A Primer on Bankruptcy for Non Lawyers

We see a notable increase in bankruptcy filings during the coronavirus pandemic. We describe the typical bankruptcy process in this primer.

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Bankruptcy Primer

Summary:

A rise in corporate bankruptcies, as well as the pressure felt by companies not in bankruptcy to rid themselves of non-core assets, are expected to result in an increase in private equity opportunities for investment in bankruptcy sales and corporate divestitures. Because management and operational problems typically accompany the financial difficulties experienced by such companies, investments in these companies are difficult to analyze. Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company, the “debtor,” might use Chapter 11 of the Bankruptcy Code to reorganize its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court. Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to liquidate (sell) the company’s assets and the money is used to pay off the debt, which may include debts to creditors and investors. The investors who take the least risk are paid first. For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy. Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment. The bankruptcy court may determine that stockholders don’t get anything because the debtor is insolvent – debtor’s solvency is determined by the difference between the value of its assets and its liabilities. Most publicly-held companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process. Chapter 11 provides a process for rehabilitating the company’s faltering business. Sometimes the company successfully works out a plan to return to profitability; sometimes, in the end, it liquidates. Under Chapter 11 reorganization, a company usually keeps doing business and its stock and bonds may continue to trade in securities markets. The U.S. Trustee, the bankruptcy arm of the Justice Department, will appoint one or more committees to represent the interests of creditors and stockholders in working with the company to develop a plan of reorganization to get out of debt. The plan must be accepted by the creditors, bondholders, and stockholders, and confirmed by the court. However, even if creditors or stockholders vote to reject the plan, the court can disregard the vote and still confirm the plan if it finds that the plan treats creditors and stockholders fairly.

 

 

Argentina Defaults on Sovereign Debt Amid Coronavirus Crisis – Debt Restructuring Case Study

Wall Street Journal, May 23 2020 ” Argentina Defaults on Sovereign Debt Amid Coronavirus Crisis – The country is struggling with economic contraction, runaway inflation and a hard-currency squeeze”

Argentina defaulted on sovereign debt for the ninth time in its history, as Latin America’s third-biggest economy grapples with a new cycle of economic contraction, runaway inflation and a hard-currency squeeze exacerbated by the coronavirus pandemic. The cash-strapped country officially entered into default on Friday after failing to make a $500 million interest payment on foreign debt. The…

We examine here the  anatomy of two historical instances of Argentina Debt Exchange Transactions — February and June 2001

–Argentina Reverse Dutch Auction exchange – February 2001 when the Republic successfully exchanged over $8.0 billion of international and domestic securities

–Argentina “Mega Debt Exchange”—June 2001 when the Republic successfully executed a $29.5 billion debt exchange of 46 eligible international and domestic debt securities

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Argentina -Sovereign Debt Exchange Transactions 2001 Anatomy

 

 

Foreign M&A Deals: Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

We expect much greater scrutiny for foreign M&A deals as well as delays especially for direct investments made by Sovereign Wealth Funds, particularly China Investment Corp. We describe the ‘typical’ approval process timeline and outline key considerations in the highly opaque and secretive CFIUS review process.

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Acquirer Considerations:

What is the host country for investor?

  • UK, Europe, Canada, Japan, Korea, raise few security or political issues
  • 7 countries investing the most in the United States, all of which are United States allies (the United Kingdom, Japan, Germany, France, Canada, Switzerland, and the Netherlands) accounted for 72.1 percent of the value added by foreign-owned affiliates in the United States and more than 80 percent of research and development expenditures by such entities
  • China raises unique issues

Does the acquirer have a good record of compliance?

  • Focus on US, foreign laws and previous CFIUS commitments
  • Focus also on acquirer’s record with respect to its own products or services or competition practices

Does the acquirer have state ownership?

  • Have the acquirer’s leaders been implicated in any law enforcement or regulatory actions?
  • Has the acquirer effectively complied with previous CFIUS commitments?
  • Will investment raise political issues in Congress?

