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Fridson: Industry High-Yield Risk-Adjusted Returns

This article is courtesy Martin Fridson, who writes weekly and monthly high yield bond analysis for LCD News. 

Tactical asset allocators may make use of our monthly reporting on industry returns (for momentum-based strategies) and relative value (for value-based strategies). Strategic asset allocators, on the other hand, are more concerned with industries’ long-run, risk-adjusted returns. The table below addresses that need, covering the industries that make a material difference.

We rank the 20 industries based on the table’s shaded column. It contains the Sharpe ratio, calculated by subtracting the mean risk-free return from the industry’s mean return and dividing by its standard deviation. Our proxy for the risk-free asset is the ICE BofA Merrill Lynch US 3-Month Treasury Bill Index, which had a mean return of 0.552%. The observation period consists of all full calendar years for which returns are available on the ICE BAML High Yield Index’s industry subindexes, i.e., 1997–2007.

Under a very strict form of the Efficient Market Hypothesis (EMH) that we might label the Omniscient Market Hypothesis (OMH), all industries would have the same Sharpe ratio. Their returns would differ, to be sure, because industries differ in the inherent volatility of their cash flows, as in the case of cyclicals versus non-cyclicals. Those differences would not necessarily be offset by companies’ financial policies, i.e., use of higher leverage in more stable industries and vice versa. In an OMH world, however, the market would cap prices perfectly in anticipation of both ordinary cyclical variation in cash flows and shocks such as the disruption of Super Retailing (department stores, specialty stores, and discounters) by online merchants. Through this market omniscience, each highly volatile industry’s return would be high enough to produce a Sharpe ratio competitive with every other industry’s.

The table shows how far the reality of the high-yield world is from that idealized vision. Sharpe ratios for 1997–2017 range from as low as 0.08 to as high as 0.37. We conclude that strategic industry allocation decisions made a considerable difference not only in absolute returns, but also in risk-adjusted returns.

As would be expected even under the OMH, historical standard deviations of returns range widely, from 3.594% for Healthcare to 10.978% for Broadcasting. In some cases, investors have been rewarded for accepting high variance by a high average return. For example, Broadcasting topped the list not only in standard deviation, but also in mean return, at 2.854%. Even that return premium over the 20-industry median of 2.505%, however, did not quite suffice to enable Broadcasting to match the group’s median 0.24 Sharpe ratio. Broadcasting came in at 0.21.

Neither was it the case that the lowest return in the group, 1.218% on Telecommunications, was associated with the group’s smallest risk. Rather, Telecommunications’ standard deviation was 7.881%, well above the 6.036% peer group median. Telecommunications’ full-period 1997–2017 performance was dragged down in the Tech Wreck. On an annualized basis, the ICE BofA Merrill Lynch US High Yield Telecommunications Index returned –25.116% during 2000–2002, versus 3.677% for the ICE BofA Merrill Lynch US High Yield Excluding Telecommunications Index. Clearly, the market extracted far too small a penalty rate on Telecommunications issues heading into the 2000 blowup.

Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Global Market Intelligence. His weekly leveraged finance commentary appears exclusively on LCD, an offering of S&P Global Market Intelligence. Marty can be reached at [email protected]

Research assistance by Kai Zhao and Yaxian Li.

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Revlon Refutes Asset-Transfer Rumors; Debt Climbs on 4Q Preview

Debt backing Revlon (NYSE: REV) was on the upswing today after the troubled cosmetics firm—whose bonds tumbled into distressed territory following lackluster earnings in November—unveiled better-than-expected preliminary results for its fourth quarter, indicating adjusted EBITDA above analyst expectations.

The cosmetics firm also addressed speculation that Revlon has been actively considering plans for an asset transfer in order to manage its debt load, with CFO Chris Peterson refuting such commentary as “false rumors and pure speculation,” highlighting in a Monday statement that “a material asset transfer is not being considered.”

