BTU - Peabody Energy

[thepupil]

- I own the 7 7/8% of 2026. I am short long term call options at 100%+ volatility and pretty out of the money.

 

- The net result of this position is an outlay that puts me long $10K face of bonds and short $10K notional (25 contracts @ $4.00 stock) of stock for a net cost of $500 (5 cents on the dollar to the bonds). I've done this a little bigger but this is the most recent tranche.

 

- I think the capital structure will be restructured out of bankruptcy and that I will be better off owning the unsecureds at 5 cents than the stock at $4.00, so I bought the bonds and "shorted" the stock via calls. I may lose money as this trade has a heap of basis risk and it loses money in extreme scenarios ( ie if the unsec'ds are worth 0 and stock is worth 0 you lose the full outlay and if the stock goes crazy high and the bonds are restructured to a low recovery, you can lose).

 

Also, since this bond is currently paying coupon, this position carries at over 100% (since the coupon is 7 7/8% and your outlay is $5/$100), but I imagine we'll have some type of restructuring/deleveraging where the carry goes down.

 

Just curious if anyone had any thoughts...

 

[Picasso]

This looks interesting.  What is the difference between BTU and ACI such that we don't see a similar slaughtering of short stock positions?

[thepupil]

well...i think BTU shorts are getting slaughtered and have been...the stock is at $2.60 versus a low of $0.99...Arch started from a lower base and is even more levered...

 

It's just a matter of how much slaughter and from what price...at $4.00 BTU price, it has an equity market cap of $1B. Compare that to BTU's $5B face of bonds trading between $26 and $34. (an implied $1.6B of value above the term loan). So the bonds have a mark to market value of about $1.6B and the stock at $4.00 has a market cap of $1B. I'll bet on the bonds any day and the call premium earned from obliging oneself to sell the stock at $4.00 if it gets there makes the whole thing more attractive in my view.

 

BTU does have lots of available liquidity and potential for asset sales; in my opinion enough that the bonds should not just roll over and accept some VERY equity friendly restructuring.

 

I'd be lying to you if i told you i've put a ton of work into this. I am by no means a coal expert, nor am i an expert in high yield, nor am i an expert in options. As this trade involves all 3, I'm well beyond my circle of competence. I don't want to misrepresent that.

 

Now if the bonds get called/restructured/exchanged/whatever to something like 40 - 50 cents and then the stock rallies to $10, you can lose a shit ton. This trade is short that tail risk. It is also short the risk of an immediate BK that results in no recovery to the unsecureds. I don't think either scenario is likely, they are possible.

 

This is basically a short volatility trade. You are writing a put (by buying the bond) and selling a call (by selling the call). I believe the call is quite rich (100+% implied vol and 34% of the stock price for a 60% OTM call seems like a wacky way to be long) and the reward for writing the put (30% cash yield) is quite high also. I imagine the vol will decrease with some sort of deleveraging exchange (convert offering, exchange etc) that will be dilutive to the equity and make the bonds less risky. In other words the outcomes will become less extreme.

 

There may be a better bond in the cap structure to purchase (the shorter bonds have much higher YTM's) but I went with the lowest $ price. This was not scientific and is frankly experimental.

[valuedontlie]

I was going to ask why you chose the 2026 bonds. To me, the first group to get an exchange offer (2018s) looks to be the most interesting here. If I were going to play it, it would be an attempt to determine how long the company could last before bankruptcy and whether I would be getting compensated enough for this.

 

Alternatively, I have my eye on the Cloud Peak (CLD) 2018s as a long. The YTM absolutely meets my hurdle and I think they're good for the entire amount. With the way these have been trading lately, I have been reluctant to pull the trigger here.

[RadMan24]

I was going to ask why you chose the 2026 bonds. To me, the first group to get an exchange offer (2018s) looks to be the most interesting here. If I were going to play it, it would be an attempt to determine how long the company could last before bankruptcy and whether I would be getting compensated enough for this.

 

Alternatively, I have my eye on the Cloud Peak (CLD) 2018s as a long. The YTM absolutely meets my hurdle and I think they're good for the entire amount. With the way these have been trading lately, I have been reluctant to pull the trigger here.

 

People have been saying Powder River Basin coal would be booming ;however, with the EPA regulations. Dirty coal has become "clean" again. Meaning Northern App and Indiana Coal, low cost underground mining will take share from Central App and PRB coal. Cloud Peak is not nearly as leveraged as Peabody or Arch Coal. Equity has a higher risk/reward, with a lot of risk and uncertainty. Westmoreland Coal, Foresight, Consol Coal REsources all offer yield, including Alliance Resource Partners, that give more options.

 

Peabody's debt load is huge. But management will do all it can to avoid bankruptcy and continue to walk as a bloated zombie for years, even if the coal market recovers. If they restructure, they could come out leaner and more efficient, but they don't want to do that...Shorting or going long Peabody is a risky proposition either way. It also depends on what happens to Arch Coal, and with the recent delay in restructuring their debt for another month, who knows what can happen. Nat gas is still killing coal.

