So we beat on, boats against the current, borne back ceaselessly into the past
-The Great Gatsby
Looking for Part 2??
As graduation nears, I am compelled to think of my past four years here. I can’t seem to make sense of it. Was it good? Was it bad? Did I have fun? Did I learn anything? Should I have gone somewhere else, majored differently or swam all four years? I can’t tell you the answers to these questions.
But maybe I shouldn’t be able to. As we learn in Bulletproof Monk, “Life is unexpected.” In the end, that’s the perfect word to describe my experience. Unexpected. Nothing turned out just right, and I’m starting to think that nothing will. It was a heck of a ride.
In the spirit of looking back, let’s talk about the arbitrage opportunity in Great Atlantic and Pacific Tea Company (GAP) from last fall (before I forget about it completely.) I’m a little fuzzy on the exact figures, so I’ll do my best to talk about the process.
Last summer, I was working for a high yield/CDS hedge fund called WestSpring in New York. In July, GAP released an earnings report that called into question its solvency. High yield shops went bargain hunting through its battered securities and I took a closer look.
Following the earnings report, forward cash flow approximately looked like
- 2Q adjusted EBITDA of $19mm or ~$80mm/year
- Run rate capx of ~$80mm/year
- Net debt ~$1.4B (including capital leases and real estate obligations) and CASH interest of ~$160mm/year plus “dark store” cash lease payments of ~$55mm (this showed up as changes in closed store and warehouse reserves on their CF statement).
Possible sources of liquidity included
- $100mm in sale-leasebacks on non-collateralized properties.
- $183mm remaining on their currently $655mm, but max $775mm bank facility.
- The company claiming that $900mm of property collateralized the facility (opening the door to negotiate with the bank).
- Injections from either Ron Burkle or Tengelmann, huge shareholders who had put up money in the past.
Chapter 11 Bankruptcy
The company looked much better in bankruptcy for at least two reasons.
- GAP held a tax NOL carry forward of $774 million. If GAP was purchased in bankruptcy, the profitable acquirer could apply the NOL carryforward to their earnings, valuing the NOL at 35% of $774 = ~$271mm. If GAP was purchased out of bankruptcy, the acquirer would not be permitted to use the NOL.
- Bankrupt companies may rejecting leases. Simply put, GAP had many unfavorable leases even besides the closed-stores (on which it was paying ~$55mm/y)
The only problem was that Burkle and Tengelmann controlled the company and only held equity. Obviously they were incentivized to bleed the stone.
Having determined that bankruptcy was likely, I looked at the capital structure. It was a mess of pension obligations, preferred stocks, bonds of all seniorities, collateralized bank facilities, and working capital obligations. Valuing the securities seemed hopeless not only due to the cap structure, but also because the company’s best hard assets were not just properties, but “favorable leaseholds.”