anything until ev breaks under $6 billion. The puts would be paying out huge before the bonds do anything.
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