Sources said some creditors were relieved that an asset transfer was not imminent, particularly as the issuer has alternative options for addressing nearing maturities, especially its 5.75% notes due 2021, pointing to debt-incurrence flexibility at non-guarantors.

Revlon 5.75% notes due 2021 and 6.25% notes due 2024 were up 1.25 points and 0.625 points, respectively, in morning trading, rising to 75.75 and 62.125, according to MarketAxess. The 2021 notes tumbled steadily into distressed over the past three months, from highs of 87.25 in early November, after Revlon booked third-quarter adjusted EBITDA that was roughly 49% below analyst estimates. Meanwhile, Revlon’s term loan due September 2023 (L+325, 0.75% LIBOR floor) was quoted at 75/78 this morning, up more than two points from before the news, sources said, and settling from bids of roughly 76 in late trading Monday. There was $1.738 billion outstanding on the term loan as of Sept. 30, SEC filings show.

Following a year of top-level management reshuffles, Revlon also said that CEO Fabian Garcia has stepped down from his role, as Revlon board member Paul Meister will become executive vice chairman of the board, overseeing day-to-day operations on an interim basis. Sources noted MacAndrews & Forbes, of which Meister is president, has a history of revamping operations at struggling companies, and that Meister may play a meaningful role in Revlon’s turnaround strategy.

Revlon said it now expects adjusted EBITDA for its fourth quarter to be within a range of $110–115 million, roughly 1.4% above analyst forecasts, based on consensus data compiled by S&P Global Market Intelligence, while expected net sales of $785 million for the period are roughly in line with estimates.

S&P Global Ratings on Nov. 16 downgraded Revlon’s corporate rating to B–, from B, citing concerns of elevated leverage in the wake of third-quarter results, and cut its ratings on the issuer’s unsecured notes and term loan to CCC+ and B–, respectively, from B– and B, while lowering its outlook on Revlon to negative from stable. Moody’s, meanwhile, maintains a B2 corporate rating on the issuer, with a stable outlook, and ratings on the unsecured notes and term loan of Caa1 and B1, respectively.

Revlon (NYSE: REV) is a New York-based manufacturer and marketer of beauty and personal care products worldwide. — James Passeri/Kelsey Butler

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Wynn Las Vegas bonds Extend Losses Amid Harassment Cloud

wynn logoBonds backing Wynn Las Vegas were falling sharply today—with the issuer’s 5.5% bullet notes due 2025 shedding three points, to 101.5—to extend declines since reports surfaced on Friday alleging sexual misconduct on the part of Steve Wynn, CEO of parent company Wynn Resorts. The casino magnate has described the accusations as “preposterous,” but on Saturday resigned from his post as finance chairman of the Republican National Committee.

Wynn Las Vegas 5.25% bullet notes due 2027 today shed about two points in heavy trading, to par, after falling as low as 98.75. The decline marked the issue’s first trades below par since the pricing at par last May, with proceeds of the $900 million offering backing the company’s purchase of outstanding 5.375% first-mortgage notes due 2022. Meanwhile, more than 18% of Wynn Resorts’ market cap was erased from closing levels on Thursday, as shares of Wynn Resorts (Nasdaq: WYNN) tumbled a further 9.2% on Monday—leading the decline of the S&P 500—to $163.54 in midafternoon trading. Trades were at a 12-month high north of $200 following the company’s earnings report one week ago.

On Friday, the Wall Street Journal reported that “dozens of people” had come forward to recount a pattern of sexual misconduct by the chief executive, over a period of more than 10 years. The news triggered an immediate plunge in the stock price, but bond-market reaction was initially more circumspect before today’s heavier losses, as analysts said the biggest risk to bonds would be the ouster of the company’s CEO. Wynn’s board of directors has formed a special committee to look into the allegations.

