The Full Story Behind Our 85% Annualized Gain With This 'Outlier'
Editor's note: The "smart money" doesn't always get it right...
Most everyday investors stick with stocks, leaving the bulk of bond-market trading to the professionals. But Wall Street isn't perfect – and Stansberry's Credit Opportunities editor Mike DiBiase says you can make a lot of money from companies headed toward bankruptcy when the "experts" overreact...
In today's Masters Series – adapted from a November 3, 2017 update for Stansberry's Credit Opportunities subscribers – Mike details a tremendous opportunity he and his colleague Bill McGilton once found in a bond-market "outlier"... reveals what professional investors missed about this investment... and explains how it led some subscribers to double-digit gains in less than five months...
The Full Story Behind Our 85% Annualized Gain With This 'Outlier'
Every month, my colleague Bill McGilton and I scour thousands of corporate bonds, looking for the best opportunities...
Generally, bonds are priced in line with how much risk the buyer will assume with the investment. Safer bonds are more expensive, while riskier bonds are cheaper and offer higher yields.
Unlike the stock market, almost all of the trading in the bond market is done by financial professionals at large institutions. They're the so-called "smart money."
They don't often make mistakes... But no one is perfect.
When we analyze the market every month, we look for bonds that aren't priced correctly given their level of risk. We search for bonds that are far cheaper than they should be. In other words... we look for situations where the smart money is wrong.
Most people will tell you that trying to find these types of bonds – the "outliers," as we call them – is like camping out and hoping to spot Bigfoot.
But we disagree...
For the most part, the bond market is efficient... However, out of the thousands of bonds we sift through each month, we know at least a few will usually provide safe, outsized returns. It's our job to find them.
Let me give you an example...
In November 2017, brand-management company Iconix Brand Group shocked investors with the troubling announcement that it lost a handful of key business relationships. As a result, the price of its only outstanding bond crashed almost 50% in less than two full trading days.
We knew the market overreacted to the news...
We didn't want the smart money to realize its mistake on this outlier before we published our regular issue of Stansberry's Credit Opportunities. The bond's price had already partially recovered from its lows... So we released a special update in early November 2017 to allow our subscribers to take advantage of the opportunity. We recommended the company's 1.5% March 2018 convertible bond when it was trading around $770 per bond.
The bond's principal was due in a little more than four months. At its distressed price, subscribers could earn a massive 85% yield to maturity.
We knew the bond was safe.
Iconix had a solid business with fat "cash profits." (As I explained yesterday, cash profits are simply the cash the company generates from its operations.)
At the time, Iconix owned around 30 consumer brands. You've probably heard of many of them – including Candie's, Fieldcrest, Joe Boxer, London Fog, Mossimo, Ocean Pacific, Danskin, Ecko Unlimited, Starter, Zoo York, and Umbro.
Most of its brands were sold exclusively by one national retailer. For example, industry giant Walmart (WMT) sold the company's Ocean Pacific brand at the time.
But here's the part about Iconix we really loved... It was a highly capital-efficient business.
Iconix didn't own any factories, it didn't maintain any distribution networks, and it never would get stuck trying to unload stale inventory. Instead, it partnered with "licensees" who designed, made, and distributed the products.
These licensees would pay a royalty every time a product bearing an Iconix trademark was sold. Iconix collected a royalty based on a percentage of the sales. Meanwhile, Iconix was responsible for marketing and protecting and enforcing the trademarks.
The company collected royalties on more than $13 billion in retail sales at the time of our recommendation. It got an average of about 3% of those sales. That was roughly $400 million in annual revenue for Iconix.
At the time, Iconix's cash-profit margins averaged more than 40%. That kind of cash margin is rare. It got us excited.
Iconix's long-term debt was around $820 million at the time, and it was sitting on about $100 million in cash. The March 2018 bond we recommended had $236 million outstanding and was its earliest maturing debt.
Iconix had just put $300 million of new bank financing in place, enough to pay off the bond in full. In fact, the cash had already been placed into an escrow account.
The market was convinced that the bond would be paid in full and on time. It traded near par value ($1,000 per bond) and yielded around 4%. Everything was in order for repayment.
That's when, in late October 2017, Iconix dropped a bombshell...
