Manager's Commentary - December 2010
The 2011 Un-Forecast
As we embark on a new year, many economic and business pundits are hard at work justifying their existence by delivering their predictions for 2011. To be sure, many make predictions that are both well researched and well articulated. However, as stewards of investors’ capital our goal is to achieve a positive investment result regardless of future macro-economic outcomes.
While some points in time present more attractive investment opportunities than others, our mandate is to only allocate capital when we believe a positive result can be achieved. Regardless of inflationary / deflationary forces, high / low interest rates, robust / stagnant economic growth. The key to achieving this goal is to ensure that a margin of safety exists at the point of entry for each investment we make.
One good example of achieving a margin of safety is our position in the Capital Source 12.75% notes due July 2014. In December, Capital Source paid us (and other bondholders of the $300M issue) a consent fee of $5 for every $100 of bonds owned. Why? Because bond holders agreed to amend certain covenants of the bond that tied up much of Capital Source’s liquidity. Even after the consent, these bonds will have asset coverage of approximately 5x compared to 10x prior to the consent.
To be certain, not all of our positions have such influence over a company. However, Capital Source provides a great example of the importance in finding the fulcrum security that earns the focus of management.
As we stated in our October commentary, we mentioned that we were actively pursuing some floating rate loan opportunities. We are happy to report that we recently purchased a piece of both the first lien (LIBOR + 600 bps) and second lien loan (LIBOR +1,100 bps) of Miramax Films.
Miramax was started in 1979, was subsequently purchased by Disney in 1993 and owns a library of over 650 films. Over the past decade Miramax became orphaned at Disney as the latter became more focused on its own branded animated/visually appealing films; and less so on harvesting the cash flow from the Miramax film library. What initially attracted us to this investment were the contractual cash flows from the many distribution agreements already in place. The value of these contractual cash flows, which are from high quality counter parties, represents almost 70% of the loans outstanding and doesn’t take into consideration the many untapped distribution opportunities.
While loans currently represent a small part of our portfolio, we will continue to pursue more of them as they represent a great hedge against an increase in interest rates. While we would defer you to your friendly forecaster of choice for an interest rate prediction, we prefer to find investments that will perform admirably regardless of the future interest rate environment.
Matthew Shandro
December 31, 2010