In Movies, Makeup, And Markets, Distress Comes Roaring Back

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With interest rates so low for so long and even the riskiest companies being able to find eager lenders, opportunities for distressed debt investors were few and few in between. But now, as inflation continues to rise and the Fed begins to aggressively raise rates to keep it under control, that’s all changing.

Data compiled by Bloomberg showed that, as of September 9, corporate bond and debt trading at distressed levels had risen to $189 billion, a 6.4% increase from the week before and 59 US companies so far this year. filed for bankruptcy. Three of them, each with liabilities of more than $50 million, also occurred during the first week of September. The most important of these was Cineworld Group, plc, which under the name of Regal Cinemas is the second largest film chain in the world with over 500 theaters in the US. The company, which has about $4.8 billion in debt excluding leases, won’t benefit from the meme-stock rally that previously saved AMC Entertainment.

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What happens to the Regal Cinemas series as Cineworld makes its way through bankruptcy will be a movie worth watching, but another interesting story for the finely distressed debt follower is Revlon.
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, That company filed for Chapter 11 protection in June with $3.3 billion in debt. Revlon is a 90 years old branded cosmetics company with a well recognized name. Still, it’s struggled in recent years as upstart celebrity-owned lines like Kylie Cosmetics and Fenty Beauty have attracted younger consumers. It is also suffering from the same woes as many other brands in the retail sector – supply chain disruptions and COVID-related issues as well as excessive leverage.

In 2020, Revlon tried to refinance and replace some of its old debt with new issues. This created a new problem for the company, affecting its bankruptcy proceedings. Citigroup
Joe, who was Revlon’s loan agent, lost some zeros when he intended to pay $9 million in interest to creditors and instead paid $900 million to a group of syndicated lenders.

Citigroup asked for the money back, but a group of funds refused to hold a debt of about $500 million. He claimed that Citigroup’s refinancing with Revlon was unfair. Earlier this year, a judge agreed with him, ruling that the law allowed him to keep the money, because at the time he had no reason to believe the payment was wrong. Citigroup filed a pre-emptive settlement claim in bankruptcy court stating that the bank owed at least $500 million and, if not repaid, had the right to become a bankruptcy claimant for that amount. In its filing, the company told the court that the lawsuit was hindering its efforts to raise capital because it was unable to identify its creditors.

The situation got some clarity earlier this month when the Second Circuit US Court of Appeals in New York overturned an earlier ruling, saying Citigroup could recover the money. Of that half a billion, how much misdirected money has actually been returned is unknown. Among the creditors that have been repaid are Cayman-based hedge funds, and some of them may be liquidated along the way. But, regardless of how it plays out for Citigroup, the new decision clears bankruptcy for Revlon and will allow it to know who its creditors are before it proposes a bankruptcy plan. , which is expected in court by mid-November.

Cineworld and Revlon bankruptcies are two of the biggest crisis investing events in the world, but recent macro events indicate that there will be more to come.

First, Jerome Powell’s speech at Jackson Hole signaled the Fed’s willingness to continue raising interest rates to control inflation. “We will continue this till we are confident that the work is done,” he said. And although Powell did not address this in his remarks, in all likelihood, the Fed will also continue to try to reduce the size of its balance sheet.

Then what’s up with junk bonds. Last year, a report released by JPMorgan showed that in many cases junk-rated paper trading with yields as low as 5% to maturity. In practice, this indicates that pricing for fixed income securities went through the roof, and that even the riskiest borrowers were able to borrow at rates less than 5%, and In some cases, less than 2%!

That was then. Now we’re starting to see a bigger reset. Each bond has gone down in price with a corresponding increase in yield to maturity. It is now very common to see pricing in the 7-9% range for junk-rated bonds. Those who have a problem or crisis are trading at very high returns, some as high as 30% or more. From what the Fed has been saying, there is still room to go in that trend as the normal level for junk-rated papers is right in the double digits, not the high single digits.

Based on these indicators, it is reasonable to assume that we will see more crises in the coming months. It may not be high-profile names like Revlon or Regal, but there will be other companies that were in debt over the past decade and are now forced to adjust to the new environment. We’re seeing this everywhere in fixed income. Year after year, the broader fixed income indices are down sharply. Even Treasury indexes are down 20% — the most in a year — and most fixed-income securities are priced lower than benchmark government securities.

If the trouble in the fixed income market, as we’ve seen already this year, continues, it guarantees you’ll have more trouble. This is because, as companies approach their debt maturity dates, there is less demand for the new securities they need to issue to refinance maturing debt. And for some of them, the window may close completely. We are seeing large YTD outflows from bond mutual funds and ETFs because investors have suffered such huge losses in those markets this year. As the market resets over the long term, there is likely to be more and more opportunities to selectively find interesting value investments amid a growing crisis-ridden debt carnage.

For individuals, it is very difficult to invest in distressed debt of a company like Revlon or Cineworld. Still, companies like these can be outstanding long-term investments if you can buy through a professional asset manager at the right price. Separately, Revlon has publicly traded shares, which means investors may be able to sell their stock short.

In fact, short selling has become an interesting opportunity right now. There are many companies whose business plans are turning completely upside down due to inflation, supply chain bottlenecks, covid issues and uncertain commodity pricing. And companies affected by those conditions that are over-leveraged are more likely to file for bankruptcy, especially if we have a recession. For investors who don’t have the ability or appetite to do so themselves, now may be a great time to choose an investment manager with experience to help them navigate these volatile waters.

Revlon may also offer some upside to patient long-term investors because it is a sound business. It’s got a great brand and strong cash flow and revenue, albeit with a temporarily exorbitant capital structure.

Many other companies could be in trouble in the coming months. Nevertheless, investors should be cautious not only about companies in trouble, but also about their regular equity investments, till they find something with short-term cash returns. They are companies that are cheap to start, but have very near-term plans to return cash to shareholders through large dividends and/or stock buybacks.

As we’ve said before, even in the most depressing markets, there are usually few opportunities for investors willing to do the homework to find them. Right now, a good place to look is in the energy sector. Some companies that produce oil or natural gas are making enough cash flow right now that they can reward their shareholders by returning capital quickly.

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