Live From the Desk 11

Bond Spreads

Ace Cash Express released their earnings at the end of September. We own the 11% 2/1/2019 Senior Secured bond in both the Enhanced Income Fund and the Vertex Fund. Traditionally, the cheque cashing industry received funding from private investors at a rate of 20% annualized. By issuing bonds, the companies lowered their cost of financing by half. So, both the investor and the company benefit.

Upon issuance, Ace Cash Express received a Single B rating. Purely look at their cash and debt metrics, the company deserved a higher rating. Historically, the industry has come under political pressure due to a lack of regulatory oversight. However, today, practically all States have regulated the sector. Cheque cashing is a revenue stream the bank does not want (anyone ever been told the bank was going to put a hold on their deposit?) however, there is a definite demand for it in the marketplace.

The latest earnings show that Ace Cash Express is only 3.25x EV/EBITDA, which is a very low multiple for such a nice yield. The company produces a stable cash flow and has an attractive model for new franchises. The typical cost to open a new store is approximately $85,000 and takes roughly 12 months to break even.

When the bond was issued, the offering was underwritten by Credit Suisse First Boston. They chose to place the deal in the hands of 6-7 large accounts rather than spread it over multiple investors. This paid off in the short term, as these bonds were “sticky” off the break (meaning there were not a lot of sellers when the bond started trading) and the bond immediately traded up. Unfortunately, this strategy can create problems longer term if one large holder wants to decrease their position. That is what we have been seeing over the past month, a large holder has been reducing their position pressuring the bond down 15 points ($15 from $104 to $89). A portion of that drop is attributed to market out-flows in the high yield space but the move was exaggerated because of the one large seller.

We like our position and are comfortable holding the bond. This is a typical example of what we are seeing across the space. It creates volatility but can also produce opportunities for new investment. All of the companies we hold are flush with cash and we continually monitor and evaluate the health of their businesses.

Interesting Note by Goldman

Goldman Sachs put out an article today on the high yield market. Here is an excerpt:

“Currently, we see attractive relative value in high yield with spreads approaching 800 basis points. In fact, high yield spreads at 800 basis points or more over Treasuries have historically offered very good value. Since 1986, high yield spreads have exceeded 800 basis points on six occasions. In each instance, the total returns for the following three-year period were strongly positive (see below Figure). The worst total return over a holding period of one year or more was only -0.84%.”
high-yield-performance-after-spreads-cross-800bp
Source: JPMorgan Global High Yield Bond Index. Data as of September 22, 2011.

until next time. . .

@The Vertex Team

For information on this update or the funds we offer, please contact your local sales representative:

Noel Dattrino
(Western Canada)
604.408.5660

Michael Lindblad
(GTA and Eastern Ontario)
416.200.4457

James Wilson
(GTA and Western Ontario, Maritime Canada)
519.902.7780