[thepupil]

taking a little off, the move to sell calls into the short squeeze worked nicely. i don't really know if this "trade" is worth posting and apologize if it is spam because i didn't really contribute any fundamental analysis, just seemed like an odd pricing where selling  60+% OTM options at 130% vol allowed you to be long bonds at 5 cents on the dollar and short stock at a high price...there is a lot of tail risk to the position and i got paid for bearing it. basically made 12 points (in bond/stock notional terms, $1200 per $10K) in 11 days.

[benhacker]

Pupil, many capital structure arbs aren't very discussed here (I think a lot don't short, so it's not as interesting), but I'm always happy to hear the ideas, so please share in the future.

 

Thanks and congrats.

[bizaro86]

taking a little off, the move to sell calls into the short squeeze worked nicely. i don't really know if this "trade" is worth posting and apologize if it is spam because i didn't really contribute any fundamental analysis, just seemed like an odd pricing where selling  60+% OTM options at 130% vol allowed you to be long bonds at 5 cents on the dollar and short stock at a high price...there is a lot of tail risk to the position and i got paid for bearing it. basically made 12 points (in bond/stock notional terms, $1200 per $10K) in 11 days.

 

Please don't consider this spam, I executed it after seeing it here and appreciate the quick win. Capital structure arbitrage is a type of fundamental analysis, imo. You're buying a dollar for 50 cents in a different way.

 

I did a considerably smaller short call, and used the $5 strike, so I made much less on a percentage basis, but took much less upside risk. I really, really don't like unlimited tail risk.  :D

 

Are you planning on keeping the long bond position at this point? It seems like it should be worth more than current prices, but I'm concerned that a subset of bonds will get exchanged into senior debt prior to an eventual filing, which would screw remaining unsecureds. If I could buy the second lien I would, as I think the risk/reward is better, but its 144a only.

[thepupil]

I've completely exited. I don't have enough confidence or conviction in the bonds and the calls fell quite dramatically. I could say I'm almost "playing with house money" given how the call sales and covers decreased the "cost" of the bonds, but I think it really is a separate decision to hold those bonds. the rest of the things I own are a by easier to underwrite (in my opinion) and this was not sized too big anyways because in the end, I don't know jack about how to analyze a coal company. Glad you made some money too.

[Patmo]

Mr. Market, in its usual myopic, maniacal nature, has oversold Peabody Energy due to its issues, departing itself of a valuable equity stake by willfully ignoring off-balance sheet assets that the company enjoys. I will briefly discuss two of these assets and their valuation, then conclude with a buy recommendation.

 

The first asset is the company’s financial structure. Recently, commodity prices generally and coal in particular have taken a significant plunge, exposing the balance sheet risk that many companies were absorbing. The market painted Peabody with the same brush as all the others. You see, the company’s odds of succeeding and its related payoff are closely in line with a lottery structure. I define a lottery as an exchange of money for the right to dream, which an investment in Peabody qualifies for. Once lottery players attuned to the stock market notice the trade, they will flock to it in droves.

 

Therefore, the correct manner to value this particular asset is using a lottery comparable. The best comp I found is the Powerball, which sells for $2 a ticket and has odds of 1 in 292mil of winning. I estimate a 1 in 1mil chance of Peabody equity surviving unscathed, implying a lottery asset value of $584.

 

The second asset is the entertainment value. As one acquires an equity stake in the company, one has roughly a month to yell, scream, sweat and generally enjoy watching its pony run before it rams into the wall in spectacular fashion.  There are many comps to look at here, such as various sports and games or movies. The best comps are paid spectating, such as horse betting or a cinema outing, as free entertainment attracts a different breed of investor who will not be attracted to this trade.

 

The best comp I found is the last date I went on with my girlfriend. It cost me $40 for roughly 2 hours worth of eating. It was less than 2 hours in reality, but for the sake of conservatism I input 2 hours in my model. This implies $20 a hour for 2 people, or $10 per hour per person. At 8 waking hours per day (again, conservatism), for a whole month, I arrive at a value of $290. Why only $290 and not $310? Because there are 29 days in February. I am looking forward here, not into the rear view mirror.

 

So, assuming that all of the company’s balance sheet assets satisfy the creditors in the case of bankruptcy with nothing left over to the equity but its off balance sheet assets, I value the company at $874,. This could be a 350 bagger within the month, which is not even a stretch as the company was trading at this level a handful of years ago. I recommend an investment into 20 shares of the company's common stock at $2.5 per share or less for $50. This satisfies the Kelly dating investment allocation criterion, and coincides with the average amount spent on lottos on big payoff weeks.

 

Disclaimer: I or individuals I advise may or may not own a position in this company. Do your own DD

 

 

 

 

[Uccmal]

Does it pay a dividend?  If so, I am in for 10 shares.

