A Generational Opportunity in Distressed Debt

One would think that after the sixteen months we've just experienced with the global pandemic and the global economic disruption, that there would be plenty of distress debt. Paul Trigg Yanni. He's a managing director and head of distress debt Ford investco joins us. Paul, thanks so much for taking the time here talk to us about the distress debt market. Are there opportunities out there? Are you seeing more distress debt or the the federal reserve backstoff? Pretty much everything?

So thanks for having me. Yes. I think generally speaking, over the last twelve d eighteen months, we have we've really seen a generational opportunity and distress debt investing um. Most companies twelve eighteen months ago had pretty severe revenue shortfalls supply chains in many cases were we're pretty severely disrupted, and in all companies were broadly affected across most geographies, and so there was there was really plenty to do

in terms of looking for distressed opportunities. If you fast forward to where we are today, we think many of the larger companies have had access to liquidity, whether that be through the public equity and credit markets rallying, or the federals are backstop as as as you as you mentioned, UM. The caveat to that is that the small cap space, which is a large focus for US, has really been left behind. In many ways. These smaller companies don't have

the same level of access to capital. Many of them are private, UM, and many of the lending facilities that were put in place really have not allowed many of these smaller private businesses, several of which are are private equity owned, to access that liquidity. So it's it's still quite a robust opportunity for small companies, Paul. How much has the market view changed? I remember, UM, last year we heard a lot of economists warning about these cascading bankruptcies.

It was going to be catastrophic, and it doesn't look like that really happened. No, I think it's I think in our view that's correct, particularly in the in the large cap market. I think many of those companies were able to get get capital through various different means. UM. The equity markets, obviously, as we all know, have come back, the public credit markets have come back, and so UM in large part, the large cap distressed opportunity, which was

significant twelve eighteen months ago, seems relatively small today. But that having been said, if you look at the private universe of smaller companies UM, again, if you were to take sort of lower middle market or small cap companies that are generally leveraged buyouts or management buyouts owned by private equity firms, UM, they're still pretty significant opportunity there. And you still are seeing a significant amount of defaults UM in in sub five million dollar companies and and

a significant amount of reorganizations. Many of those companies because their private have less access to capital. The direct lending and private credit universe has not has not stepped into

finance distressed companies. And if you look, for example, at what we put in place in the US in terms of the main street lending facility that that ended the year less than one percent utilized, which was fairly significantly underutilized obviously because it effectively barred private equity owned companies from borrowing. So UM it's really been a very different story in in the small cab universe in terms of bankruptcies, Paul, what sectors are you guys doing some of your most

work right now? So the the the interesting point about the smaller cap segment is that it tends to be more diverse. If you look at large cap distress, it's tended in the last five seven years to be very focused around retail and energy UM, and that's probably not surprising given what's gone on in those two industries. The small cap space over time, if you look over the last two decades, has been pretty pretty diverse in terms

of industry focus. So we're looking at companies in general industrials and the healthcare sector, UM, in consumer sectors, in in small financial businesses. So it's it's it's really across the board, UM a very diversified opportunity set in terms of the smaller end of the market. What have you look at it the other way around? I mean you're used to obviously trying to find UM areas that the market sees as distressed, but you think, you know, maybe

not may may not fail. Are there industry groups, for example, that you think it's been given too much credit? UM? So we I think we were initially very cautious in some of those industry groups UM that were particularly COVID impacted. And so maybe one way to think about it was UM that there's really been sort of the direct COVID

impacted industries UM. And you can think about UM theater change for example, or you can think about shopping malls and things like that where social distancing norms changed over the last twelve to eighteen months, or airlines for example, UM and so obviously UM this pandemic has had a sort of beginning of middle and hopefully an end here and so people have seen their way through UH distress and are looking forward a year or two in terms

of normalization of those UM we still remain pretty cautious on on those areas. I think the larger funds and larger cap dis stress market has has shown quite a bit of interest in those, and we're still fairly cautious on that part of the market. Again, those are those are larger companies than we generally focus on um. So that's our thoughts there A. Paul, thanks so much for

joining us. Really appreciate getting your thoughts here on this interesting segment of the fixed income markt Pltrigg and he's a managing director and head of Distress Credit at Investco. I want to bring in now Mira Panda. As we said, she's a global market strategist at JP Morgan Asset Management. And the reason I almost forgot tomorrow is Job's Day. It's a non far forget. This is like Tom's monthly highlights. Well it is. It's I've always called it the Granddaddy

