A Year in Review – Looking back at 2018 

Jan 15, 2019 | Investment Management

Core Activity
Non-Core Activity
Other Interests

What a great year 2018 was for Ballast. We completed our second year of operations, with goals of providing clients with security, stability, and innovative investment strategies. The year brought many unanticipated events – some investable, others not – and we tried to comment in our newsletter and blog on ones we found more noteworthy. As the year closes, we wanted to take the opportunity to reflect more wholly on what we did during the year.

 

Activity

 

Core Investment Strategy

Among other client constraints, return requirement remains top-of-mind as we build and maintain investment portfolios. The bedrock with which Ballast portfolios are built upon is core, yielding investments. The average investor requires a well-diversified portfolio, and so, investment positions within are numerous. These core holdings provide relatively low-risk return and cash flow for clients in fulfilling their investment objectives.

Credit – Credit provides the bulk of the yield allocation for achieving desired cash flow and return within an investment portfolio. The risk premium, or credit spread, is typically higher than comparable maturity securities due to risk considerations like collateral, degree of leverage, management, credit ratings, et cetera. Nevertheless, with a little bit of analysis and monitoring, there are high-quality credits worthy of investment. Here we list some examples of core yielding bonds put into Ballast clients’ portfolios during 2018: Dollar General, Priceline, and Time Warner. Our clients may recognize these as high-quality, household names. Other high-quality names enter the portfolio through one-off market events to contribute incremental yield within what Ballast views as core:

Bayer – The German group operates in pharmaceutical, consumer health, and crop science industries. In order to complete its acquisition of US-based Monsanto, which would increase the size of its crop science division, Bayer was issuing $25bn of debt. This was a large overhang to the credit – in terms of size for the market to digest – and the increased leveraged caused the credit ratings to slip from single-A to triple-B. While it is still investment grade, it is lower quality and yield commensurate. The market anticipated this in the months leading up to the debt issuance, and Bayer credit spreads widened 50bps. We assessed the two companies and felt the extra spread was more than commensurate for the combined company’s ability to deleverage over the next couple of years.

 

ABS – Asset-Backed Securities provide yield with substantial risk protection through strong collateral or structure. United Airlines and American Airlines are examples of investments many Ballast clients would recognize. The bonds are highly rated and secured with the airlines’ aircraft. Another example of an ABS investment includes agency residential mortgage-backed securities (RMBS).

 

CMBS – Commercial Mortgage-Backed Securities are used by Ballast to generate incremental yield for short-term, or cash-like, allocations within client accounts. CMBS are pools of loans backed by properties such as Office, Multi-family, Retail and Industrial properties.  These securities are structured to provide short-term or long-term cash flow and credit characteristics for buyers.  Ballast acquires the short-term (“front-end sequential”) to acquire decent yield without much principal or credit risk.

 

Non-core Investment Strategy

For many clients, especially in the current market, core investments do not provide enough returns alone. Ballast adds incremental yield to client portfolios by investing in non-core opportunities. These include credits of high (and low) quality and strategies of high yield and total return. What is common of these non-core opportunities is that they require Ballast’s vigilance, patience, and analysis. Here we list some examples of investments made during 2018:

General Electric – The former industrial titan has become a hollowed version of its earlier might. The year 2018 brought several major capital charges: 1) in a life insurance unit and 2) in a major acquisition from three years prior, where carrying value was no longer supported by earnings expectations. GE’s balance sheet is highly leveraged and now has less reported assets (following the charges to support the leverage). GE’s CEO at the beginning of 2018 was no longer the CEO by the end of the year. Both the stock and bonds performed poorly during 2018. We saw opportunity arise during a major credit market selloff to leg-in on the credit at opportunistic price (for what remains, for now, as an investment grade credit with, in our opinion, enough asset coverage and runway to right-size the balance sheet).