 

Target Considerations:

  • How important are target’s assets to national security of the United States?
  • Are there government contracts?  With which agencies? Classified?
  • Is target a direct supplier to U.S. government or subcontractor?
  • Does the target have export-controlled technologies?
  • Are the target’s assets considered “critical infrastructure”?
  • Does target have outstanding litigation or competitive issues that could lead competitor to politicize CFIUS process?
  • Who are the target’s non-government customers?
  • Has the target effectively complied with previous CFIUS commitments?
  • Does target have dominant position in market for key technologies or services?

Economy: Oil Market May 22, 2020

Oil prices rise to $33. Storage crisis easing. Supply curtails to 11.5 million b/d. Fuel demand increases and stockpiles reduce 5 million barrels. States ease lock-down and travel rises.  Demand uptick matched with OPEC supply cuts, and U.S. wells shutdown. But gasoline demand is still soft, and outlook is still fragile with low prices discouraging production.

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M&A Collar Comparison Floating vs. Fixed Exchange Ratio

6- M&A COLLAR Comparison

ActiveAllocator Research- An excellent Forbes article points out that the M&A environment has radically altered in the coronacrisis. Among other things, pandemic induced uncertainty increases negotiation period, surfaces newer due diligence issues as well as increases effort to obtain third-party consents. It also delays antitrust and regulatory approvals, makes buyers and their boards of directors much more cautious, shifts more closing risk and indemnity risk to sellers, brings added risks of “buyer’s remorse” and above all raises valuations concerns.

We recommend a collar to hedge the time to closing risk and point out the advantages and disadvantages of fixed vs. floating ratio hedges.

Source Forbes article: https://www.forbes.com/sites/allbusiness/2020/04/17/impact-of-coronavirus-crisis-on-mergers-and-acquisitions/#3cae7092200a

Mechanics:

5-M&A collar illustration

 

 

The Capital Allocator’s Perspective – Framework for Operational & Investment Due Diligence

The record of Operational & Investment Due Diligence within private equity, real estate, hedge funds and traditional investing has been dismal through the ages. An after the fact event, it is usually about shutting the barn after the horse has bolted. The function has done very little to insulate investor portfolios from losses. The activity has devolved to fiduciary CYA, designed to protect the wealth management firm, pension or sovereign fund, consultant or product purveyor from liability. In going through a roster of standardized questions, to which are offered standardized answers, it is about dotting the ‘i’ and crossing the ‘t’.  One now sees new digital platforms that collate, collect, structure, and offer fund manager data for easy access to prospective investors.

The Capital Allocator is in the business of entering into partnerships with fund sponsors to potentially generate significant returns, mainly through long-term capital appreciation, by making, holding and disposing of privately negotiated equity and related investments.

Such investments are usually made as a passive investor in vehicles directed by a third party fund sponsor; as a result, the investor has only indirect influence over-achieving ultimate investment objectives. We believe that a methodical approach to selecting sponsors—which combines scientific rigor with seasoned subjective judgment— may contribute to creating strong results in a variety of economic environments. We present here a ‘best practices’ framework for selecting financial sponsors. We draw attention to important issues, metrics and considerations deemed worthy of exploration.

What follows does not represent an exhaustive list, of course. Each investment and operational diligence mission inevitably take one down paths that are not common to other missions. One must be prepared for this—and even seek it and relish it. For, it is forays beyond the common and readily available, that enable real insight into the people with whom one entrusts with one’s capital.

What is missing is the capital allocator’s nuanced perspective. We suggest one here.

Download PDF here:

Direct_Investing_DueDiligence_5-20-ActiveAllocator

Do Illiquidity Provisions Boost Hedge Fund Performance?