of all economic statistics. It's it's a big deal and there's a lot of volatility around it. A lot of times people stopped trading for a moment while it comes out. Um, Amira, welcome to the program. Thanks so much for joining us. Let us get your insight on on what to expect here. You know, we've had some big misses, but obviously things are going in the right direction. Yeah, absolutely, and thanks

for having me. So. We're forecasting about six hundred thousand jobs were added in June, so pretty much in line with what we saw back in May. Slightly above but we're probably going to see continued strength and areas like leisure, hospitality broad based within the services. As those areas of the economy really come back, could potentially see um some seasonal effects on the negative side in terms of education

as teachers adjournal for the summer. But given the layoffs we've already seen that space, those challenges are are well understood and could be less of a headwind around and I'd say that overall that could bring our unemployment rates from about five point eight percent down to about five point five percent, in line with the decline last month.

So ultimately the risk here in the jobs reporters probably really to the downside, and not because the economy is not creating jobs, but just because we can't feel them at a rapid enough clip. So mirror as we think about the jobs market, that brings us to potential for wage inflation we haven't had. You know, there was a period in the market, you know, it's called it a month or two ago where inflation was really a concern for this market. Seems to have faded a little bit.

Where are you in terms of thinking about inflation in this market, whether it's transitory, whether there really is some of longer risk concerns. Ultimately, I'd think about it on the basis and then the kind of three to five year basis, and I think from perspective, the higher inflation

numbers we're seeing now probably are mostly transitory. We're seeing some of those base effects play out, higher energy prices versus last year, higher services on a on a month over month basis, as services kind of start to come back um evidence of supply chain issues. But look, we've already seen a lot of commodity prices peek out. I think that some of these things will play out over

the course of the year. But I mean, as you say, with some of the higher wage pressures will probably in for an environmentment of slightly structurally higher inflation over to say that three to five year timeline, Let's think maybe two to three percent inflation as opposed to the sort of two percent or sub two percent inflation we've been seeing kind of pre COVID post financial crisis. It's no big deal. Me and Paul are children of the seventies.

We know what real inflation is like, and that wasn't even like real inflation. It's always interesting. Somebody today brought up the Weimar Republic, and I was like, dude, that was really bad. The seventies were not even there yet, So we're worried about three or four percent. It's n b D. The labor shortages, are they going to be a problem for the market or um just add to upward pressure in such an odd environment in that there's about nine point three million job openings, but there's also

about nine point three million people unemployed. So the labor shortage challenge is an interesting one that we're seeing across small business surveys, consumer surveys that people just can't still openings. And I think in the short run that's probably going to continue to push up wages because we are seeing companies either offer you know, bonuses to submit applications, bonuses after you know, two months time, higher wages. We're seeing

that in a month over months basis. But the question is how long or a thousand to start for a June your analyst, Yeah, exactly so. But what we are kind of seeing from a broader perspective is that a lot of states are taking away those UH enhanced supplements

to unemployment benefits. In fact, about half of states have throughout the month of June and a few more in July, so by the time we get to September when the rest will also expire, and you know, people should be um kind of coming back off the sidelines, combined with the fact that um, hopefully kids will be back in person full time at school, so people who have childcare challenges should also have a bit of luck there and

be able to get back into the labor force. Amara, thank you so much for joining us to really appreciate it. A mere appendant. She's global market strategist at JP Morgan Esset Management, joining us on the phone from New York. Max Chafkin joins us. He's a calumnist for Bloomberg Business Week. He's actually Matt in our Bloomberg Interactive Broker studio here in New York. And the story he has as a junior Microsoft engineer figured out a nearly perfect bitcoin generation scheme.

So notes right down your alley, met and part of the heist issue, Yeah, exactly ten dollars okay, so it's part of it's big take, right, but it's also Max is this also in the Business Week heist issue? Yep, yep for for for this week, we've got a full issue. There's actually no news in the issue, it's only stories about um sort of crimes, scams. Um, it's it's our as you say, be treating issue. So we've got this really fun one about a it's kind of a weird

digital currency scam. We're talking about this a lot of tier of crime, it seems like. So it tells US's not weird. It's awesome. Yeah, So this is we were we the writer Austin car and I we're joking about this as as the you know, Ultimate Xbox the Ultimate video game cheat. This was a basically a junior employee at Microsoft whose job was to test the store where people buy stuff on Microsoft's website, and he figured out a way to get basically an unlimited number Xbox gift cards.