The company announced that Walmart would no longer sell Danskin – Iconix's 135-year-old women's fitness staple – after January 2019. By losing the Walmart license, Iconix said it would miss out on around $16 million in royalty revenue. On the surface, that news seemed relatively harmless, since $16 million was only around 4% of the company's revenue.
But because of this development, Iconix said it no longer thought it could comply with its debt covenants – financial restrictions imposed by its lenders, like keeping certain debt ratios under the bank's thresholds.
And because of the potential debt-covenant violations, the banks pulled the $300 million of new financing earmarked to pay off the bond. That put Iconix in a liquidity crunch... It had to come up with a new way to pay off the bond.
If it couldn't refinance, it would go bankrupt.
The stock and bond markets both reacted violently. As you can see in the following chart, Iconix's stock and March 2018 bond prices fell off a cliff...
The bond lost almost 50% of its value. It dropped from around $970 on October 27 to as low as $519 on October 31... before recovering slightly to around $770 per bond at the time of our special update in November 2017.
But we believed investors were severely overreacting to the news.
You see, the bank lenders left a lifeline for Iconix. They agreed to amend the loan and provide the financing if Iconix could meet a few further conditions...
First, the lenders cut the size of the credit line they were willing to extend from $300 million down to $225 million. That was still more than enough to pay off the bond in full.
More important, to secure the new financing, Iconix had to come up with $125 million in cash.
We knew Iconix would be able to work out an agreement with its lenders to keep the bond from defaulting.
By our estimates, in a worse-case bankruptcy scenario, creditors would likely receive around $0.60 for every dollar of the amounts they're owed. So our downside as bondholders was limited. Meanwhile, stockholders would be completely wiped out.
Of course, we never recommend any bond if we think the worst-case scenario will happen. But we always want to understand our downside risk with any bond we recommend.
By recommending this bond, we were betting that Iconix could come up with the additional $125 million it needed under the bank's conditions.
With Iconix's portfolio of brands and strong cash flows, we knew that wouldn't be a problem. The company could secure the $125 million in any number of ways.
So what happened? How did this situation play out?
In February 2018, roughly three months after our special update, Iconix reached an agreement with its large institutional bondholders – investors who held $125 million of the bond we recommended. Those bondholders agreed to exchange their bonds for new bonds maturing five years later. That reduced the amount of debt that Iconix had to pay in March 2018 by $125 million.
For all other bondholders, including our Stansberry's Credit Opportunities subscribers, nothing changed. The exchange allowed Iconix to complete its refinancing and pay off the rest of its bondholders. They were paid on time and in full as expected in March 2018.
Subscribers who bought the bond when we recommended it in November 2017 earned a 31% gain in less than five months. That's an annualized gain of 85%.
People say that finding safe, deeply discounted distressed debt – like this Iconix bond – is impossible. It's like spotting Bigfoot. But as I've shown you today, it's not impossible.
We let our subscribers know immediately when we find these opportunities so they can take advantage of them and earn huge, safe returns. That's exactly what happened at the start of the COVID-19 pandemic...
When the market fell in March 2020, Bill and I were ready. We issued an emergency alert with seven high-quality bond recommendations trading at fire-sale prices... plus one more a few weeks later. And we closed out all eight winners within the year – for average gains of 18% in 112 days, or 59% annualized.
The next financial crisis is right around the corner. I expect it to arrive sometime in 2022. Don't get caught off-guard when the deals start to roll in... If you do, you could miss out on the opportunity of a lifetime.
Good investing,
Mike DiBiase
Editor's note: In March 2020, while the rest of the market was panicking, Stansberry's Credit Opportunities subscribers who followed Mike and Bill's advice were able to lock in eight winners in a short amount of time – for average gains of 59% annualized. And when the next recession hits, Mike believes the pandemic sell-off will look like nothing in comparison...
According to Mike, the Federal Reserve's record stimulus has pushed the U.S. economy to a tipping point... And he predicts the credit bubble will finally pop in 2022, creating a wave of potentially massive opportunities in the corporate-bond market.
For a limited time, subscribers can access two full years of Stansberry's Credit Opportunities for the lowest price we've ever offered... and likely ever will. Plus, you'll receive Mike and Bill's newly updated special report with everything you need to know to prepare for the credit collapse. Get the details here.