HOLT Template Jan 12 2005 - CFA Society

PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information

contained herein may be reproduced or disclosed to any person under any circumstances without express written permission.

Professor Joel Litman

v.2014 04 12

FIDO

VALENS SECURITIES

Credit Analysis for Equity and Credit Investing

Joel Litman

April 2015

Valens Securities

425 5th Avenue, New York, New York 10016

[email protected]

PRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the

document nor any of the information contained herein may be reproduced or disclosed to any person under any

circumstances without express written permission.







China (2008 Peak)



BEAR CYCLEBULL CYCLE

Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top

CREDIT EASINGCREDIT EASING CREDIT TIGHTENING

Credit Demand FallingCredit Demand Increasing

DivestingNet New Investing



65%

70%

75%

80%

85%

90%

FY

19

95

FY

19

96

FY

19

97

FY

19

98

FY

19

99

FY

20

00

FY

20

01

FY

20

02

FY

20

03

FY

20

04

FY

20

05

FY

20

06

FY

20

07

FY

20

08

FY

20

09

FY

20

10

FY

20

11

FY

20

12

FY

20

13

FY

20

14

Corporate Cash to Short Term Debt

Percentage of Firms in S&P 500 withMore Cash than FY+1 Debt

Source: Capital IQ, Valens Securities Analysis



0x

2x

4x

6x

8x

10x

12x1

99

4

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Historical S&P 500 Aggregate Interest Rate Coverage

Aggregate EBITAP/Interest Expense




-40

-20

0

20

40

60

80

100

0

200

400

600

800

1000

1200

1400

1600

1800

20001

/1/1

99

0

1/1

/19

91

1/1

/19

92

1/1

/19

93

1/1

/19

94

1/1

/19

95

1/1

/19

96

1/1

/19

97

1/1

/19

98

1/1

/19

99

1/1

/20

00

1/1

/20

01

1/1

/20

02

1/1

/20

03

1/1

/20

04

1/1

/20

05

1/1

/20

06

1/1

/20

07

1/1

/20

08

1/1

/20

09

1/1

/20

10

1/1

/20

11

1/1

/20

12

1/1

/20

13

1/1

/20

14

Credit Standards and the S&P 500: January 1990 to

Recession S&P 500 Credit Tightening

May 2014

Source: Senior Loan Officer OpinionSurvey,

U.S. Federal Reserve Board



200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

Commercial and Industrial Loans Consumer Loans

Data Frequency - Weekly - January 1980 to June 25, 2014

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

2-Ja

n-80

2-Jan

-82

2-Ja

n-84

2-Jan

-86

2-Jan

-88

2-Jan

-90

2-Jan

-92

2-Ja

n-94

2-Jan

-96

2-Ja

n-98

2-Jan

-00

2-Ja

n-02

2-Ja

n-04

2-Jan

-06

2-Ja

n-08

2-Jan

-10

2-Ja

n-12

2-Jan

-14

S&P 500

Source: The Federal Reserve System, Valens Securities Analysis



0

200

400

600

800

1,000

1,200

1,400

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14

bp

s

IG XO HY

Valens Custom Aggregate CDS Index

Data Coverage: Weekly from Mar-2010 to Oct-2014Source: Valens Securities




Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top







Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top




PROFIT COLLAPSINGCORPORATE PROFIT INCREASING

MULTIPLE EXPANSION MULTIPLE COMPRESSION









Earnings is a problematic indicator (leading vs lagging)