If you're a gamer, these cards contain codes and you can use them to buy games, you can buy content, you can also buy you know, stuff like I am an Xbox fanatic. My gamer tag is shower fan. If anybody wants to challenge me, from Halo to Call of Duty to Red Dead Redemption, I have easily spent thousands of the okay, but I've also always wanted to be part of a heist. And this is a pretty awesome one because the guy actually guess what like ten million bucks, right,

and he spends it on cool stuff. Oh yeah, he gets ten million bucks. He uh flips these five by five codes on a website called packs full, which is a site where people trade these things. This is something I didn't know about it, but it's a it's a really robust market. In fact, he was selling so many of these codes, you know, thousands of them, that he was manipulating the price of of xbox currency, according to I R. S. When they, you know, came after him,

then he turned that into bitcoin. He put his bitcoin through a crypto money laundry thing, spits out some clean coin, and then, as you say, starts buying cool stuff. When the Feds caught up to him, you know, they found him in his you know, seven figure late lakefront house somewhere some nice part of washing the Pacific Northwest. It's some place amazing, by the way. Fun fact, I used packs full a few years back. I went two weeks

without spending US dollars. Well, I only spent bitcoin. Was my was my challenge, and I had to get stuff um from game stop. I had to buy gas, I had to buy food, and so packs full is really helpful because I could take my bitcoin and get gift cards for the stuff I needed, and that's part of the way I made it through these two weeks. Yeah, and one of the points, I mean, it's so wonderful we talk to such an expert here I have said.

But but one of the interesting things, the points that we make in this piece is that, you know, we think about digital currencies being bitcoin, you know, ethereum whatever, um. These gift cards are their own kind of digital currency. And then they've been around for a really long time and they're actually really important to big companies, including Microsoft, but also of course Apple and you know, and others.

So it's kind of a sort of nice reminder that you know, you think of you think of one one side of crypto and on the other side you have sort of the real economy. But they're you know, they're

all together and and mashed up in interesting ways. So you make a great point about, um, why companies love these gift cards so much, And I hadn't ever thought about it before, but the fact is, so many people get these gift cards, actual physical cards, not just the five by five codes, and they have them lying around and they forget about them, and that turns into millions or even maybe hundreds of millions of dollars with the revenue that a company gets without ever having to give

out products. Yeah, and there's been some regulation here. You know. A few years back, Congress uh made a rule saying you couldn't have the gift The gift cards had to last I think for at least five years. But but at some point these things expire their fees. And the other interesting thing that that's brought up in this story. You know, Microsoft can give out the gift cards as like a marketing spence and then it only has to book that, uh, if somebody actually redeems them. Otherwise it's

just you know, they just give them out. They don't do anything with it. So it's basically free money for a lot of these big companies. So Max, how did they catch this guy? Seems like you talk about bitcoin, you can't trace that, presumably, although now there's maybe that's kind of what we just it's the most traceable currency that there is. So yeah, they didn't. It had nothing to do with the crypto thing. That's not how they caught him. They caught him because he was basically using

his colleagues passwords, which which worked for a while. Basically, his colleagues had really bad passwords. As he's saying the story, you know, one of them was you know, secret one to three. So he was he was guessing these passwords. He was using a kind of a VPN situation where it looked like his traffic was coming from a different continent. But he's easy the same computer that he was logging on with. So so he's logged on into his work computer. Uh, and then he logs on as a criminal. It's the

same computer. They were able to find him. The other thing he did was he shipped one of his stolen graphics cards. He used the he's the codes of biographics cards, shipped it to a previous address, and they connected it to him. Basically was a big data project, I mean, really interesting in this story, the kind of scope of Microsoft's security operation. I mean, they were the real ones who broke this case. Then they turned it over to

the federal government. But but they're the ones who initially fingered, uh, the purp here, and then the Feds picked up the capes that they did their own investigation, and then they prosecuted the guy had a stolen a copy of Microsoft Office essentially and registered it to his startup. So that wasn't very smart, right exactly? So yeah, they if he had just done the crypto, I think he could have gotten away with it for a while longer. Alright. That a lot of cool stuff. And he was planning on

getting a seaplane, a ski shalet, a yacht. He has a great list in the story of the stuff he's gonna get with his next ten million. But I mean, when you're doing a good hist you gotta have a seaplane, exactly. All right, Max Chapkin, thanks so much for joining us. Max is a calumnist for Bloomberg Business Week. Joining us here on a Bloomberg and exacortive broker's studio. And again the big big take stories. These are fascinating stories. This