Retail investors who are ineligible to invest in quality hedge funds, in hard to access investment vehicles, either because they do not meet minimum levels of wealth or income standard, or the high subscription amounts often needed to participate in such funds gravitate to liquid alternative investments. The rise of liquid alternative investment funds, packaged in mutual fund formats over the past years, as the fastest growing category of “alternative investments” is now well documented. McKinsey & Company suggest “retail alternatives will be one of the most significant drivers of U.S. retail asset management growth over the next five years, accounting for up to 50 percent of net new retail revenues”.

With liquid alternatives beginning to find increasing traction in institutional portfolios too, the question is – are they an effective substitute for hedge funds and other illiquid structures? Little empirical fact based exists and opinions abound.

Our research at ActiveAllocator.com attempts to answer this question and concludes that they are not.

Retail investors in considering hedge funds immediately encounter a wide variety of strategies, organizations and structures. Indeed, hedge funds, rather than being an asset class, are broadly a collection of governance structures and investing techniques with many common structural features. Unfortunately, from an investor’s perspective, it is often difficult to decipher which structural features are useful, which imply tradeoffs and which are simply undesirable. The dearth of empirical research leaves investors to make intuitive judgments about what features they should favor.

We re-examined a sub-set of provisions governing fund investing- liquidity terms. In contrast to alternative mutual funds, which allow investors to redeem their holdings on a daily basis with little or no advance notice, hedge fund investors are subject to a variety of terms that may restrict their ability to access their capital. All things equal, investors prefer more liquid investments to less liquid investments. Liquidity provides investors with a valuable option – specifically the opportunity to trade in and out of investments in order to rebalance a portfolio, respond to unforeseen cash flow requirements or redeploy capital towards other opportunities.

While the benefits that liquidity offers to investors are clear, the costs associated with greater liquidity are less apparent. We explored two related questions:

•Do investors pay a price – in terms of lower investment returns – for better liquidity? In other words, do funds with more favorable liquidity terms underperform less liquid funds?

•If the answer to the question is yes, then what drives this cost? In other words how can one explain the under-performance of more “liquid” funds?

Our research finds that there has been a substantial performance cost from offering increased liquidity. The under-performance cannot be attributed to fee levels or the strategy pursued by a particular fund. We are unable to attribute the liquidity cost to differences in skill across managers; we do not find strong evidence that less skillful managers (whose performance is weaker) offer more attractive liquidity terms.

Instead, our results indicate that managers who offer more restrictive liquidity terms are able to outperform more liquid managers because they are able to pursue a broader range of attractive trading opportunities.

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Do Illiquidity Provisions Boost Performance

Model Portfolios. One Size Fits All. Bad Bad Idea During Coronacrisis.

The notion of putting retail investors in cookie-cutter mass-produced standardized buckets of allocations, referred to as model portfolios, is remnant of antiquated ‘90s thinking. In 2020, during the coronacrisis it is akin to paying a doctor expensive (very typically over 1% of assets) fees for an over-the-counter pain medicine prescription.

Bespoke allocation goes far beyond conventional passive risk and return trade-off found in model portfolios. It personalizes for unique investor preferences including accommodating a desire or aversion to alternative investments, expressing preferences for desired levels of illiquidity, considering different investing horizons, incorporating time varying risk preferences as well imposing constraints on specific asset classes to reflect unique investor circumstances.

Departing from model portfolios has potential to foster greater transparency. Moreover, it raises the quality of discourse an advisor has with her client. It encourages a conversation not on historical, but around forward looking risk- return expectations. It also brings nuance in investment decision making, conspicuous by absence in model portfolios.

Rather than persist with the historical notion of putting clients in coarse model portfolios, a far better approach is to begin by analyzing the forward-looking statistical properties and expected behavior of a client’s existing portfolio. This helps to arrive at the best combination of asset sub-types that improve existing allocations on a variety of chosen metrics.

ActiveAllocator.com lets you create bespoke portfolios in 10 clicks, in 10 minutes and at 1/10th cost.

