Chrysler Sale to Go Forward

According to the AP, the Supreme Court declined to review the appeal brought by those Indiana funds: Supreme Court to let Chrysler sale go forward. From the press release,

the automaker's secured debtholders would get $2 billion in cash, or about 29 cents on the dollar, for their combined $6.9 billion in debt. Some of the debtholders balked at the deal, saying as secured lenders they deserved more. The Indiana funds involved in the Supreme Court appeal hold about $42.5 million, or less than 1 percent, of Chrysler's $6.9 billion in secured debt. They bought it in 2008 for 43 cents on the dollar.

Why didn't any of the bondholders who hold the other 99% of Chrysler's secured debt appeal to stop the deal? I wonder if they bought the debt at low enough prices that they'll still come out ahead with a payoff of 29 cents on the dollar.

Given the extent to which the bankruptcy deals for GM and Chrysler favor the unions over the bondholders, it will be interesting to see if unionized manufacturers will have to pay offer higher coupon rates to attract buyers of their debt in the future. We may find out soon enough¹. According to Tony Jackson in his Financial Times column yesterday ("GM shows gravity of pension challenge"):

In the thunderous collapse of General Motors last week, one detail seems to have gone almost unnoticed. The old GM’s US pension fund, with its near-$100bn (£63bn) of liabilities, is being transferred lock, stock and barrel to the new entity. As a direct result, the new GM could be bankrupt again in a very few years.

[...]

GM’s US fund is, of course, in deficit, but the company has made no contributions since 2003. Back then, it put in $18.5bn, which it raised through a bond issue. Since this counted as a pre-payment, GM is not obliged to pay any more for the next year or two. However, it will then have to start plugging the gap, under the new rules set down by the Pension Protection Act of 2006. This, [independent UK consultant John] Ralfe calculates, would involve diverting $1bn to $2bn annually from operating cash flows. If GM cannot do that, bang it goes again.

We do have a government-sponsored organization designed to take over the pension funds of bankrupt companies, of course: the Pension Benefit Guarantee Corporation (PBGC). Had the PBGC taken over GM's pension, the new, post-bankruptcy GM wouldn't end up saddled with these liabilities, but that would have required GM's pensioners to take a significant haircut, since many of them earn higher pensions than the PBGC's maximum guarantee. Jackson offered the following numbers by way of example in his column,

Its maximum annual payment is $54,000 for a 65-year-old, but only $20,000 for a 50-year-old. And in Detroit, it is commonplace for car workers to retire on full pension at 50.

The PBGC has calculated that if it took over all the auto industry’s pensions, members would lose 40 per cent on average.

A 50-year-old GM pensioner with a $54,000 annual entitlement, Mr Ralfe reckons, would lose 60 per cent. Add that all up, and GM’s annual $9bn pension bill would be cut by $3.5bn.

¹Or not, if the now-bankrupt auto companies end up going to the federal government for more money in the future, instead of trying their luck in the capital markets.

Applying the Altman Z-Score Model to Mining Companies

Tools and ideas for short sellers, including an automated calculator and screener based on the Altman models.

In a couple of recent posts ("Using the Altman Z-Score Model to Calculate the Risk of a Company Going Bankrupt" and "Applying the Altman Z-Score Model to a Non-Manufacturing Company") we discussed the use of the original, five variable model for manufacturers and the modified model for non-manufacturers. Recall that the modified Altman Z-score model for non-manufacturers excludes the fifth variable in the original model (sales/total assets), to account for different levels of capital intensiveness among non-manufacturers.

Since mining companies, like manufacturers, are also capital intensive, I asked Dr. Altman via e-mail which of his models would be best for miners. His response:

Try both, but probably the 4 variable model is more appropriate.

The photo above, of a copper smelter, is from the website of the Canadian mining company Hudbay Minerals.

