Tag Archives: STP

Portfolio transactions (EHL.AX, STPFQ, PRIS.A/B)

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Emeco Group (EHL.AX)

I exited a couple of positions the past few days for various reasons. Today I sold my stake in Emeco Group because I think that my initial thesis is broken. I bought the company because I believed that the assets would be worth more than the current enterprise value of the business, and that the company would earn enough to manage their debt load.

Based on the latest trading update both now appear to be false. The company announced one week ago that it would close the Indonesian business segment and that they would incur a A$38.5 million impairment charge on their equipment. They have also relocated approximately A$10 million of their Indonesian fleet to Australia. Given the fact that their Indonesian fleet was just A$81 million at the end of this year this means that the impairment was approximately 54% of original book value. If you would apply the same discount to the remainder of their fleet it would completely wipe out equity.

So I think the margin of safety that I thought was there simply isn’t there. I also didn’t like that they had to refinance their debt at a high interest rate to get rid of some covenants. I originally thought they would be able to meet them by simply selling equipment.

Suntech Power Holdings (STPFQ)

I also exited my short in Suntech, and this is something I should have done a few months earlier because at the current low price of the stock the carrying costs of the position are a bit too much (despite the fact that I was synthetically short using a structured product instead of having to borrow shares). The short position returned 56.4% in a bit more than a year time, a result I’m happy with since the leverage of the position was less than one.

Prisa capital structure arbitrage (Class A/B shares)

When I wrote about the irrational pricing of the Class B shares compared to the Class A shares the B shares were cheaper than the A shares despite the fact that they were superior in almost every way. We are now nearing the automatic conversion of the Class B shares in the Class A shares, and I managed to exit most of my position at a fair premium. The automatic conversion will be at 1.33x A shares for every B shares, and there will be a 24.8% dividend on the B shares as well (payable in A shares).

Calculating the performance of a long/short trade isn’t easy, especially when you have traded a bit and when one leg is traded in euro’s and the other leg is traded in dollars. So the results below aren’t totally accurate. I have measured the gains and losses in the table below compared to the initial value of the short leg (the Class A shares):

Gross total return 130.5%
Borrow fees -12.0%
Trading costs -3.1%
Net return 115.5%
Return attributable to dividend payments 14.3%
Return attributable to premium increase 55.6%
Return attributable to residual long exposure 33.0%
Return attributable to trading profits 12.5%

I think this might be one of my best trades ever. That the outcome would be this favorable was certainly not a given: if Prisa would have entered bankruptcy I would probably have made just a little, or lost a little. But being able to double your money without significant market exposure is obviously pretty awesome :).

Disclosure

Still long some Prisa Class B shares, and short a few Prisa Class A shares. No position in STPFQ or EHL.AX anymore.

Suntech announces new forbearance agreement

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I have been short Suntech since the beginning of this year, but despite the fact that the company is in default on more than $500 million in bonds that were due last March not a whole lot has happened. Some subsidiaries are in bankruptcy proceedings, but the holding company itself has managed to push their debt problems forward by entering in forbearance agreements with the majority of convertible note holders. The second forbearance agreement ended today, and unsurprisingly a new agreement has been made that will expire on August 30, 2013. This time there is more clarity on how the debt problem will be tackled though:

In particular, the new agreement contemplates an equitization of all major debt claims held by the Bondholders. In addition, the Bondholders will nominate two additional members to the Company’s Board of Directors who will provide guidance and assist in the Company’s ongoing restructuring efforts.

It’s taking more time than expected, but the massive dilution to the equity that I’m betting on is getting closer…

Disclosure

Short STP

Bunch of quick updates (STP, WH, DSWL, SALM)

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Suntech Power (STP)

With the debt maturity of Suntech’s $541 million in convertible bonds at the end of this week it’s not a surprise that this issue is getting a fair amount of attention recently. Today the company announced that it had entered a forbearance agreement with 60% of the convertible debt holders. They have agreed to not exercise their rights until May 15, 2013 if the company doesn’t pay at the end of this week. Suntech’s plan is to try to restructure the notes. My bet is that this is going to result in massive dilution for the equity. Bankruptcy as a step in between also seems like a plausible scenario since 40% of the bondholders haven’t signed the agreement. It could take some time to see how this is going to play out.