ActiveAllocator is a digital asset allocation platform with technology-enabled customized advice capabilities. It is the world’s first portal that seamlessly integrates traditional, illiquid and alternative investments within portfolios. It helps investors analyze existing allocations, discover inefficiencies and create bespoke portfolios in minutes.

 

Transcend Cookie Cutter ‘Model Portfolios’ in 10 clicks, 10 minutes, 1/10th Cost

ActiveAllocator helps you go beyond traditional model portfolios by utilizing disruptive technology driven personalization. Create directional, semi-directional and non-directional market exposures in minutes.

  • Aggregate your holdings in seconds across your banks, financial advisors and custodians. Arrive at your true economic exposure. Go beyond financial products, and funds and securities you own. Understand why you may be sub optimally allocated.

 

  • Then, in seconds, optimize your portfolio on by linking your brokerage accounts and send order messages to your broker directly from ActiveAllocator’s platform. Once done, import real-time portfolio data from your brokerage firm, and see the most current picture of your portfolio’s – not historical but rather,  forward facing characteristics.

 

  • Compare your portfolio with others’. Including those, supposedly bespoke, being created by private banks and wire-houses at huge fees with attendant product driven conflicts of interest.

 

  • Increase your asset class universe to over 50 sub asset-classes including alternative investments, automate implementation, trading and periodic re-balancing.

 

  • Express your own investment views while making strategic allocation decisions.

 

Investing in Distressed Debt

Download white paper authored by Sameer Jain to explain the characteristics of distressed debt.

investing in distressed debt

#ActiveAllocator Research – Distressed Debt. WSJ today, May 19 page B2, reports that 59 distressed debt funds are in the process of raising $67 billion. I have long advocated that opportunistic and distressed debt may have a useful role in investor portfolios. I had authored one of the early white papers explaining the characteristics of distressed debt which whilst dated in the data is still very useful.

Watch video: The updated 2020 opportunity

 

Commenting on WSJ Article May 18 2020, “Saudi Fund Snaps Up Some U.S. Stock Bargains”

WSJ article May 18, “Saudi Fund Snaps Up Some U.S. Stock Bargains”.  Saudi Arabia’s $300 billion SWF, The Public Investment Fund,  in Q1 2020 bought around $500mm equity each in Facebook, Walt Disney, Marriott, Cisco, Citigroup, Bank of America, Boeing, Carnival, Live Nation Entertainment inter-alia.

The U.S. has long been very open to receiving foreign capital in U.S. firms. Now we see a rise in protectionism,  trade barriers and inward-looking sentiment seeping into policy and regulation. The number of transactions reviewed by the Committee on Foreign Investment in the United States (CFIUS) has been growing and the fear of foreign state governments buying distressed assets increases. Opposition is no longer just vocal; a lot of activity is taking place behind the scenes in Washington. Constituency interests, too are crowding out traditional policy interests. Any involvement, other than through voting of shares, in substantive decision making of key U.S. companies is likely to be scrutinized. For mergers and acquisitions post CFIUS review, the standard process could now be longer than the typical 45-60 days if the transaction is believed to be a “threat to impair” national security.

This will be especially true for direct investments, more than for portfolio investments. How different SWFs are treated depends in large measure on how transparent they are, national security concerns as well as reciprocity.

11=Saudi PIF

Increase in Corporate Separation Choice After 2020

As coronacrisis progresses expect companies to separate portions of business. Such actions will be typically driven by strategic decisions to divest businesses and/or valuation creation opportunities. Often there is a valuation drag on due to ownership of lower valuation businesses. Spin-offs often have potential for shareholder value creation when investors have higher valuation expectations of the new separate public company.

spinoff-1

Technology Driven Personalization in Financial Advice

ActiveAllocator’s core growth strategy capitalizes on several long-term industry trends that continue to be valid and even stronger in 2020. One being mass-customization. Technology driven mass customization is affecting many customer oriented industries, driving clients to expect highly personalized services uniquely tailored to their specifications. ActiveAllocator allows the “traditional” advisor to provide a modern digital advice experience. Recognizing that the “market of one” is the new norm, we go far beyond broad meaningless categories such as the wide spectrum of “very conservative” to “very aggressive” investors. Rather, our system is designed to drive the individualization of every aspect of asset allocation, down to the level of a single client.