 

Third Point Reinsurance – Here is a little-known reinsurance company with an investment grade balance sheet and public debt yielding substantially more than similarly rated peers. Because the amount of debt outstanding is small (not index eligible), it is difficult to source after initial issuance. Ballast has relationships with the brokers that could source the bonds, and after much effort, we were able to add Third Point to many client accounts.

 

Seaspan Corp – Seaspan is a little-known global freighter ship owner under the influence of two billionaires. While its industry has fallen on hard times, Ballast is interested in Seaspan since several key elements are aligned to create an attractive investment opportunity. Given the asset intensiveness of owning and leasing ships (and despite being unrated), Seaspan has publicly traded senior debt outstanding. These notes command a hefty yield. The parties of interest at Seaspan are Prem Watsa (often considered the Warren Buffett of Canada) and David Sokol (a former top lieutenant of Berkshire Hathaway). The two men have joined forces with Seaspan to consolidate its industry. Prem Watsa, through his insurance company (much like Buffett and Berkshire Hathaway), has committed $1 billion in equity capital to Seaspan to make acquisitions and shore up its balance sheet. After considering the pedigree and track record of the key people involved, the size of fresh equity capital infusion, the management objective to achieve investment grade ratings, and the various nuances to the bonds that keep other investors away (and, therefore, yield up) – Ballast saw attractive opportunity to add yield to clients’ accounts.

 

Other Interests

Each day, investing is busy and brings a new rock to turn over. With all the things Ballast examines and thinks about during the year, it is difficult to note them all, but there were a couple of areas we found interest in during the year. Although we have not acted on them, we continue to monitor each.

 

Major wildfires in California for the second year in a row caused substantial damage to surrounding communities. According to California law, the electric power utilities may be held liable for damages if their equipment is at fault. Several of the wildfires appear to have been caused by electrical equipment. This has resulted in substantial capital erosion of the major utilities operating within the state. Bankruptcy is a possibility for at least one of the utilities, and stock and bond prices have gyrated during the second half of the year. We think the situation will provide an attractive investment opportunity, but we have yet to find good entry.

 

Another area of interest for us was the property/casualty insurance and reinsurance industry. The year 2017 brought significant economic loss due to natural disasters in North America, and 2018 brought more losses, albeit much reduced from the year prior. With each years’ economic losses came significant insurance losses. Although stock prices of many insurance companies suffered meaningful decline due to capital erosion in 2017, we found limited opportunity to invest, so we did not. During 2018, these stock prices went sideways so we, again, did not find any places to invest. No good opportunities appeared in the credit of the insurers either. If industry losses are elevated again in 2019, good opportunity may arise, but we expect the status quo of a generally soft insurance market in the absence of additional insured losses.

 

Another area of interest was offshore drill rig companies. Some of the biggest names in the industry include Diamond Offshore, Transocean, and Ensco. The industry has suffered as oil price declines of 2015/2016 led to drill fleets being underutilized. As an asset intensive industry, leverage use was (and is) high. As the oil market downturn took hold, the offshore drillers fell to financial distress and were forced to deleverage.  After a couple of years of some oil price recovery and deleveraging & refinancing, we think at least some of the industry has de-risked enough for our interest. The oil prices that declined during the fourth quarter have brought this opportunity back to center.

The new year always brings with it more challenges and opportunities. This new year brings global central bank balance sheet reductions, rising short-term interest rates, elevated equity market prices, and plenty of unknowns. With more insight into what Ballast did during 2018, clients can expect the same commitment in the year ahead. We look forward to navigating the challenges and providing our clients with security, stability, and innovative investment strategies in 2019. Click here to see our goals.

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Our Goals for your Financial Success in 2019

Jan 11, 2019 | Investment Management, Investment Philosophy

As we enter 2019 and people lay out their goals for the year, we thought of highlighting some themes, or goals, we have for your capital this year.

