Thursday, June 3, 2010

ACAS: To Fear Bankruptcy?

There's been some fear and uncertainty about ACAS in connection with the debt restructuring and the lock-up agreement's extension to June 8. Allow me to explain why I think ACAS is turning into a screaming buy.

ACAS is Solvent
ACAS hasn't failed to make any payment due under any of its debt agreements. It makes principal and interest payments timely, even at the jacked-up interest rates with which it's been stuck since the breach of the net asset covenant during the market collapse in 2008. Nobody at ACAS is going unpaid, and none of the creditors are being stuck with a bounced check. Under these circumstances, ACAS is not insolvent. ACAS is a diligent debt payor.

ACAS is also creating huge cash piles with which to pay obligations as they come due, including the anticipated obligation to make substantial principal payments in connection with a planned debt restructuring agreement.

Restructuring Isn't Liquidation
A bankruptcy court presiding over a proceeding conducted under Chapter 7 of the United States Bankruptcy Code is basically a funeral director: it invites all the mourners, says a few words over the corpse, and lets everyone go home red-eyed and empty-handed. (By the time a company files Chapter 7, even the optimists have long since given up; there's not much left to chew on.) Chapter 7 is the end of a dying business, and is conducted to wipe the slate clean of claims for whomever is left alive. Chapter 7 is the debtor's winter.

Chapter 11 is Spring. Under Chapter 11, a business with a liquidity problem can get turned around under a reorganization plan that takes account of everybody's interests. The alternative is a feeding frenzy that causes every creditor to tear flesh from the debtor as fast as possible in order to avoid losing the race to the assets. Chapter 11 is about the orderly process of reorganizing debtors' affairs with an equal eye to all the interested parties. ACAS has a reorganization plan to which 100% of its $1.4B in unsecured creditors agree, and varying percentages of its bond holders agree. The agreement ACAS has obtained is very close to statutory thresholds that would require the Court to order the reorganization plan urged by ACAS. With a few percent more of certain debt classes, ACAS would be entitled to stuff its plan down the throats of uncooperative debtors over their most strenuous objections. And let's face it: while ACAS continues to make all its interest payments, ACAS is entitled to continue to conduct its business as debtor-in-possession despite the preferences of some unhappy creditors. (Mind you, I don't think the creditors are unhappy at all: I think they love getting paid default rates of interest and don't want to see the golden goose killed, so they are doing everything possible to delay the debt restructuring. ACAS is so solvent, and so full of cash, there's no risk that other creditors would get advantage by delay – so I think all the creditors have a pecuniary incentive to toss sand into the gears.)

While ACAS continues its business, it becomes more liquid because it keeps piling up more cash. (By the end of April, unrestricted cash stood at $1.2 billion. Not million but billion.) At some point, ACAS can simply ask the Court to approve the payoff of the unhappy creditors' principal (the uncooperative creditors' claims are based on a few hundred million in principal, well within ACAS' budget), which would free ACAS to agree to a restructuring with whomever is left. That is, if the Court doesn't first order the parties to perform the restructuring plan urged by ACAS.

Of course, there are Chapter 7 debtors (like KSRP Ltd., now pending in the Southern District of Texas) that pretend to be Chapter 11 debtors. KSRP Ltd. has reported to the Court that it has no income and has made no expenses in the last year because it's had no active operations, but it turns out that lots of immigrants with H1-B visas are telling the INS they are employed by KSRP. Since KSRP hasn't had income or expenses in over a year, it's clear the only reason KSRP is trying to avoid liquidation is to keep all these fraudulent visas from being discovered by the INS and causing lots of deportations to India. For the employment with KSRP to have been legitimate, the immigrants would have to be drawing income from KSRP; it's a sham intended to perpetrate an immigration fraud. This, of course, all came as a surprise to KSRP's creditors – you don't expect the principal of a firm to admit all this under oath. Usually they are better advised and know when to plead the Fifth. Ridiculous Chapter 11 filings like KSRP Ltd. get converted into Chapter 7 proceedings pretty quickly.

