Catalyst Identification: Outside in Analysis
Hi everyone,
Been a long time reader here and have tremendously benefited from the insights here.
I am putting together some trade ideas (case studies) as part of a recruitment drive aimed at credit HFs (broad umbrella, I know) but mostly names that play in the stressed / distressed space.
I am wondering if someone can point on how to identify or look for core catalyst(s) on an outside in basis. For instance, I don’t have access toGLG / Third Bridge so doing DD beyond what is in the public space is a bit harder for me. So if I am looking private names (i.e., non-plc) with only public information being an offering memorandum, recent news and some annual reports to what extent can I flesh out a thesis on an outside-in basis for differentiated view?
When identifying catalysts on an outside-in basis, especially for stressed/distressed credit opportunities, here are some actionable steps based on the most helpful WSO content:
Focus on Publicly Available Information:
Triangulate Data:
Identify Industry-Specific Catalysts:
Leverage Alternative Data:
Develop a Differentiated View:
Timing and Probability:
By combining these steps, you can build a robust thesis even with limited access to proprietary data. Remember, the goal is to identify actionable insights that others might miss, which can set your trade ideas apart.
Sources: How on Earth to put together company profile for a private company?, My Investing Framework: How to Analyze a Company, Guide To Evaluate a Biotech Company, Guide To Evaluate a Biotech Company
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You don't need expert calls to identify a catalyst in general, let alone for a case study. Expert calls help to diligence the feasibility or timing of the catalyst.... but for case studies you won't be expected to have that level of diligence anyways
this is a very simplistic example... but say you're given a case study on a private performing software credit. You go through the CIM and that it reports RPO and ARR... and you notice that there's an increasing disconnect b/w the two based on historical trends (maybe RPO is growing and ARR is declining)... a good candidate would realize that the catalyst for a potential short would be the front book pricing flowing through and being margin dilutive and build a thesis around it despite mgmt saying everything is fine... maybe from what you have read on CIMs (and public comps), there is a possibility that it is terminal and could lead to FCF being constrained and/or a RX. For a case study, as long as you identify that disconnect, sound smart about the probability of it being a structural vs. cyclical issue (and can defend either case) and identify it being a short, you're probably in the green.
In neither of those steps would I need an expert call to identify a catalyst or a high level initial thesis if I work on a name for 1-2 days. Most funds know you're doing a case on top of your typical day to day work.. so they're not expecting you to drop everything and do tons of expert calls to be smart on a name. For junior analyst roles they're just looking to see if you can 1) identify the right business trends, 2) identify the bull and bear debates (and do enough research or have a view to defend either one), 3) can assess valuation in either case, and 4) tie that all together and recommend a trade based on risk/reward today
Great write up. Can you give a concrete example on the risk / reward part. Mathematically, what does that look like?
in the above example, assuming your "FV" is in the 60s if your thesis plays out (recovery maybe even lower), would you short that bond at mid 90s-par? what would give you comfort shorting the bond at those levels? if it's call constrained, your loss is most likely -ve carry + few pts vs. if you're correct you make 30+pts. Easy trade if you're convicted in your thesis + catalyst timing.
Would you make that trade in the mid 80s where in theory you could lose ~15pts and make 20+? What if you place the probability of being wrong at only 20%? How would you assess risk/reward at that point?
Inversely, what if instead of pricing being a structural headwind you think its only cyclical or whatever, and you believe FV is closer to 80s though recovery in a worst case is still lower. Would you go long in the 70s? 60s? Where would you sell if you're long? How much would you lose or make if you're wrong or right.
These are all just simple scenarios to think through that should be enough for a case study... and this is probably a bit too much for most places anyways if you're a junior.
What will put you a step ahead would be to think about what could be a good hedge for the trade. what if instead of a unitranche cap structure, you now have multiple securities with different ranking/maturities/prices (or even different boxes and covenants if you're looking at more complex cap structures) and you can either go long or short not only bonds but also CDS and equity
Thanks a lot for the original answer and this addition. In the last part I presume you are referring to capital structure arbitrage?
You keep saying "outside in" like that's a thing. No idea what you're referring to.
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