Customers demand personalization without realizing they are demanding it, as they grow accustomed to companies anticipating their needs and offering what they’re looking for – sometimes before they even know what that is. Retailers and travel companies are using predictive tools and algorithms to exceed expectations, yet digital teams at financial firms have been slow to re-engineer websites and apps to enable highly personalized digital experiences. As consumers become more accustomed to personalized services – from online music selection, to customized exercise plans, to personal shopping, to travel – expectations will further rise. Within the financial advice sector, our approach rapidly exposes the fallacy of the “one size fits all” solution approach – such as those embodied in model portfolios and managed accounts.

Personalized service is going to be a key weapon in advisors’ battle, against competition from and disintermediation by, digital advice platforms. Once investors realize that the same managed accounts offered by advisors can be manufactured in minutes by robo-advisors at a fraction of fees, advisor fee compression is but inevitable. In an era when money can be managed effectively, efficiently and cheaply, ActiveAllocator helps advisors move up the value curve. Marrying our cutting edge fact-based, algorithm-driven predictive analytics with the advisor’s special understanding of the client’s unique circumstances drives superior outcomes. We believe that this powerful combination goes far beyond anything offered by emerging digital financial advice platforms, robo advice and digital investment managers.

 

 

Central Bank Reserve Management: How Much is Too Much?

6-how much central bank reserves

#ActiveAllocator Research: Ideas about the right level of international reserves have changed with the evolution of markets and crises. Paul Krugman in a recent interview suggested that the attitude at the moment should be “don’t worry about government deficits so much and start spending”. The U.S. Federal Reserve and other counterparts have moved aggressively with sweeping emergency rate cuts, and offers of cheap dollars, to help combat the coronavirus pandemic. Emergency policy easing by central banks in UK, Europe, Japan provide stabilization. But can countries pump indefinite  liquidity into markets to support monetary and fiscal stimulus? The coronavirus pandemic will test how much debt countries can bear.

 

For much of the post-war period, the rule of thumb was that international reserves should cover three-to-four months of imports. The Guidotti rule that reserves should exceed short term debt is now generally accepted as benchmark for assessing the adequacy of reserves – governments should be able to stay out of market for new financing for up to a year if needed. With the growth of capital markets, views of reserve adequacy have changed. Countries are now expected to have more reserves to protect against potentially large and disruptive capital flows, even if the exchange rate regime is floating

Factors include the exchange rate regime, the size and currency composition of the debt, trade flows, monetary aggregates and an assessment of risks and structural aspects of the market. Taking all these into account often raises the estimate of required reserves

 

Which Asset Class is Now Attractive For You? Which is Not?

The world has changed in 2020 and so should your investment portfolio. But has it?

Given what you/ your client already owns within a portfolio, should  one own more of a particular asset class? Or less? What is attractive and what is not?The most consequential, and often best decisions, are those that are made at the margin. However marginal decomposition, on a forward- not backward -looking basis within portfolios is easier said than done. While there is much written in the academic literature, one is often hard pressed to arrive at fact based decisions at the moment of making investing calls.

In the past such was often relegated to opinion, conjecture and gut feel. Not anymore. ActiveAllocator calculates it for you in 15-20 seconds.

M&A Collar Mechanism – Floating Exchange Ratio Terminal Choices

I illustrate a variant of the M&A collar  through a floating exchange ratio. This is rather atypical but I have encountered it in the past. Here, issues differ from a fixed exchange ratio giving rise to multiple possible events at end points. There are many ways one can prepare for this including : (i) Terminate / Walk Away (ii) Renegotiate Exchange Ratio (iii) Pre-signing Agreement to Accept Fixed Exchange Ratio (iv) Possible Cash Top-Up

5-M&A collar illustration

M&A – Uber Grubhub Merger Can Benefit From Collar

Given heightened market uncertainty, volatility in share prices, a cloudy outlook it is now important to hedge time period to closing risk in M&A deals.  We recommend that a  collar around announced deals is especially useful.