As you may know, we are not very concerned with the market return. However, for reference, the market’s total return, as measured by the S&P 500 in 2018, was -4.37 (minus 4.37 percent). In comparison, we continue to build out portfolios with line items (investments) that generate reliable cash on cash returns.  Depending on what type of investment they were (investment grade debt, strategic debt, equity, alternative, etc.), cash on cash returns per line item in 2018 ranged approximately from 2% to 18%. Many of our clients sought returns of 6-7% from their portfolio, and these investments were blended together to meet their objective. This was done all while avoiding much of the market volatility experienced through other investments conventionally used to achieved these returns.

With that, our goals heading into the new year are to:

1.Continue our investment process that seeks to build portfolios, generating cash-on-cash returns in the 6 to 7 percent range

Regardless of market returns being up 10 percent or down 10 percent, the cash flow of underlying securities accumulates (hence our agnosticism as it pertains to worshiping the market gods…)

2. Continue seeking opportunities with double-digit total return profiles

Some investment objectives (even with strong cash flow yields) require greater returns – as does our own personal capital we manage. Therefore, we are always on the lookout to acquire assets that we feel offer attractive risk/reward

Examples of this are owning an office building in Bloomington, Minnesota and secured lending to a cellular tower owner/operator in Ohio. Both situations are currently yielding double digits and provide equity upside.

3. Apply an institutional risk management process to mitigate downside risk in portfolios

Our risk management process sizes each investment by numerous qualitative and quantitative factors including type, quality, and objective of investments.

4. Improve our portfolio reporting process

We are currently investing money into a portfolio reporting system that we once utilized while at a life insurance company we were once employed at. Our goal is to provide clients easy-to-digest portfolio reports, as well as more clarity in the construction of your portfolio.

 

We think if we can achieve solid cash on cash returns and find/acquire value-add ideas, while properly managing risk and reporting all this to you in a clear manner, then 2019 will be a successful year (regardless of whether or not the S&P has a successful year)! To take a look at what we accomplished in 2018, click here.

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Permanent Loss of Capital

Aug 1, 2018 | Investment Management

At Ballast, hopefully you have seen many blog entries talking about our investment philosophy, investment ideas and portfolio construction.  These are things we talk about daily on the investment desk.

 

However, one thing that we have yet to discuss (which runs through our veins and is likely why we have overlooked writing about) is permanent loss of capital.  Permanent loss of capital is exactly what it sounds like – a permanent loss of capital.  If you pay $10,000 for a new widget only to discover that the best anyone will pay for that widget is $5,000 (and there is no alternative economic value exceeding $5,000), then you have permanently lost 50% of your capital.   There is no way to replace that $5,000 loss unless you find another asset that can create $5,000 of incremental value.

 

This might be overly simplified, but this thought process is core to constructing a portfolio that will meet a return goal while also mitigating risk.

 

To us, risk is the chance of permanently losing capital. It is not correlations, volatility, diversity of funds. It is making sure we have a reason why something is in your portfolio and sizing that opinion to make sure any bad decision doesn’t affect your overall portfolio as it pertains to permanent loss of capital.  We want cash flow to always move a portfolio forward each year, and we will make investments with growth in mind but ensure that any one investment doesn’t ruin a whole year’s worth of effort.

 

What many don’t understand or appreciate is that to effectively and properly execute this process, there are multiple hours on investment function required daily. Whether that is analyzing fundamentals of an asset, evaluating types of securities or evaluating a portfolio’s goal with the investment opportunity at hand, there is a great deal of time required.  Every day is spent – in some capacity – on the front lines of your portfolio in order to avoid this permanent loss of capital.

 

 

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Comparing Curves

Jul 2, 2018 | Investment Management

As the Fed moved again on June 13th,  we thought we would share our thoughts on portfolio construction as it pertains to one’s fixed income allocation. At Ballast, we think about credit first (see this piece), and then, we move on to the curve. The below chart shows the treasury curve from June 13th (green line) compared to five years ago. So, today’s long bond (30-year) is the same yield as it was 5 years ago.  The 10-year as of today is just shy of 3%, whereas it was about 1.80% 5 years ago.