WSP Holdings (WH)

Basically nothing has changed fundamentally between 21 February, when I first wrote about the going private arbitrage opportunity, and today. We are still waiting on the SC 13E3 filing, so it’s probably going to take at least a few more months before before it will go private at $3.15/share. Despite this the price has gone up from $2.83 to $3.05: changing the potential return from 11.3% to 3.3%. Annualized that would still be decent if it’s a transaction with zero risks, but it isn’t. So I’ve decided to substantially reduce my position in the company, and I’ve sold all my shares that I bought two weeks ago.

Salem Communications (SALM)

SALM has been on fire since I bought the stock a bit more than a year ago, returning almost 170% including dividends. Intrinsic value has been moving upwards at a significantly slower pace, and while I don’t think the company is expensive at current prices it’s probably getting pretty close to fair value. At the same time SALM had grown into a big position in my portfolio. Because of this I’ve decided to sell 50% of my position last week at $6.99. I’ll keep the other half to see at what rate they will be able to refinance their debt: I expect that this will provide a nice boost to FCF.

Deswell Industries (DSWL)

I have been looking at various Chinese small caps, but in most cases I’m thinking that I simply like DSWL more because it’s profitable, the balance sheet is rock solid and the company has a long history of returning cash to shareholders. Since Deswell wasn’t a very big position to begin with I thought the logical thing to do was to add a bit to this position instead of buying into an inferior idea. Increased my position size last week by 33% at $2.51.

Disclosure

Short STP, Long WH, SALM, DSWL

STP debt maturity in 9 days, board without plan

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The maturity date of Suntech’s $541 million in convertible bonds is getting very close and it seems that the company is heading straight for bankruptcy. Shi Zhengrong, who was ousted as chairman this week, said that the board has no solution to handle the debt maturity. With the maturity in 9 days there is definitely not enough time to organize a debt for equity swap, so bankruptcy is the only option if there is no miracle bailout. Despite this the market cap of the equity is still more than $200 million while the bonds are trading at 37% of par…

Disclosure

Short STP

Suntech Power (STP) short

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The Credit Bubble Stocks blog has written repeatedly about the overvaluation of Suntech Power, a Chinese manufacturer of solar panels. The Company has $541 million of bonds that are due in March and are trading for roughly 50 cents on the dollar for a yield to maturity of almost 500%. Despite the fact that the senior part of the capital structure expects to lose money the equity part of Suntech Power has a significant market capitalization. The stock has more than doubled last month and the company is now valued by the market at $340M.

Just based on the discrepancy between bond and equity prices you know that something doesn’t add up, and if you start looking at the financials I think it’s pretty obvious what part of the equation is right. The company has approximately 2 billion in debt and isn’t earning any money at the moment. EBITDA for the last twelve months is minus $117M, and that is a number that’s not including some very real costs. Last year the company paid for example roughly $100M in interest. It’s a bit unclear what the current financial condition of Suntech is. While the company announced financial results for the third quarter last month it’s a press release short on details: I don’t think I’ve ever seen a company announce financial results, but not tell anything about the achieved earnings or EBITDA. The latest complete financial numbers are from the first quarter of 2012.

What we do have is a nice presentation for bondholders that the company filed with the SEC last November. Included is for example a graph of the debt maturity profile:

Suntech Power Holdings debt maturity profileSuntech has been able to work with bank lenders to refinance their existing domestic loans, but the offshore debt that will reach maturity this quarter is more problematic. Suntech included the follow slide in the presentation about possible solutions:

Suntech Power Holdings Capital Structure Objectives And AlternativesAs is visible the company doesn’t expect to have a lot of options. Chinese banks are not willing to refinance the offshore debt, and issuing new bonds also doesn’t seem to be an option. So that means that there are basically two options left: bankruptcy or a conversion of the bonds to equity. It’s hard to see how that could work out favorable for equity holders…

It’s not a long, but is it a short?