But ACAS is a real Chapter 11 story: it has plenty of power to pay the interest on its debt, and even a well of cash for paying down principal without interfering with ongoing operations. So long as a Chapter 11 debtor can make interest payments at the non-default rates of interest, the bankruptcy rules allow the debtor to continue operating his business as debt0r-in-possession. If ACAS were to stop paying interest above the non-default rates while in bankruptcy court, as the Rules apparently invite, ACAS' NOI would soar as its cost of funds plummeted back not only to single digits, but to levels not seen since 2008. ACAS' NOI is based in large part on the spread between its borrowing price and the interest it is paid by portfolio companies, so ACAS really wins if it is allowed to pay only non-default interest as the price of continuing its operations. Unless ACAS decided to pay default rates of interest simply to keep creditors happy, ACAS' NOI could multiply overnight simply by making a $1039 or so filing fee with the local bankruptcy court.

Result
The question what happens in Chapter 11 is not "what" really, but "when" – ACAS has the power to pay creditors indefinitely, and despite the default interest, its business is apparently improving. It can either urge the Court to quickly approve its reorganization plan or it can enjoy the benefits of having creditors over a barrel to get a better deal and prolong the non-default-interest while doing business as usual. Creditors deprived of default-rate interest might suddenly decide the reorganization plan is attractive and sign on, but that's not essential to ACAS' financial success. Since no claims are being eliminated in the reorganization, and no creditor is becoming an equity owner, there's no impact on equity owners other than (a) the flight of institutions forbidden by their charters to hold equities under the jurisdiction of a bankruptcy court, and (b) the reorganization of ACAS debt to lower interest rates and the consequent increase in NOI as ACAS' cost of funds plummets out of the double-digit range.

Frankly, I can't tell why ACAS didn't file months ago.

Any big downward post-filing price move in ACAS shares is a buy: it's based not on rational appraisal of ACAS' likely long-term results, but on the fear caused by ignorance of Chapter 11 proceedings and terror of the stigma of bankruptcy courts. Also: imagine the post-bankruptcy pop when ACAS, free of any debt default, emerges with a low cost of funds to continue business as usual. Yes, a definite buy.

Even for the ACAS-overcommitted Jaded Consumer!

12 comments:

Anonymous said...

Great, great write-up. It makes this equally overcommitted reader relax just a bit more.

Jaded Consumer said...

I hate to think I might find myself dispensing Kool-Aid in Jonestown, but the fact is that nobody who's published a bear take on ACAS has offered anything that smacked of cogent analysis. I'm therefore sorely tempted to look at ACAS' record for getting "fair value" and better on exit from investments, its substantial discount from NAV, and the impending drop of interest rates in a debt restructuring (whether by agreement or by court order), and conclude that there is so much upside (and in light of ACAS' interest coverage, hardly any discernible downside other than caused by panicked sellers offering another buy op) that one would miss a fantastic opportunity to fail to buy.

In comparison, I offer AGNC. Run by the same management, AGNC has liquid assets and thus avoids the "what is it worth" problem that has plagued ACAS in the hearts of bears. AGNC trades at a premium to NAV and has a dividend so fat it's hard to believe. Even down to $1.40/q from the $1.50/q peak, AGNC is a monster income stock. ACAS holds a big pile of AGNC and takes a management fee from it; ACAS buyers get a slice of AGNC at a discount with every share of ACAS. They also get a slice of ECAS (at a double discount, which is likely to evaporate when the debt restructuring takes both ECAS and ACAS out of technical default), a discounted stake in MION (which ACAS claims has a "fair value" of $10 but refused to sell last week at $11, suggesting strong effort to get more), and a broad portfolio of smaller companies with diverse businesses.

As the economy improves, so will the broad base of ACAS' income-generating portfolio companies.

Hard to say "no" to that.

Berkshire Hathaway, which I bought last year at $3000 per share (before the 50-for-1 split), has a diverse porfolio of hard-to-value companies but no debt default, and has done something like +20% or so even after these last few awful months. When ACAS gets out of default, it'll be catching up both because of economy improvement and because of discount evaporation: a double-whammy.

Incidentally: did you ever read Double Whammy by Carl Hiassen? Hilarious.

Matt said...

IMO I think the book value is north of $8/share. That is also a depressed book value. From what I can tell the risk to owning ACAS right now is solely headline risk. When it comes across the tape that ACAS files for ch 11, this thing will get crushed, I imagine. At that point the equity will be a compelling value.