 

Treasury Curve May – June 2018

Source: Bloomberg

Why is all this important? 

The chart above shows that 5 years ago it was the Fed’s mission to get people to lend at all costs (aka- free money). You were paid to extend (steep slope to yield curve – orange line). This resulted in the unintended consequence of people lending or investing in items that may not have been a good asset for them.

 

This reminds us of Argentina.  One year ago, the market was ‘yield hungry’ – so hungry, that it has gobbled up $2.6 Billion of Argentinian debt at a 7.90 yield.  We remarked back then with surprise. Today, that bond is at $77.  So, although an investor clipped 7 points of interest, they have lost 13 points of principal.  We don’t have an opinion on Argentina and are simply citing its track record. This isn’t the opportunity for your capital.

What does this mean today?

It means that you get paid almost as much for lending 5 years as you do for 10 years. In bond jargon, we talk about ‘the roll’. The roll five years ago made sense – since when you buy a bond, you buy a coupon.  As that bond moves closer to maturity, [if the required yield from market is lower (steep slope) as you move shorter] there is price support provided.  This is unlike today, where you get no roll, so you would not extend maturity unless there were other reasons to do so.

 

So, as we construct portfolios, we continue to focus on the 3-5 year part of curve (thus limiting our duration while capturing yield).  If we had a strong bias of rising or falling rates, we could see ourselves adding or shortening duration, but at this time, it seems the Fed is on record for another 2 hikes this year – which will really flatten the curve.

Which means what?

Well, it means that the long end of the curve yields less than the short end of the curve.  Therefore, the long end is saying forward rates need to be lower – which some tend to associate with anticipating an economic slowdown.  The chart below shows the 10-year treasury versus the 2-year treasury. The top chart shows the 10-year yield (white line) and the 2-year treasury (orange line).  The bottom chart shows the yield difference.  Notice that the difference went below zero in early 2000s (preceded recession) as it did again in mid-2007 (another recession).  The recent trend seems to be heading toward zero,. Also, with market expectations of two more fed hikes, that takes Fed Funds to 2.25-2.5 % and the 2-year will move close (if not above) the 10-year.

2 – 10 Year Spread

Source: Bloomberg

What does this mean for our clients?

It means there is less incentive to lend money long term. They can capture yield in the front end without risking it for 10 years.

 

If the curve inverts,  it could indicate we are closing in on the end of one the longest economic cycles in recent times.  If that is the case, we look forward to clipping our coupons and being presented with many opportunities to choose from as risk assets re-price for the end of growth.

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Our Year in Review

Jan 5, 2018 | Investment Management

Core Activity
Non-core Activity
Other Interests

What a great year 2017 was for Ballast. We began operations in April, with goals of providing clients with security, stability, and innovative investment strategies. The year brought many unanticipated events – some investable, others not – and we tried to comment in our newsletter and blog on ones we found more noteworthy. As the year closes, we wanted to take the opportunity to reflect more wholly on what we did during the year.

 

Activity

Core Investment Strategy

Among other client constraints, return requirement remains top-of-mind as we build and maintain investment portfolios. The bedrock with which Ballast portfolios are built upon is core, yielding investments. The average investor requires a well-diversified portfolio, and so, investment positions within are numerous. These core holdings provide relatively low-risk return and cash flow for clients in fulfilling their investment objectives.

 

Credit – Credit provides the bulk of the yield allocation for achieving desired cash flow and return within an investment portfolio. The risk premium, or credit spread, is typically higher than comparable maturity securities because of risk considerations like collateral, degree of leverage, management, credit ratings, et cetera. Nevertheless, with a little bit of analysis and monitoring, there are high-quality credits worthy of investment. Here we list some examples of core yielding bonds put into Ballast clients’ portfolios during 2017: Abbott Laboratories, Aetna, Anheuser-Busch Inbev, Kraft Foods, and Thermo Fisher Scientific. Our clients may recognize these as high-quality, household names. Other high-quality names enter the portfolio through one-off market events to contribute incremental yield within what Ballast views as core:

Kroger – Amazon announced the acquisition of Whole Foods Market and set the grocery industry into a whirlwind. Grocer stock prices fell and bond spreads widened in knee-jerk reaction. We assessed the industry and found opportunity in Kroger bonds with spreads 40 bps wider on the news alone. Spreads have since returned to pre-announcement levels.