S&P 500 Earnings and Performance

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

12/3

1/1

988

09/3

0/1

989

06/3

0/1

990

03/3

1/1

991

12/3

1/1

991

09/3

0/1

992

06/3

0/1

993

03/3

1/1

994

12/3

1/1

994

09/3

0/1

995

06/3

0/1

996

03/3

1/1

997

12/3

1/1

997

09/3

0/1

998

06/3

0/1

999

03/3

1/2

000

12/3

1/2

000

09/3

0/2

001

06/3

0/2

002

03/3

1/2

003

12/3

1/2

003

09/3

0/2

004

06/3

0/2

005

03/3

1/2

006

12/3

1/2

006

09/3

0/2

007

06/3

0/2

008

03/3

1/2

009

12/3

1/2

009

09/3

0/2

010

06/3

0/2

011

03/3

1/2

012

12/3

1/2

012

S&

P 5

00 P

rice

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

S&

P 5

00 E

arn

ing

s

Earnings S&P 500 Price




The Statement of Cash Flows

Operations

Investing

Financing



Corporate Profitability and Valuation

Adjusted Earnings

Adjusted Assets

Adjusted Enterprise Values



Distortion Issues requiring “adjustments”

• The Statement of Cash Flows, Earnings, and Balance Sheet

• M&A accounting through time (including through 1 year)

• Merger Related Expenses

• Pension Expenses versus Pension Service Costs

• Restructuring Charges

• Goodwill Impairment, PP&E Impairment, R&D Impairment

• Legal Settlements, Insurance Settlements

• Gain/Loss on Sale of Investments, Gain/Loss on Sale of Assets



Performance and Valuation Prime™ Analysis4,058 U.S. companies (non-financial)

7.8% 7.7% 8.3%

4.9%

1.5%

4.9%5.8% 5.8%

6.2%

4.7%

3.3%

6.0%

0%

5%

10%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E Mkt Imp

Asset'Growth

8%9% 9% 8%

6%8%

9% 9%10% 10% 10% 10%

0%

5%

10%

15%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E Mkt Imp

ROA'

1.9 2.0 1.9

1.4 1.51.7 1.6 1.7

2.0 2.1 2.1

0.0

1.0

2.0

3.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E

V/A'

21.0 21.1 22.7 22.018.2 18.8 17.2 16.6

18.921.3 21.2

0

10

20

30

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E

V/E'

Data Date: As of 13-Feb-2015




Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top









Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top

BEAR SENTIMENTBEAR SENTIMENT BULL SENTIMENTPanicDisinterest Hope Mania Despair








5

10

15

20

25

30

35Ju

l 1

0

Se

p 1

0

No

v 1

0

Jan

11

Ma

r 1

1

Ma

y 1

1

Jul

11

Se

p 1

1

No

v 1

1

Jan

12

Ma

r 1

2

Ma

y 1

2

Jul

12

Se

p 1

2

No

v 1

2

Jan

13

Ma

r 1

3

Ma

y 1

3

Jul

13

Se

p 1

3

No

v 1

3

Jan

14

Ma

r 1

4

Ma

y 1

4

Jul

14

Management Growth Confidence Index

Data Coverage: Monthly from Aug-2007 to Aug-2014Source: Valens Securities




Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top










Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top







LEADING AND LAGGING ECONOMIC INDICATORS





0

1

2

3

4

5

6

7

8

9

10

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Jan

-48

Jul-

50

Jan

-53

Jul-

55

Jan

-58

Jul-

60

Jan

-63

Jul-

65

Jan

-68

Jul-

70

Jan

-73

Jul-

75

Jan

-78

Jul-

80

Jan

-83

Jul-

85

Jan

-88

Jul-

90

Jan

-93

Jul-

95

Jan

-98

Jul-

00

Jan

-03

Jul-

05

Jan

-08

Jul-

10

Jan

-13

Civilian Unemployment Rate

Source: The Federal Reserve System Data Coverage Monthly from Jan-1948 to Jul-2014






Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top











Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top








Credit Worthiness







Credit Protection Buyer

e.g. Owner of

the bond

Pays for the CDS

Recovers loss if

bond issuer defaults

Credit Protection Seller

e.g. “Insurer”

of the Bond

Sells the CDS

Pays for loss if bond

issuer defaults

Credit Default Swap

bps per year

$$ of loss



<->

?





Source: Moody’s Investors Service, Inc.