Just because a company is a terrible investment it doesn’t have to be a good short. Especially when something is obviously overvalued there is often no cost effective way to go short. It might be impossible to borrow shares or the annualized cost of borrowing might be through the roof (100%+ was not uncommon for Chinese frauds). Not only can a short position be difficult and expensive to maintain, if it’s a popular trade you also risk a short squeeze. At the same time you also see that the implied volatility of put options increases dramatically. So what often happens is that you end up with a situation that can only be ‘arbitraged’ away by people that are currently long the stock.

Suntech Power certainly falls in the ‘obvious short’ category. My broker has currently just a handful of shares available for shorting and for the privilege of borrowing these you’ll have to pay a 25% annualized fee. With a possible catalyst in March when the bonds reach maturity this might be doable, but it’s certainly not perfect. Same can be said about buying put options. If you think that STP will go to zero in a few months time you can make a profitable bet, but profiting from a small(er) decline isn’t that easy.

Mini Short Certificates

Luckily for us there are also some exchange traded structured products that have STP as an underlying that make it possible to initiate a cost effective short position. RBS is offering several STP Mini Long and Mini Short Certificates. These are popular retail products (marketing names of similar products: Turbo’s, Speeders, Sprinters) in Europa that offer the possibility of creating a levered long or short position with some build-in risk-management since you can’t lose more than your initial investment.

Let’s take a look at the Suntech Power Mini Short Certificate with a $3.40 stop loss and a $4.08 financing level. The value of the product is the financing level minus the value of the underlying, so with STP trading at $1.75 this product is currently worth $2.33 (€1.78). When STP reaches the $3.40 stop loss the product will be liquidated. In theory you should receive roughly the difference between $4.08 and $3.40 when this happens, but it could also be zero if, for example, STP gapped up on open to more than $4.08. So the risk that RBS is taking is limited: only when the price moves up more than 20% above the stop loss they will need to take a loss. But it’s nice that they offer some insurance against a tail event: you basically get a call option with a $4.08 strike. Because the financing level of this product is high relative to the share price the leverage is less than one (0.84x).

RBS offers a few different variants: this certificate has a lower financing level ($2.52) and has as a result more leverage (2.2x). The downside is that you will be stopped out of your position as soon as the STP price reaches the $2.10 level. I suspect that the Mini Short Certificates are relatively cheap because they are targeted towards retail investors, and RBS does not have a need to hedge their short position and borrow shares if they sell more long certificates then short certificates. The bid/ask spread for the certificate with a $3.40 stop loss is at the moment of writing €1.79/€1.82, so you are paying a very small premium.

Investing in structured products does have a number of risks. It’s a retail product, but it’s nearly impossible to figure out how it exactly works. The base prospectus (that should be read in combination with the final terms) is ~1000 pages thick. Despite the number of pages the document is surprisingly short on details. A search for the words “reasonable discretion” (my translation: we do what the fuck we want, and if we can screw you, we will) generates 516 hits. The fact that RBS is issuer, counterparty, and the only market maker is probably also not working in your advantage.

Conclusion

It’s obvious that I’m not a lover of Turbo’s and similar structured products, but compared to simply shorting the stock or buying puts I think it’s in this case a superior solution. That STP itself is a good short actually doesn’t need a whole lot of in-depth analysis. Based on the bond prices, the maturity profile, EBITDA and the short interest in the stock it’s clear that the current stock price is too high. With the bonds maturing in March it shouldn’t take too long to see how this is going to work out.

Disclosure

Short STP through a long position in STP Mini Short Certificates ($3.40 stop loss)