Equifax – Equifax announced a data breach of record size. The data also happened to include critical personal information of most US citizens. Capital markets were harsh and devalued the company by billions over a short period of time. Our focus turned to the Equifax bonds. There, spreads widened more than 100 bps over two weeks. We assessed the liability and determined the market reaction was well overblown. Spreads have since narrowed to within 10 bps of the pre-breach levels.

ABS – Asset-Backed Securities provide yield with substantial risk protection through strong collateral or structure. United Airlines and American Airlines are examples of investments many Ballast clients would recognize. The bonds are highly rated and secured with the airlines’ aircraft. Another example of ABS investments includes agency residential mortgage-backed securities (RMBS).

CMBS – Commercial Mortgage-Backed Securities are used by Ballast to generate incremental yield for short-term, or cash-like, allocations within client accounts. CMBS are pools of loans backed by properties such as Office, Multi-family, Retail and Industrial properties.  These securities are structured to provide short-term or long-term cash flow and credit characteristics for buyers.  Ballast acquires the short-term (“front-end sequentials”) to acquire decent yield without much principal or credit risk.

Non-core Investment Strategy

For many clients, especially in the current market, core investments do not provide sufficient returns alone. Ballast adds incremental yield to client portfolios by investing in non-core opportunities. These include credits of high- and low-quality and strategies of high yield and total return. What is common of these non-core opportunities is they require Ballast’s vigilance, patience, and analysis. Here we list some examples of investments made during 2017:

 

Kohl’s – Amazon and Kohl’s announced a couple of test partnerships, effectively using Kohl’s “brick and mortar” for certain sales and returns. Markets did nothing. We viewed Kohl’s as top of a difficult sector and viewed the Amazon announcements as optionality on Kohl’s. After all, look at Whole Foods Market. We saw Kohl’s bonds as the best way of investing. The bonds offer attractive yield on a BBB, investment grade credit with real option on acquisition by a stronger peer.

Teva – The thesis continues to play out. Teva is a pharmaceutical company that needs to repay debt with smaller cash flow and fewer assets than when debt was incurred. The credit ratings are migrating lower, and credit spreads continue to widen. We’ve taken the approach of cost averaging, and we are in a good position. We anticipate making one or two more critical additions.

Pitney Bowes – The mail industry is in decline because of the digital world, yet in demand from e-commerce. Parcel shipping appears to be the future, and Pitney Bowes is finding its way. In the meantime, we found an attractive entry into the bonds. Credit spreads gapped significantly wider over the course of the week as financial results were reported. Spreads have narrowed since. Although the position has performed well, it is relatively new, and we positioned for (and anticipate) opportunity to add.

Tidewater – A broker came knocking, and we listened. We were re-introduced to Tidewater and diligently got comfortable with the bonds. This position is providing good yield in a tough yield environment.

Clients may recognize some of these company names. Non-core holdings provide higher return for clients in fulfilling their return objectives. Non-core positions generally arise infrequently, and therefore, require patience. Extra analysis is also required of non-core because the positions may carry more relative risk. Risk management plays an important function in the Ballast investment process, especially with non-core investments. A primary layer of risk management comes from position sizing, which limits the impact of any investment on the overall portfolio. Of course, Ballast’s first layer of risk management is analysis – understand and evaluate the investment.

Other Interests

Each day investing is busy and brings a new rock to turn over. With all the things Ballast examines and thinks about during the year it is difficult to note them all, but there were a couple of areas we found interest in during the year. Although we have not acted on them, we continue to monitor each.