One thing I would like to know is who are the debt holders that are holding up the restructuring. I have heard whispers that it is Paulson & Co, among others. What I can't figure out is why Paulson would inject 200m+ of equity just to have that cash turned around to pay off creditors, but then not agree to restructure the debt.

There is either a high level game of chicken going on or else the public debt holders are holding out for an ungodly restructuring package.

Part of me hopes ACAS trades with a 3 handle.

TR said...

Excellent post. I understand how much cash ACAS has on hand, but I worry about the common shares. If a bankruptcy judge decides to cancel the common shares, as is common in a Chapter 11 for a publicly traded concern, we have nothing to show except for penny shares in ACASQ.PK.

I'm cursing over exercising my ACAS 2.50 May calls instead of selling them.

Jaded Consumer said...

TR: On what basis would a judge ground an Order "canceling" the equity of a solvent company? With all the debt holders being paid timely interest, ACAS is entitled to keep running its own business.

ACAS isn't looking for relief from equity obligations. There's no replacement of equity holders with former creditors on the table here.

This kind of fear is what I think will create the crazy buy op that bankruptcy filing would create. ACAS' interest coverage is solid, its NAV is not only positive but increasing, and it's flush with cash.

The fact people have seen restructuring that involves debt cancellation and the replacement of common holders with former creditors doesn't mean that has any prospect of occurring in ACAS. ACAS can pay its bills. ACAS could retire all the non-consenting debt with cash on hand, even.

On filing, ACAS will be a "be greedy when others are fearful" opportunity.

If you have ACAS and fear the filing, sell with an eye toward repurchase on post-filing price collapse. NAV greatly exceeds even current prices, and the debt restructuring will eliminate the theoretical basis for the NAV discount. Improved borrowing costs will drive up NOI because of spread increases.

The sun will come out and faeries will dance on the dandelions! Okay, maybe not the faeries. Still, I'm waiting for some rational bear explanation. Sure, exiting institutions will drive down ACAS shares on filing, but this has nothing to do with operations, and in the end the market will be a weighing machine rather than a beauty contest. The profit will out.

Matt said...

TR: No way in hell the equity gets wiped out. In this case, Ch 11 is more of a formality and will not really be used to determine the recovery of debt holders, because in reality they debt holders are getting better terms than they got pre-default. 44m shares traded today...I think those who wanted to get out got out.

TR said...

I agree, it sounds silly. But this is new ground for me. I have not owned any stocks in Chapter 11 that have not ended in canceling of common shares. See
http://www.sec.gov/investor/pubs/bankrupt.htm

So OK, in ACAS's case, this probably won't happen. But I could envision some sort of outcome where the stock becomes delisted and trades on the Pink Sheets as ACASQ. The company pays off all the debt holders. Whatever is left is distributed to common shareholders as cash (a few bucks maybe, forget about valuation multiples). They could then start over with a new ticker symbol on the big board, or hell, even go private with Paulson & Co. and some spanky new bond holders.

Thanks for letting my imagination go wild here. :)

Jaded Consumer said...

You can never say it's over. Bankruptcy will also cause some departures if it occurs, which does in fact look likelier now that it's clear some of the smaller creditors are voting no. (When I say smaller creditors, I mean there's precious little principal behind the "no" votes in comparison to the 100% "yes" behind the $1.4B unsecured credit line.)

Since the plan ACAS urges on the Court calls for no debt forgiveness, and for no conversion of creditors' claims into equity, there's no basis for the Court to do anything shareholders would find to prejudice their rights. ACAS will conduct business as usual as debtor-in-possession, and ACAS will seek Court approval of some plan – presumably including, if necessary, alternatives that simply call for paying objecting creditors their equity to get rid of them.

ACAS has much more cash than needed to make the payments called for in its debt exchange agreement.

The secured creditors have no call to cause anything to be liquidated, because ACAS has more cash than is needed to satisfy the secured creditors.

All the nightmare scenarios are pretty much taken care of, and what's left looks pretty good: debt restructuring by agreement or by Order, NOI improvement due to interest rate reduction from default levels, and more business as usual while the NAV is heading back up.

