Wednesday, June 3, 2009

An arb trade and some other random thoughts

Here is an arb trade that one can play with. As you undoubtedly follow the bedding industry, including the recent successful bid by Sleepy for the assets of the former Long Island City-based powerhouse 1-800-MATTRESS, you know that Sealy (NYSE: ZZ) has been going through a recap on its own. ZZ was a KKR portfolio company that went public may be two years ago, and has been on the decline ever since. KKR paid themselves a nice dividend with the IPO and transferred a chunk of the equity of the debt-laden mattress maker and marketer to the public. The little problem is that mattresses are discretionary and big ticket, and somewhat connected to housing (and sleeping). You get the picture. ZZ announced a recap plan a few weeks ago, consisting of a privately placed debt piece and a rights offering of a third-lien PIK convertible note, backstopped by KKR. You can read the materials on edgar, should you feel so inclined. The rights are now tradable as "ZZRT". Here are my thoughts from earlier today:
ZZ is at $2.10. The convert ZZRT is at $2.16. 13x ZZRT can buy a $25 convertible note that can be converted into 25 ZZ shares at $1 each (I think after 6/26).
Sell 2,500 ZZ for $5,250
Buy 1,300 ZZRT for $2,808
Convert 1,300 ZZRT into 2,500 "new" ZZ and cover the short
Net pre-comm $2,442
Seems too easy so I would be careful and check the math. I should recheck the math myself. My stupid online broker Fidelity does not let me short ZZ (as well as a number of other highly shortable names) so I am not doing the trade. Caveat's on you. Update: this does not work as 13 ZZ.RT require a $25 cash pay to get the convert.

ZZ is a great example of why one should not be buying when people in the know are selling. HTZ is a similar PE-owned masterpiece that recently announced a recap itself. HTZ were flipped very quickly with great returns because the sponsors were able to utilize some pretty creative securitization techniques on the fleet, wrapped in a guarantee by, you guessed it, everyone's favorite bond insurers. An even more aggressive package came with the Dunkin deal but they have held up thus far. Back to look who is selling: take a look at the IPOs of the former masters of the universe, such as BX (-70% since IPO) or GLG (-90%+ since IPO).

On to another potential short, HMR. This is a SPAC that has reportedly reached an agreement to buy the Florida Panthers. "Sports Properties Acquisition Corp. agreed to buy the National Hockey League’s Florida Panthers, Bank Atlantic Center, an arena-management company and some land for $240 million, Reuters reported, citing a person it didn’t identify." I am pretty bearish on pro-sports but there are very few pure-plays through which one can short them. Most teams are privately held by independently wealthy people who really do not care about the team's profitability. They normally stick their no-good sons or daughters to run the teams. There have been 1-2 bks recently in the pro-sport world, one in Phoenix and one in TX (and I am not talking about personal bks of athletes, mind you). So HMR, if the merger is approved, might well become a nice short: third-rate league with a third-rate team in a third-rate market during very slow times for entertainment revenues. May be they are counting on all the Canadians buying up the distressed properties down there once the loonie is 10 to 1 for the US dollar or something. And they (HMR) have Hank Aaron as a Director.

Finally, please note the nice bump in TBT since I last discussed it earlier this year. We are headed to double-digit interest rates very soon. Despite Zimbabwe Ben's attempts to manipulate the credit markets, I was delighted to see bond market 1, benny 0. We might also see the demise of the traditional 30-year fixed rate mortgage in the near future, replaced by a 50% LTV, 5-year, floating rate, weekly pay product. Something like L+2,000. I would also exercise caution in investing in companies that would do well in inflation (ie energy) as the current administration might well confiscate them (with popular support) directly or indirectly via backdated windfall taxation. Most elected reps are innumerate so if XOM is making nominal record profits due to inflation they would think that XOM is thieving when, in fact, the theft is occuring by the printing press. XOM's $10 bn quarter might well be its peak in real terms. Of course, if the dollar is devalued by 90%, $10 bn would not be so much. So keep that in mind, even if you think that secured lending does not matter if the prez sez so.

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