The declines mark an abrupt reversal from gains last week, after the issuer on Jan. 22 detailed better-than-expected earnings for its fourth quarter. Wynn Resorts booked adjusted EBITDA for the quarter of roughly $480.2 million, topping analyst forecasts by about 7.9%, as net revenue of $1.69 billion for the period also beat estimates by roughly 8.3%, based on consensus data provided by S&P Global Market Intelligence.

On last week’s earnings call with analysts, Steve Wynn touted progress on its “first class” Wynn Boston Harbor construction project in Everett, Mass., which he said represents the “largest private investment in the history of the Commonwealth.” Notably, the Massachusetts Gaming Commission initiated a review of the project over the weekend in response to the emerging allegations.

Wynn Resorts, which is based in Las Vegas, develops, owns, and operates destination casino resorts in the U.S. and Macau. — James Passeri

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Dell Bonds Rally on IPO Chatter Ahead of Looming Debt Maturities

Bonds backing Dell Technologies rallied today following reports that the company is considering an initial public offering, which could provide a liquidity influx just as the maturities across the company’s LBO-inflated debt stack begin to mount.

After founder Michael Dell took the company private in the 2013, the company placed $20 billion of high-grade, senior secured notes (BBB–/Baa3) on the private market in May 2016 to facilitate its $67 billion acquisition of EMC Corp. The offering remains the fifth largest corporate bond placement on record, according to LCD. The $2 billion issue of 8.35% bonds due 2046, which were priced at the time at T+575, traded today at T+305, or 25 bps tighter on the day and down from T+362 in early December, trade data show.

Similarly, the 6.02% senior secured notes due 2026, which were priced in May 2016 at T+425, traded 20 bps tighter today on either side of T+177, or 30 bps tighter week to week and down from T+229 in early December.

The issuer’s $5 billion term loan due 2023, which the company repriced last year, also firmed up on the news. Dell’s term loan due September 2023 (L+200, 0.75% LIBOR floor) was quoted at 100.5/100.75 this morning, up from 100.375/100.875 yesterday.

Dell carried roughly $52.5 billion of consolidated debt as of Nov. 3, 2017. Near-term debt maturities in 2018 include $500 million of 5.65% Dell unsecured notes (BB–/Ba2/BB+) due on April 15 and $2.5 billion of legacy EMC 1.875% unsecured notes that come due on June 1. Additionally, it started the year with a $1.4 billion remaining principal balance on its A-3 term loan due December 2018. The LBO debt from May 2016 then starts to roll off in 2019, when $3.75 billion of Dell International 3.48% senior secured notes come due on June 1, 2019, immediately followed by the maturity of the company’s $600 million issue of 5.875% unsecured notes due June 15, 2019.

Bloomberg on Thursday reported that Dell’s board would take up strategic options for the business, including an IPO, citing undisclosed sources close to the matter. However, a range of options will be on the table, including further acquisitions and/or a pursuit of the remaining stake in VMWare that Dell does not already own, according to press reports. Silicon Valley–based VMWare is controlled by Dell Technologies, which holds roughly 82% of the common stock and nearly all of the voting power, but the debt at VMWare is currently considered by ratings agencies as insulated from Dell credit risk given VMWare’s stand-alone, severable independent operating profile.

VMWare’s BBB–/Baa2 3.9% notes due Aug. 21, 2017 notes widened as much as 13 bps today, to T+142. The notes were placed last August, at T+170, as part of a $4 billion debut offering of public notes to fund higher shareholder returns and potential M&A options. — John Atkins

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US High Yield Bond Funds See $1.1B Investor Cash Withdrawal

high yield bond flows

U.S. high-yield funds recorded an outflow of roughly $1.1 billion for the week ended Jan. 24, according to weekly reporters to Lipper only. This week’s outflow follows last week’s exit of roughly $3.1 billion, and brings the total outflow from high-yield funds so far this year to about $1.4 billion.

ETFs made up the bulk of this week’s outflow, with an exit of roughly $621 million, while $510 million was pulled out of mutual funds.

