In the Air But Grounded

Last December 28 AirAsia Flight 8501 left Surabaya in Indonesia bound for Singapore with 162 passengers and crew on board. An hour from takeoff the plane disappeared from radar, and five days later searchers found the wreck in the Java Sea. There were no survivors. AirAsia is one of the global airline industry’s great success stories. It was founded in 2001, when CEO Tony Fernandes, a former music company executive, bought the struggling company for $0.39. By 2014 he had made it into one of Asia’s largest discount airlines. Flight 8501 was AirAsia’s first fatal accident. With the untimely death of so many people and the shocked grief of so many families and friends, the loss of Flight 8501 is above all a tragedy. For AirAsia’s lenders and investors it’s also a major risk event and a test of management’s ability to meet the challenges rising from that event. We see meeting challenges to be one of the key factors in evaluating management and its impact on a company’s risk. By challenges we mean problems that go way beyond the ordinary operational and financial difficulties of running a business. They can range from integrating big acquisitions, to far-reaching business turnarounds, to comprehensive financial restructurings. Challenges also include responding to major product recalls, natural disasters, and accidents. There are two dimensions to meeting any event risk challenge: operational and financial. For AirAsia the operational tasks are to find the plane, recover the bodies, analyze the accident, and keep it from happening again. Of course, where human suffering occurs there is an added responsibility to comfort the injured and bereaved. AirAsia’s...

Men’s Wearhouse Plays Defense

On September 18, 2013 men’s clothing retailer Jos. A. Bank (ticker JOSB) made a $2.3 billion unsolicited offer to acquire larger rival Men’s Wearhouse (ticker MW). JOSB was seeking to take advantage of MW during a vulnerable time for the company. The MW Board of Directors had dismissed its founder, public spokesman and executive chairman George Zimmerman in June due to disagreements over company strategy. Shortly afterwards, the company announced a cut in its expected profit forecast. Even though the offer price was a substantial premium to MW’s market price, the MW Board considered it below the intrinsic value of the company. After rejecting the offer, the Board implemented a flip-in poison pill that would allow existing shareholders to acquire stock at a discount if a third party acquires more than 10% of the company in a transaction not approved by the Board. In November, MW went a step further by undertaking a Pac Man strategy, launching its own $1.5 billion unsolicited offer to acquire the smaller JOSB. The JOSB Board rejected the unsolicited offer, declaring it too low and not in the best interest of shareholders. MW vowed to continue its pursuit of JOSB, possibly by nominating its own directors at the next JOSB shareholder meeting. On January 6, 2014, MW further increased the pressure on JOSB by increasing its bid from $55.00 per share to $57.50 per share, placing a value of $1.6 billion on the company. There is still a chance the two companies will combine their operations, as most analysts believe it makes strategic and financial sense. But who will play the role of acquirer and who...

5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...

My Favorite Bank Ethics Story

The Background: I was a vice president at a global bank, responsible for a diverse group of clients in North America.  One of my clients was considering a major reorganization of its business and restructuring of its balance sheet, and it hired my bank as financial advisor.  Since we were a lender to client and a restructuring could have impacted our position, the bank saw the conflict and (with the consent of the client) set up separate teams.  Given the size of the assignment and the large potential fees, the advisory team was led by the bank’s Vice Chairman, and included the head of my department, who was my boss.  My “team” (really just me and an associate) was responsible for the bank’s balance sheet – our counterparty risk and our lending position, including a large syndicated loan for which we were the agent. The Setup: The advisory assignment went on for several months, during which I could not discuss the client with my boss or anyone else on the advisory team.  This led to some strange situations, like running into people from my bank in the elevator at the client’s headquarters (a very silent ride), or sitting across the table from them in client meetings. Finally, key elements of the restructuring began to emerge.  To make it work, one large asset of the client had to be quickly and quietly sold.  This is when my boss called me into his office and gave me the term sheet showing our bank buying the asset.  But, since he was on the advisory team, he couldn’t buy it.  It was up...

Decaffeinating Green Mountain

Last October, David Einhorn, head of Greenlight Capital, a hedge fund famous for taking short positions in Lehman Brothers’ shares before Lehman failed, attacked Green Mountain Coffee Roasters’ in a presentation at an investors’ conference. It was a tour-de-force of financial analysis. Using only publicly available information, Einhorn made a strong case for unrealistic sales growth and overstated earnings. Since then, things have only gotten worse for Green Mountain. The share price collapsed. Robert Stiller, the founder, was forced to sell shares to meet margin calls on $617 million in personal debt secured by his Green Mountain shares and had to resign the company’s chairmanship. The SEC continued with an investigation into the lack of disclosures about a key distributor. And many of David Einhorn’s concerns remain. We’ve looked at one of the issues he raised: capitalizing operating costs. Here’s our own analysis, updated with the latest fiscal year data. As Green Mountain reports it, sales have been growing at an striking rate, propelled by demand for its K-Cup coffee brewers and pods and by acquisitions. After a dip in 2010, Green Mountain’s EBITDA margins expanded along with sales, peaking at nearly 18% in the fiscal year ending in September 2011. One tactic companies use to understate expenses is to capitalize them. That is, they add current period operating costs to property, plant, and equipment — or some other asset with a life of more than a year — instead of treating them as cost of goods sold or selling, general, and administrative expenses. That spreads them out over a number of reporting periods as part of depreciation expense...