 

One area of interest for us was the property/casualty insurance and reinsurance industry. The year 2017 brought significant economic loss due to natural disasters in North America. With these economic losses came significant insurance losses. Although stock prices of many insurance companies suffered meaningful decline due to capital erosion, we found limited opportunity to invest, so we did not. No good opportunities appeared in credit of the insurers either. If industry losses are elevated again in 2018, good opportunity may arise, but we expect the status quo of generally soft market in absence of additional losses.

 

Another area of interest was offshore drill rig companies. Some of the biggest names in the industry include Diamond Offshore, Transocean, and Ensco. The industry has suffered as oil price declines led to drill fleets being underutilized. As an asset intensive industry, leverage use was (and is) high. As the oil market downturn took hold, the offshore drillers fell to financial distress and were forced to deleverage.  After a couple of years of some oil price recovery and deleveraging & refinancing, we think at least some of the industry has de-risked enough for our interest.

 

The new year always brings with it more challenges and opportunities. This new year brings new tax law, low interest rates, record equity market prices, and plenty of unknowns. With more insight into what Ballast did during 2017, clients can expect the same commitment in the year ahead. We look forward to navigating the challenges and providing our clients with security, stability, and innovative investment strategies in 2018.

Ballast Capital Advisors, LLC is a Registered Investment Adviser with its principal place of business in the State of Iowa. Please do not send orders via e-mail as they are not binding and cannot be acted upon. Please be advised it remains the responsibility of our clients to inform Ballast Capital Advisors, LLC of any changes in their investment objectives and/or financial situation. This message, including any attachments, is confidential and intended for the recipient(s) above. Past performance is no assurance of future results. This email/newsletter is limited to the dissemination of general information pertaining to investment advisory/management services. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Ballast Capital Advisors, LLC and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security.

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Tidewater

Dec 6, 2017 | Investment Management

A look at our investment process –

We were recently introduced to exploration and production services provider, Tidewater, and we purchased their bonds. There were appealing qualities and circumstances about the company that recently emerged from bankruptcy. First, the bankruptcy process tends to understate the enterprise value of the company before the judge in order to improve recovery-of-value lost as a result of bankruptcy. Second, the fresh-start accounting and financial proforma tend to be based on the economic value of the underlying assets – with intent to not attract outside equity capital (hence no need to over-promise).  So, the other day we were shown to Tidewater bonds (TDW 8% 8/1/22).  What attracted us is that the bonds were unrated, which creates opportunity by limiting buyer base, as many bond market participants are constrained by credit ratings.  Also, perhaps most importantly, the bonds are senior (high-ranking of legal claim) AND they are secured – with all the company’s assets.

For any investment decision, we tend to go through the process outlined below.  Our process starts with information gathering – both business and financial.  In this case, we had three primary sources of information:

1. Company presentations – Specifically, TDW management’s presentation to investors on Sept 15, 2017

 

2. Court filings – In particular, there are two documents, which are the Plan of Reorganization and Disclosure Statement. – The latter walks through the financial model and assumptions around each financial category

 

3. SEC Filings – here we look at 10Q (quarterly report) and 10Ks (annual report)

After spending some time in these documents and putting together some notes and spreadsheets, we like to test our thoughts against other opinions. We do this, not only to test our understanding of the business side, but to also test ourselves on the security side as well – does this security provide the protection we think it does, is there a better point in the capital structure to invest, et cetera.  To conduct this test on a small and somewhat obscure company, we made one call. We spoke with a street analyst. (Street analysts tend to cover the company, but they also speak with investors, such as insurance accounts, money managers and funds.) In this case, we spoke with Patrick Fitzgerald, a distressed credit analyst at R.W. Baird, which is a large bank.  The reason we spoke with him is that we have a relationship with Baird, and the distressed debt trader who was showing us the bonds was a Baird trader.  Therefore, the analyst had reason to speak with us (he would otherwise be difficult to engage with), but also an incentive to get a transaction done. To the latter point, we critically evaluate the analyst’s assessments and ask questions to root-out incentive from knowledge.