Aside from the ugly word "bankruptcy" what's not to like? ACAS isn't bankrupt in the sense anyone usually means the word, of course; but it's the bankruptcy court that has jurisdiction to sort out the creditor dispute that will result if ACAS' creditors all try to accelerate on the basis of blown debt covenants despite being paid timely all the payments due under the debt agreements. All the Court will do is ensure order while this is sorted out. That's what the Court is there for.

Jaded Consumer said...

TR re distributing cash:

Nobody at ACAS is planning to liquidate in favor of distributing cash. ACAS as debtor-in-possession will keep operating its business. Management believes in its business – have a listen of the conference calls, and see if you disagree they mean what they say – and is building something for the future. The debt exchange isn't about liquidating, it's about reducing the cost of debt for future operations.

The chain of events that would lead to liquidation would require factors simply not present here.

The reason most bankruptcies involve the destruction of the pre-bankruptcy equity is that in most bankruptcies, the company has negative enterprise value when the company enters bankruptcy. Chapter 11 is, for these companies, a desperate attempt to avoid the loss of a business that has failed. ACAS, by contrast, has positive net assets and ALSO sufficient operating cash flow to service existing debt even at default rates of interest. ACAS isn't a liquidation praying for the world to change in its favor during the pendency of court proceedings, it's a solvent going concern well able to pay its debts as they become current, provided they don't all accelerate overnight due to debt covenant breach. The bankruptcy court will ensure the acceleration doesn't happen (the Chapter 11 debtor can avoid this simply by paying non-default interest timely) and will have jurisdiction to handle disputes over the shape of the debt exchange.

I can see why people are confused – most folks heading into bankruptcy are really worth more dead than alive – but ACAS isn't a liquidation, and there is no plan to require any debtor to accept less than 100% of the principal due. There is therefore also no expectation that equity holders will get diluted by conversion of debt to equity, or the like. ACAS' situation is different, and its outcome will reflect its situation.

ACAS doesn't want to go private; it started private, and management went public to access more funds. Management wants to be the biggest and the best private asset manager and middle-market private equity company on the planet – which is why it created ECAS, and why it was opening Asian offices before 2008 hit.

ACAS doesn't plan disappearing, and it's got both the cash flow to keep afloat and the bankroll to ensure it survives as the market turns in its favor. Look at the NAV trend the last few quarters: ACAS is doing fine.

The debt default panic and the bankruptcy court are causes of uncertainty, and uncertainty poisons buy sentiment. We could see even better deals in ACAS shares before the cloud passes. Looking at the information known about ACAS, though, it's clear that this is a cloud that passes.

Jaded Consumer said...

Another view of ACAS in light of the Chapter 11 prospects is here at wallstreetmedia.com.

Anonymous said...

Dear Jaded Consumer,
Great analysis as usual and a cool head as always. One question -- in case of a BK like this one, how would the court value the company? Would it use ACAS's valuations?

(Note: I'm long and likewise overcommitted because this position could significantly shorten my working years.)

Jaded Consumer said...

Anonymous re Court valuing ACAS: The Court doesn't value debtors. The Court just decides disputes.

When the Court has a debtor that can't pay off its creditors, it does things like decide how different creditors' claims will be classified if there's a dispute under the rules governing prioritization, decide whether someone was committing fraud if someone alleges it, decide whether to allow a creditor to pursue a lawsuit against a debtor to create a new debt once the debtor is already before the bankruptcy court, and so on.

In this case, ACAS wants the Court to decide whether its reorganization plan (that pays down principal and gives creditors a bonus on the way) should be shoved down the throats of the minority of unsecured creditors who are not in favor of the plan. While ACAS is before the Court, it'll keep operating its business as debtor-in-possession, because it's fully capable of making timely payment of interest to all its creditors.

The Court will never be asked about ACAS' value, although ACAS will have to make reports about its value promptly on filing with the Court (it has to prove it's a real Chapter 11, for example, and not a Chapter 7; its huge positive net asset value is the key to making this obvious, but without ACAS' financial condition reports, the Court would never know).

While I'm not eager to see ACAS take a hit, I would be interested in an opportunity to make an investment at obviously erroneous prices. The bankruptcy filing could be just the opportunity.