The four-week trailing average widened to negative $342 million, from negative $119.5 million last week.

The change due to market conditions this past week was an increase of $123.5 million. Total assets at the end of the observation period were $207.8 billion. ETFs account for about 24% of the total, at $50.3 billion. — James Passeri

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US Leveraged Loan Funds See $477M Investor Cash Inflow

US loan funds

U.S. loan funds recorded an inflow of $477 million for the week ended Jan. 24, according to Lipper weekly reporters only. This inflow snaps a streak of 14 consecutive weeks of outflows that totaled $4.35 billion over that span.

Note on the week ended Nov. 8, U.S. loan funds recorded an exit of roughly $1.5 billion, although roughly $1.1 billion of that total outflow was the result of a reclassification at a single institutional investor, whereby the investor’s open-end fund was liquidated and merged into its closed-end fund. The transaction was reported as a net outflow as money exited the open-end universe into closed-end funds.

Mutual funds made up roughly $295.5 million of the total inflow this week, while $181.5 million entered ETFs.

The four-week trailing average came in at positive $55 million, up from negative $114 million last week, and it follows twelve consecutive weeks in the red.

The change due to market conditions this past week was positive $136 million. Total assets were $95.8 billion at the end of the observation period. ETFs represent about 19.8% of the total, at $18.9 billion. — James Passeri

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Toys R Us Plans to Close Up to 182 Underperforming Stores

Toys R Us is seeking bankruptcy court authority to close up to 182 “underperforming brick-and-mortar store locations” in the United States, according to a court filing.

The company has roughly 900 stores in the U.S.

According to a Jan. 23 court filing, the company has not yet made the final decision to close all of the locations, saying that some final decisions will depend upon whether the company is able to negotiate more favorable lease terms for those stores.

The company did not specifically state when those final decisions would be reached, but said lease negotiations are “continuing.” The company said, however, that it expects most of the closings to be completed by April 16.

The company said the store-closing plan follows a performance evaluation that included “an extensive store-by-store performance analysis of all existing stores evaluating, among other factors, historical and recent store profitability, historical and recent sales trends, occupancy costs, the geographic market in which each store is located, the potential to downsize certain stores, the potential to consolidate certain Toys “R” Us and Babies “R” Us locations within a reasonable proximity of one another, the potential to negotiate rent reductions with applicable landlords, and specific operational circumstances related to each store’s performance.”

With respect to the stores pegged for closure, the company said that “overwhelming majority … have negative sales trends and have failed to meet the performance standards set by the debtors.”

The company added that it may ultimately need to close additional stores, noting that it had recently filed (and following a hearing yesterday, the Richmond, Va., bankruptcy court had granted, according to the court docket) a motion to extend the deadline for deciding on the assumption of store leases through the date that a reorganization plan is confirmed (the current deadline to decide upon leases was April 16).

As reported, the company is targeting the summer of 2018 for confirming a reorganization plan, with the goal of emergence from Chapter 11 ahead of the 2018 holiday season.

Meanwhile, in connection with the current round of story closings, the company is seeking to retain two groups, joint ventures Hilco Merchant Resources/Gordon Brothers and Tiger Capital Group/Great American, to manage the process and related sales of merchandise and furniture, fixtures, and equipment.

A hearing on the motion is set for Feb. 6. — Alan Zimmerman

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Netflix Expects to Again Tap High Yield Markets, Highlighting Equity Cushion

Alongside Neflix’s fourth-quarter earnings rollout today, indicating adjusted EBITDA for the period above consensus forecasts, the issuer noted in a filing that it again intends to seek capital through high-yield markets, three months after the issuer placed $1.6 billion of unsecured bullet notes due 2028.

“We anticipate continuing to raise capital in the high yield market,” the company said in the Monday filing. “The new limitation on deductibility of interest costs is not expected to affect us. We are striving to make the right choices and investments to grow the value of the firm, and that is what also ultimately secures our debt. High yield has rarely seen an equity cushion so thick.”