Source: Valens Credit Analysis

Intrinsic Credit Default Swap (iCDS 5yr)




ADJUSTED PAYMENT CUSHION




ADJUSTED CASH TO DEBT LEVELS




ADJUSTED DEBT REPAYMENT SCORE




ADJUSTED ROA’ TREND




ADJUSTED TOTAL DEBT & RECOVERY RATE



0

200

400

600

800

1,000

1,200

1,400

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14

bp

s

IG XO HY

Valens Custom Aggregate CDS Index

Data Coverage: Weekly from Mar-2010 to Oct-2014Source: Valens Securities

iCDS (Intrinsic CDS) is market-relative

Adjusted factors drive a specific iCDS above or

below the market CDS




Intrinsic Credit Default Swap (iCDS 5yr)




Add: Quantamental & Fundamental Forensics™

?




contained herein may be reproduced or disclosed to any person under any circumstances without express written permission. KENNEBEC RIVER CAPITAL | PRIVATE AND CONFIDENTIAL

Performance, Valuation, and Credit Cash Flow Prime™Unparalleled Attention to Removing GAAP Distortions

Credit and Cross-Capital Analytics™Early Identification of Mis-pricings Across the Capital Structure

Financial Red Flags™ and Forensic AccountingThe Foremost Financial Statement Expertise in the World

Earnings Call Forensics™Audio and Linguistic Based Cognitive & Emotion Analysis™

Incentives Dictate Behavior™Uncovering Drivers of Debt/Equity Actions and Returns

Market Phase Cycle™ Powerful Market Macro and Sector Analytics





GAAP distortion examples as of March 2015

DAL

• Capitalized leases of 398mm vs. 1,200mm

• Pens Exp 885mm vs. 603mm vs. ZERO

• ROA of 6% versus Adjusted ROA’ of 14%

• P/E of 9 versus Adjusted P/E of 20.5




Delta Air Lines, Inc. (NYSE:DAL)

Stock Price USD 44.57 - Market Cap 36.7B Data Date - 3/9/2015

Industrials - Airlines Fiscal Year - 12/31/2014 - Current Quarter - Q42014

x x

-8%

-23%

19%14%

-8%-2%

1%

15%

0% 0%

0%

-30%

0%

30%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD 5Yr CAGR

Asset'Growth

0%

0%

0%

-3%

2%

9% 8% 9% 10% 9%

14% 16% 14%

-10%

0%

10%

20%

30%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E Mkt Imp

ROA'

1.2 1.1 1.2

1.7 1.7 1.7 1.7 1.8 1.7

2.32.1

0.0

1.0

2.0

3.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E

V/A'

-270.9

1780.2

-35.0

75.8 20.1 23.4 19.4 14.9 19.6 15.0 20.8

-1000

0

1000

2000

3000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E

Fwd V/E'

0.0

1.0

2.0

3.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD

TSRr




DAL:

1/20/2015 - CEO Anderson generated multiple highly questionable“sandbagging” markers when saying they expect to have their adjusted net debt below $6bn by the end of 2015 and achieve a $5bn target in 2016

Management generated highly questionable “sandbagging” markers when talking about their debt reduction plan and hitting their debt reduction targets.

Considering how strong cash flows are, these markers look like sandbagging, meaning they think they’ll hit their debt reduction targets more easily than they let on




DAL – Incentives Dictate Behavior

A strong compensation framework for both credit and equity investors.

Promotes focus on ROIC, Return On Invested Capital for capital efficiency.

Promotes pre-tax Income and TRASM for revenue growth. Promotes Operating Income Margin for efficiency.

Focus on service and customer enrollment in loyalty program promotes sustainability of the above.