After the analyst conversation, we regroup and discuss three things – (1) the company’s business, (2) the security which attaches us to the company and (3) the price at which the security can be purchased.

Here are some high-level thoughts from that perspective:

1. Business: TDW is among the world’s largest off-shore service providers. Its customers include RD Shell, Saudi Aramco, Petrobras, and other major oil companies. It provides services around the world (think Gulf of Mexico, North Sea, Persian Gulf, West coast of Africa, etc.).  Customers contract with TDW to shuttle people and supplies to off-shore rigs – both for exploration and production (think people, drill bits, large pipes, etc.).  The ships that perform these services are $50mm new, and TDW owns about 240 of these boats. 

 

2. Security: The security at hand is an unrated, first-lien security and is issued to former creditors as part of the bankruptcy process.  The amount outstanding is $350 million, and it carries an 8% coupon that pays quarterly.  The common stock trades publicly (ticker: TDW) at around $25 per share, implying an equity market cap of $750mm.  Therefore, you basically have a company with $1.2 billion capitalization comprised of $750mm of equity and with $450mm of debt. The company owns about $800mm (GAAP basis) long-term assets. At the recent quarter, TDW had $460mn of cash on-hand – this represents a net cash position, or cash balance exceeding debt outstanding.  Therefore, we think of the debt as fairly secured from a downside protection standpoint.

 

3. Price: The bonds were offered just above $103 price, which is approximately a 7.5% yield.  So, earning 7.5%, we could own a secured interest in the ships, or we could own the stock which pays no dividend (and may or may not be worth $25 because it is secured by nothing).  Of course, management forecast is for improving conditions several years out, but this is difficult to accept as base-case, especially given the cap that onshore shale production seems to have placed on the price of oil. Offshore market activity and relevant operating statistics are so far off previous highs [and remain in relative oversupply (weak utilization rates)] that it is difficult to assess exactly when the market (and TDW) will re-establish baseline and support higher equity prices.

Many of our clients will notice Tidewater 8% 8/1/22 as a new line-item in their accounts. There was additional analysis done prior to making the final decision. However, this write-up is intended to illustrate, at a high level, our process in regard to sourcing, analyzing and purchasing an investment. This is the type of process and thinking Ballast does on behalf of our clients.

 

We discussed Business, Security, and Price, above, but for those of you that are intrigued and want a little bit more to think about, continue reading for the fourth point we are considering for Tidewater.

A fourth item discussed (and one that we continue to evaluate) is using the publicly traded warrants of TDW as a potential return enhancement. Warrants act like stock options in that for a low upfront “premium” the holder effectively has the option to capture future price appreciation above a stated strike-price and before an expiration date. An investor in the warrants could conceivably earn a multiple of return on a low cost basis if the underlying stock appreciates substantially. If the stock price does not appreciate substantially (to above the strike price), the warrant expires worthless. For this reason, investing in warrants (and options) on their own can be dangerous. The trade we are evaluating, as relates to TDW, would be to enhance the bond position by buying the Series A warrants to add TDW equity upside exposure – without taking direct equity risk (buying the stock), which includes substantial downside risk. For 2-points of first year bond cash flow, the investor would hold the bond yielding 7.5%, as well as the warrant, to buy the stock at $57.06 (currently around $25). Given our confidence in the bonds, we view the downside scenario of this full position as a net 7.0% yield to maturity, where the warrants expire worthless. In an upside scenario – and this is purely hypothetical – if the stock price appreciates to $87, the warrants would be worth $30, and this would take the overall position return to 12%. The cost would be 0.50% of downside (the yield consumed by the warrant from the bond) for some return greater than 7.0% (not necessarily the 12% presented). The greatest consideration for this fourth point (and we continue to evaluate this) is whether it is reasonable to expect the stock price to exceed the strike price by expiration date in July 2023. If it is unreasonable then it is simply not worth the two points of cash flow (0.50% yield) for the option. Stay tuned.

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