[Picasso]

We think this idea is ill advised and as such BTU represents our largest short holding at Yolo Capital Management. The author has failed to note key risks to the thesis, including Netflix and chill entertainment value which has rapidly destroyed the classic dinner for two. At $9/month for two people, that represents $0.16 of entertainment value. We think this short will generate outsized returns with similarly outsized risk.

[influx]

http://brontecapital.blogspot.com/2016/03/being-punished-for-doing-obvious.html

[thepupil]

it's a little different to do this when market cap is below $200MM or whatever. the stock is down 83% since the beginning of this thread (and the bonds are down a shit ton as well)

 

I prefer to do this when there is more implied market cap.

 

The other day I shorted CRC calls to buy bonds, that's worked so far. CRC had something like an $800MM market cap market cap at the time, bonds are in low $20's. You do have to always size as if you could handle a doubling, tripling, qudrupling etc. of the stock and that's a lot easier to do when the stock is almost $1B than when it is $60MM or whatever BTU was at the low.

[influx]

it's a little different to do this when market cap is below $200MM or whatever. the stock is down 83% since the beginning of this thread (and the bonds are down a shit ton as well)

 

I prefer to do this when there is more implied market cap.

 

The other day I shorted CRC calls to buy bonds, that's worked so far. CRC had something like an $800MM market cap market cap at the time, bonds are in low $20's. You do have to always size as if you could handle a doubling, tripling, qudrupling etc. of the stock and that's a lot easier to do when the stock is almost $1B than when it is $60MM or whatever BTU was at the low.

 

I would just go long the bond

Havent read much about them...have to check the management's skin in the game. one of the most important things for me

[Picasso]

Patmo, your $2.50 buy recommendation has already returned significant outperformance.  Assuming you bought those 20 shares, what do you plan to do with the sudden windfall of $75?

[Guest roark33]

How did I miss these last few posts...I have not been generating anywhere near the alpha this thread has over the past few weeks. 

[Patmo]

Patmo, your $2.50 buy recommendation has already returned significant outperformance.  Assuming you bought those 20 shares, what do you plan to do with the sudden windfall of $75?

 

http://s27.postimg.org/dpwtftuq7/BTU.jpg

 

It has generated lots of outperformance indeed. We are talking over 3000000% annualized return here. All proceeds will go to Charity, as I am doing the Lord's work.

 

I have been waiting to see if a trend was establishing, today proved it clearly as the stock went up 8% again in a down day. It is clear that it will go UP UP UP and it is time to BUY BUY BUY. I have liquidated my portfolio and allocated my margin into call options to better concentrate on my best idea. I was considering allocating my credit cards to this idea but since I am a leverage-averse value investor in the likes of Ben Graham and Seth Klarman, I have decided against it.

 

I am glad a like-minded value investor of esteemed skill such as yourself has been following this idea, although I am not surprised; as you can see, I am without doubt an investing visionary/iconoclast, and fellow skillful investors are bound to take notice. I welcome your feedback on my thesis and will keep you updated on the results.

[Jurgis]

I'd buy too. Are there any gurus in this? I don't buy anything that's not a cloned idea. And only genuine gurus please.

[adesigar]

I'd buy too. Are there any gurus in this? I don't buy anything that's not a cloned idea. And only genuine gurus please.

 

I believe the guru you are looking for is John Clifton Bogle.

[Picasso]

Vanguard is a top three shareholder of BTU with a 5.5% stake.  Guru to follow confirmed.  But the real guru here is Patmo.  He was smart enough to buy in 99.9% cheaper than the infamous John Bogle.

[Jurgis]

Wonderful news! Two gurus in one stock. This is rare.

 

I see that the stock is trading at 0.1 p/book. This is really cheap. I am not sure why book is so expensive though. Perhaps it is first edition?

 

I'll buy as soon as cup and handle mining formation is established.

[Palantir]

What would Charlie do?

[Guest Grey512]

Any thoughts on the 10K?

I tried to short this on Tuesday (with a teeeeny 0.5% of my portfolio) but could not find any borrow. Oh well.

[dorsiacapital]

This thread is everything.  A funny story on this - A few weeks ago, as the Bowie deal fell apart, I put in a trade where I bought $1-2 April puts (at around .15-.5 a put) figuring BK was near inevitable and then partially hedged with the incredibly cheap 2018 calls in case BK became uninevitable (i.e. at $2.23 a share, the $2 2018 calls were selling for .23 cents). So then of course there was a stupid short squeeze and my $2 calls went up about 1000% at the bottom - I mostly sold them with the stock trading around 6-ish, and then after the 10k, it seems likely, although not guaranteed that at least some of the $1-2 April puts will pay off but I'll have made far more on the calls. Better to be lucky than good.  Any more recommendations Patmo?

 

Grey512

 

-Didn't read the 10k closely, but my general impression/cw is BK within 30 days unless the Bowie deal comes off but financing that right now seems very difficult. Also, very bad sign when your senior lenders (Franklin) are pushing for BK.