Using The Altman Z-Score to Calculate the Risk of a Company Going Bankrupt

The Altman Z-Score is a model developed in 1968 by NYU Finance professor Edward Altman to predict the likelihood of a company going bankrupt within the next two years. According to Investopedia,

[R]eal world application of the Z-Score successfully predicted 72% of corporate bankruptcies two years prior to these companies filing for Chapter 7"

In creating the Z-Score model, Professor Altman studied an initial sample of 66 firms, half of which had gone bankrupt, and looked for the balance sheet and income statement ratios that had the most predictive value. Dr. Altman settled on these five ratios¹:

T₁ = Working Capital / Total Assets
T₂ = Retained Earnings / Total Assets
T₃ = Earnings Before Interest and Taxes / Total Assets
T₄ = Market Value of Equity / Total Liabilities
T₅ = Sales/ Total Assets

He then assigned weightings to them based on their predictive values to create his model:

Z Score Bankruptcy Model:

Z = 1.2T₁ + 1.4T₂ + 3.3T₃ + .6T₄ + .999T₅

Based on this model, a Z-score below 1.8 means bankruptcy is likely within two years; a Z-score between 1.8 and 2.99 is a gray area; and a Z-score above 2.99 means there is little likelihood of bankruptcy within the next two years.

There are several free Altman Z-Score calculators available online to facilitate the use of the model. There is also a fully-automated Altman Z-Score calculator (where you just need to enter a company's symbol and the calculator does the rest) at Shortscreen.com. I used the one at Ironwood Advisory's website to calculate an Altman Z-Score for Alloy Steel International (OTC BB: AYSI.OB). The calculator gave a Z-score of 4.89, and included this commentary:

Your Z score is in the high range. This company is in good financial health and is predicted to remain solvent for the next two years. Smaller firms should note that these models are based on data from firms with assets in excess of $1,000,000². If it is believed that asset size affects Z scores, then their use may not be appropriate.

The photo above of Professor Altman comes from the CFA Institute.

¹The components and weightings of Altman's model come from Wikipedia.

²Alloy Steel's total assets are approximately $7,030,000 and its net assets are $4,393,000.

The Kimbo Crash

This will be old news for those of you who follow mixed martial arts, but the rest of you might see some parallels between the story of Kimbo Slice (né Kevin Ferguson -- the formidable-looking fellow pictured above) and the fall of some formerly formidable-looking businesses this year.

The heavy-handed Kimbo Slice became famous as videos of his street fights, such as the one below, circulated on the internet.



Capitalizing on Kimbo Slice's notoriety, the mixed martial arts league Elite Xtreme Combat ("Elite XC"), operated by ProElite, Inc. (Pink Sheets: PELE.PK) signed him up as its marquee heavyweight fighter. ProElite signed a deal with the Showtime Networks, Inc. subsidiary of CBS (NYSE: CBS) to show fights on Showtime and CBS. Elite XC brought Kimbo Slice along deliberately, attempting to match him with beatable opponents. Kimbo's first Elite XC fight, with a 10-10 MMA fighter named Bo Cantrell -- who had lost his previous 4 fights -- ended in seconds, with Cantrell seemingly giving up after barely being hit. Next, Elite XC matched Slice with the 43 year-old David "Tank" Abbot, who had a 9-13 MMA record going into the fight. Another knock out for Kimbo.

Elite XC did step up the level of competition for Kimbo's third fight, against the 14-8 James Thompson (although Thompson was coming off two back-to-back knockout losses). Kimbo won in the third round, after a controversial stoppage. After that close call, Elite XC picked the 44 year-old Ken Shamrock as Kimbo's fourth opponent, in a fight it would broadcast in prime time on CBS on Saturday Night, October 4th. Shamrock had a 26-13-2 record going into the fight and a storied reputation in mixed martial arts, but he had also lost his last five fights. At the last minute though, Ken Shamrock backed out of the match due to a training injury. Elite XC replaced him with a light heavyweight named Seth Petruzelli had been scheduled to fight on an un-televised undercard. Petruzelli was a part-time MMA fighter whose day job was running his Smoothie King franchise. Below is a video of the fight.




Two weeks later, ProElite, Inc. received a notice of default from Showtime Networks and the Los Angeles Times reported that ProElite was considering filing for bankruptcy.