market folly

We're posting up notes from the Capitalize For Kids 2018 investment conference.  Next up is the credit panel which consisted of Ted Goldthorpe (BC Partners) and John Zito (Apollo Global Management).


Credit Panel at Capitalize For Kids Conference: Ted Goldthorpe & John Zito

Ted - Illiquid Credit
John - Liquid Credit

•    Markets less efficient than ever - main theme
•    ETFs today 10% of the market
•    ETFs and high yield all driven by flows
o    Leads to interesting decoupling in the market`
•    John: ETF Creation - buys the biggest issuer of debt, not the largest market cap. Not a function of who is the most solvent. Buy a unit of risk in the co with the most debt outstanding.
•    When there are outflows, could be very violent moves
•    Tesla - Disconnect between equity and debt
o    Historically over 30 years - 88% correlation between Russell 2000 and HYG
o    HYG unchanged last 30 days, Russell down 30%


•    Credit / equity relationship completely changed
•    TSLA, Carvana, Wayfair are good examples
•    Softbank / VCs paying high revenue multiples for companies that are growing fast.
•    Carvana 9bn mkt cap, 9x revs, $350mm of HY, looking for 6% bond yield. 9% cost when it priced.
o    Shows divergence between credit and equity markets. Stock down 50% this month, bonds unchanged
•    Tesla, despite good earnings, has bond at 80cent on dollar, $50bn of equity, big difference
•    Liquid / illiquid risk
•    Value being created by taking illiquid loans off of balance sheets, lending to PE.
•    Bought unrated debt from bank to a power plant with A rated customers. Bought at 70c on dollar, got it rated, flipped for 1.2x MOIC, infinite IRR
•    A loan they underwrote had 38% LTV, 13% IRR on loan, whereas equity sponsor expecting 15% IRR. Illiquid credit allows for great risk adjusted returns
•    SUNE + private or public, high quality MLPs, gaming RE (vici),with  long term cash flows getting underpriced in public equity markets
o    Can reclassify as infra debt instead of public equity and get cost of debt couple hundred BPs lower. No one wants mark to market headache
•    multiple infra vs equity buyer base looks at stuff there is a big spread between yields as infrastructure investors are thirsty for yield

•    More stuff being called infra – be careful
o    TXU equity held in infra funds
o    GreenForLife BC Partners bought (waste management) - some LPs classify as infrastructure
o    call it infrastructure = cost of capital goes down

•    When is next default cycle?
o    EU HY 3x higher, triple B grown crazy
o    Lots of stress in hospital, mining, retail
o    Default rate underestimate stress being felt by companies

•    Growth in insurance cos crazy
o    To make money, must get a very large Triple B portfolio optimal portfolio
o    Lots of the growth in assets around there because of it
o    10-20% of triple B. —> HY during a down cycle. What does that impact HY?
•    Central banks pulling out lots of liquidity in the next 18 months
o    real delta into short rates globally
o    EU bonds swapped into dollars is 300+bps positive spread
•    ECB causing serious distortions in EU credit market

•    Steinhoff
o    Filed for bankruptcy
o    No entities in Germany originally.
•    Incorporated an entity because of IG rating
•    Issued bonds in Germany
•    1.85% yield
•    Much of it was placed with ECB at par
•    6 mos later at 40c on the dollar
•    ECB set to be largest HY manager in EU.
o    Distorted market, now exited market and lots of issues with defaults and downgrades now
•    Active management will need to be really important for the next 5 years because of these risks to serious dislocations
•    Could lead to massive repricing’s in the FI market

•    J Crew
o    Took IP away from lenders and raised money on it
o    Covenants and document ignorance are killing lenders due to scummy sponsors
•    All metrics on covenants worse than 2007. Investors need bonds so they just take it
•    Covenants matter only at most importance time (recession), so there is a non-linear negative impact

•    Last 3 biggest deals, if they want to sell assets, they can take a dividend without compensating creditors.
o    Reuters - 6.5bn
o    AkzoNobel - 3bn
o    Envision - 2bn
•    EBITDA adjustments at ATH too
o    EBITDA quality getting worse



Be sure to check out the rest of the presentations from Capitalize For Kids 2018.