isn't give me two hundred words on Microsoft. These are deep dives, deeply reported, really interesting stories. Uh. And again check out the Bloomberg Business Week for the heist issue, and of course for all these big take stories. You can find them at Bloomberg dot com. All right, let's get over to built Smeat right now. Chief Investment Officers Meat Capital Management, I love to talk to Bill and Cole as well about value investing, their principal investors out

of Phoenix, Arizona. And Bill, you've got some interesting plays that you think are are undervalued. UM in the pharma's side, am Jen murk Visor, and I wonder why you think the markets haven't given the valuations to these investments that you think they deserve. Well, thank you for having us, and and we think that first of all, the relative values are incredible compared to the last twenty years. They're they're the cheapest relative to the rest of the stocks

in the SMP they've been in twenty years. The second thing is anecdotal. We have a cardiologist in our building in Phoenix, and since people got vaccinated, it's standing room only in the waiting room to get in there, and that is not yet reflected in the price of these medicine stocks. So part of it it seems Bill, you know, it's just kind of I would think that pharmaceutical stocks now I think about them a lot more. With COVID nineteen,

I think about him in a good way. I'm not sure if that translates into higher stock prices, but part of it seems to be just perception. These companies maybe don't market themselves correctly. Yeah, that they've made the last five to teen years one of the biggest pr errors and advertising errors in history. But it looks like they're

already to rectify that. Now. I noticed Lily's running a commercial where they teach people about a bunch of different medicines they make, and at the end of it, it comes on and the tagline is Eli Lily a medicine company. Right if Nancy Reagan said just say no to drugs, cannabis,

cannabis stores sell drugs. Uh, these people sell medicine. And now that people have been touched their lives, even even very healthy people have now been positively benefited by these vaccines, they now realize that these folks make medicine and and ultimately that won't switch things over in a day, but at some point in time, their earnings will be better than a lot of other people, and their prices will have started cheap, and it will be a successful three

to five year uh outlook investment. Now I'll stand up for the for the weed here. Um. You know, liquor stores sell drugs too, and a lot of people use cannabis as medicine. I know you guys are a pretty conservative shop, but have you ever invested have you ever thought about investing in cannabis? No? I will say though, I had a back massage at a reputable place called hand in Stone, and she offered me for extra money, uh, and oil that that she thought would be good for

the muscles that were bothering me CBD cannabinoid oils. I want to ask you also about something else, Bill, because I love Phoenix. I love hanging out, having dinner in Scottsdale, going out to Sedona. Um, if I could get on the course and play at TPC, that would be amazing as well. We've seen housing prices skyrocket all over the country.

What's real estate like down there? Well, it's been pretty nutty. Uh. But what what what everyone needs to understand is it is in the DNA of Americans going back to their great great great grandparents who came to the East Coast and then constantly for the last two hundred years have arbitrage land values. So people are like shocked. It's like, Okay, there's ninety million millennials. They're gonna want what six million

gen xers wanted. That means thirty more humans, and they were delayed in this whole process until COVID hit and the pandemic UH brought the need for a home to the forefront. So now, the first arbitrage was Los Angeles to Las Vegas and Phoenix. That the next arbitrage after that is the you know, the Spokens and Reno's and and we're those have already exploded. So just think of anywhere across the country where it's a pleasant place to live.

There's a hundred thousand people there, and there's water and WiFi. We're gonna build a ton of homes in those places because that's what the land arbitrage dictates. And the market share of our home builders, which would be Dr Horton Lennar and NBR Ryan Holmes, is nine times what it was seven years ago. So a disapportionately large part of the homes being built will be built by us. All right, hey, Bill,

just real quickly. What's the high temperature there today? I'm not in Phoenix, it is it's sixty three degrees in seaside, Oregon. We're on a bit alright. Good move there, Bill. I'll tell you what last time I was. Last time I was in Phoenix. It was a hundred six degrees but it's but it's a dry heat. It's a dry heat. And then we shot up to Flagstaff and it was much cooler up there. So I just love that. All Right,

Bills all over, he's got it covered here. Uh Bill Smee, chief investment officer Smead Capital Management, that two point eight billion dollars in assets under manager. Talking to us today about pharma stocks, he thinks that they have some room to go. Thanks for listening to the Bloomberg Markets podcast. You can subscribe and listen to interviews with Apple Podcasts or whatever podcast platform you prefer. I'm Matt Miller. I'm on Twitter at Matt Miller y three and on Fall

Sweeney I'm on Twitter at pt Sweeney. Before the podcast, you can always catch us worldwide at Bloomberg Radio