If acquiror share prices fall or rise beyond a certain point, the transaction switches to a floating exchange ratio. Collar establishes the minimum and maximum prices that will be paid per target share. Above the maximum target price level, increases in the acquiror share price will result in a decreasing exchange ratio (fewer acquiror shares issued). Below the minimum target price level, decreases in the acquiror share price will result in an increasing exchange ratio (more acquiror shares issued).

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Financial Sector Distress – Restructuring and Common Solutions

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#ActiveAllocator Research – If the corporate sector is increasingly distressed, won’t the financial sector follow? Historically, governments have used a variety of tools to address financial crisis and recessions with policies of either containment or resolution. For example, in 2008, government intervention moved from the provision of short-term liquidity, through distressed asset funds to medium-term guarantees to full-scale bank capital injections, nationalization and brokered rescues. Whilst the banking system seems secure in the coronacrisis, I think it is inevitable that governments will borrow from previous playbooks.

As one who was a front row participant in the 2008 crisis here are some of my takeaways to what may be an inevitable sector restructuring – if not in the U.S., then most certainly in many countries where the contagion is already spreading from the real to the financial sector.

M&A – Uber Grubhub Merger Can Benefit From Floor & Cap

Proposed Uber Grubhub M&A lends itself to be a game theory case where the acquiror (Uber) and target (Grubhub) share holders have opposite interests in pricing  – i.e. how to get the acquiror and the target to agree on a price at which the acquirer can purchase the target. Locking in a floor and cap brings benefits to both parties.

3- floor and cap

M&A – Uber Grubhub Proposed Merger is Not Pandemic Profiteering

ActiveAllocator Opinion –  I profoundly disagree with U.S. Rep. David Cicilline, D-R.I., who chairs the House’s antitrust subcommittee, and  has come out in opposition of the Uber Grubhub deal. In a statement, he described it as ” marks a new low in pandemic profiteering”. I compare the pros and cons of fixed price (number of shares issued varies depending on acquiror’s stock price changes) and fixed exchange ratio (constant number of shares issued, value delivered changes). The Uber offer is a fixed exchange ratio and show in this visual that in my opinion Grubhub investors interests are well served.  This is not pandemic profiteering!

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Uber Grubhub Proposed Stock Merger Structuring Alternatives

Uber recently approached Grubhub with a potential all-stock takeover bid. Apparently it is structured as a Fixed Exchange Ratio (Floating Price) offer. This suggests Uber does not expect stock price to  rise during the time it takes to consummate the merger. In public market M&A transactions, where at least part of the consideration is stock of the acquiror public company, the value offered is subject to market risk as the acquiror’s stock price changes. A visual illustrates.

1-Uber fixed shares

 

Rise of Protectionism in M&A Deals in USA

We build on our M&A series by drawing attention to changes in US regulatory environment for foreign deals in the Trump presidency. The national security landscape has shifted in recent years, and so has the nature of the investments that pose the greatest potential risk to national security. Recent amendments to the Committee on Foreign Investment in the United States (CFIUS) process now brings significant hurdles to foreign investment in ‘sensitive’ sectors. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) was signed into law after receiving broad bipartisan support in Congress and new regulations are expected. We provide historical context, highlight recent evolution and provide color on consummating such transactions.

New USPS Postmaster General Louis DeJoy Should Divest Real Estate Portfolio

The changing dynamics and competitive pressures of  the postal industry should catalyze introspection to monetize its real estate portfolio. USPS core business is not be a real estate owner. Portfolio analysis and segmentation ensures that maximum value is extracted real estate owned. We urge new Postmaster General Louis DeJoy to segment and monetize  its considerable real estate assets.

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