Netflix 4.875% notes due 2028 rose 1.375 points on the day, to 99.875 in midafternoon trading, according to MarketAxess. Meanwhile, shares of Netflix (NYSE: NFLX) rose 9.3% in postmarket trading, climbing to about $248.50.

The streaming media provider booked adjusted EBITDA for the quarter of $312.9 million, topping analyst estimates by roughly 2.4%, based on consensus data provided by S&P Global Market Intelligence. Meanwhile, negative free cash flow of $524 million for the quarter topped forecasts of about negative $732.8 million. Netflix noted the FCF beat was largely due to the timing of content payments, which will now occur in 2018. Meanwhile, revenue of about $3.286 billion for the period fell roughly in line with estimates.

Netflix reported FCF for 2017 of about negative $2 billion, on the narrower of the issuer’s guidance of negative $2–2.5 billion, and above consensus estimates of roughly negative $2.175 billion for the period.

“In the near term, however, membership, revenue and original content spend are booming,” the company added. “We’re growing faster than we expected, which allows us to invest more in original content than we had planned, so our FCF will be around negative $3 billion to $4 billion in 2018.”

Netflix (Nasdaq: NFLX) is a Los Gatos, Calif.–based global streaming media provider. — James Passeri/ Jakema Lewis

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Secondary Buyouts Dominate LBO Activity in Leveraged Loan Mart

Rallying stock markets and sky-high business valuations led cash-rich private equity firms to turn to other sponsors for acquisition targets in 2017. As a result, secondary buyouts (SBOs), as a share of all LBO financing transactions in the U.S. leveraged loan market, hit a record high of 65% in 2017, according to LCD.

That’s up from 56% in 2016 and tops the previous record of 62% in 2014 (these numbers are based on transaction count).

The SBO activity easily surpassed the 2017 share of old-school take-private acquisitions (14%) and corporate carve-outs (9%), illustrating just how firmly the sponsor-to-sponsor activity has taken root in today’s market.

“Not only are we actively buying from private equity, but we’re actively selling to private equity, and in almost equal amounts,” explains the head of a large buyout firm. “It’s been an active strategy of ours since the beginning, but the opportunity is different now than it was then, when there were thousands of companies that the IPO market had shut out.”

All-in, PE sponsors raised $55.8 billion in the leveraged loan market to fund secondary buyouts in 2017, including $49.2 billion of institutional issuance. That’s the most ever, and is 10% higher than the prior record, $50.6 billion in 2014.

Investors have been eager to allocate capital into the private equity space, an appealing asset class in what has been a stubbornly low-yield investment environment. That appetite for juicier returns drove fundraising to new heights last year, with dry powder at U.S. PE firms rising to $565.9 billion in 2017, according to Pitchbook. Of course, those shops are inclined to put that money to work.

The challenge has been finding good-quality targets in an expensive market. Given the mounting demand, purchase price multiples for LBOs hit an all-time high of 10.6x in 2017, according to LCD, marking the third straight year above 10x. Secondary or tertiary buyout multiples rose to 11.1x at the same time, likewise a record. — Jon Hemingway/Mairin Burns

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After Big Inflow, US High Yield Funds See $3.1B Investor Cash Withdrawal

high yield bond flows

U.S. high-yield funds recorded an outflow of roughly $3.1 billion for the week ended Jan. 17, according to weekly reporters to Lipper only.

This week’s outflow follows an inflow of $2.65 billion last week, and puts the total outflow so far this year at about $238 million.

ETFs accounted for roughly $2 billion of this week’s outflow, while $1.1 billion exited mutual funds.

The four-week trailing average swung to negative $120 million, from positive $371 million last week.

The change due to market conditions this past week was an increase of $316 million. Total assets at the end of the observation period were $208.8 billion. ETFs account for about 24% of the total, at $50.8 billion. — James Passeri

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