Management are also material owners of DAL equity.Source: Valens Credit Analysis




Add: Quantamental & Fundamental Forensics™



DAL

Moody’s Rating is Too Low

Equity isn’t a compelling value name,

Yet should move up with or outperform the industry



SD

Sandridge



SD - Trade Idea as of January 2015

SD – Long 2020 and 2023 bonds; low equity valuations driven bydistressed pricing in the credit markets; substantial equity upside likelyif perceived default risk decreases










GAAP and Ratio Distortion Examples at SD

• Cash Flow From Operations: $669MM • Adjusted Cash From Ops: $813MM

• Moody’s: RCF/Debt: 16.9%• Debt to Avg Daily Production: $40,900

• Debt due in in the next 5 years Zero







SandRidge Energy, Inc. (SD)

Source: Valens Credit AnalysisPRIVATE AND CONFIDENTIAL: This document is confidential and contains proprietary information. Neither the document nor any of the information




EXPE

Moody’s rating too low

Some near-term issues with equity,

though longer-term could outperform the industry



GAAP distortion examples seen post-adjustments

EXPE

• Pension exp of $36mm vs Adj of $10 vs. Zero

• Cap leases of Zero vs. Adj Cap leases of $508mm

• ROA of 4.4% versus Adjusted ROA of 19.7%

• P/E of 30x versus Adjusted P/E of 21x





Expedia Inc. 2020 5.950% Bond at 112.29 Reference Bond Data date: 3/9/2015

iCDS 144 3.091% Intrinsic YTW Valens Credit Rating IG4+ (Baa1)

Actual CDS 82 3.441% YTW 179 G-STW Moody's Rating Ba1 (XO-)

Debt Maturity Stack

0

1,000

2,000

3,000

4,000

5,000

6,000

2015E 2016E 2017E 2018E 2019E 2020E 2021E

Obligation & DebtMaturity Schedule

Other Uses of Cash

MaintenanceCapex Pension ServicingCosts R&D Maintenance

Dividends

RentalMaintenance Interest Expense

Debt Maturities

Gross CashEarnings'Cash Available forOutlays



Expedia, Inc. (EXPE)






EXPE:

10/30 - CEO Khosrowshahi was highly confident when saying Q3 2014 adjusted EPS was up by 35% year-over-year

10/30 - CEO Khosrowshahi was highly confident when saying that trivago is growing a lot of share as far as overall traffic to travel websites

2/5 - CEO Khosrowshahi was highly questionable when saying that their customer volume in U.S. travelling to international is strong at 50%, which is offsetting the weakness of the volume coming from international markets-to-U.S. due to forex headwinds












Market Bubble

Capitulation

Bear Rally

First

Stage

Bull

Second

Stage

Bull

Double Top










Valens Credit and Valens Equities

Reliable, Timely Corporate Credit Ratings

Embedded Expectations of Equity Pricing

Valens Credit Weekly Insights

Valens Equity Insights & Inflections

Valens Market Phase Cycle Report: Equity & Credit

Custom Security, Tranche, Basket, Portfolio Analysis

Education & Training; Strategist Meetings



Disclosures

Disclosures

© 2014 Valens Securities and/or its licensors and affiliates (collectively, “Valens”).

All rights reserved. CREDIT ANALYSES ISSUED BY VALENS CREDIT AND ITS AFFILIATES ARE VALENS’ CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF

ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT ANALYSES AND RESEARCH PUBLICATIONS PUBLISHED BY VALENS (“VALENS

PUBLICATIONS”) MAY INCLUDE VALENS’ CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE

SECURITIES. VALENS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE, AND

ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. VALENS’ CREDIT ANALYSES DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO:

LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. VALENS’ CREDIT ANALYSES AND OPINIONS INCLUDED IN VALENS PUBLICATIONS ARE NOT

STATEMENTS OF CURRENT OR HISTORICAL FACT. VALENS’ CREDIT ANALYSES AND VALENS PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR

FINANCIAL ADVICE. VALENS’ CREDIT ANALYSES AND VALENS PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD

PARTICULAR SECURITIES. NEITHER VALENS’ CREDIT ANALYSES NOR VALENS PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY

PARTICULAR INVESTOR. VALENS ISSUES ITS CREDIT ANALYSES AND PUBLISHES VALENS PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT

EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL

INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED

OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR

SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT

VALENS’ PRIOR WRITTEN CONSENT.

All information contained herein is obtained by VALENS from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as

other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. VALENS adopts all necessary measures so that the information it uses in

assigning a credit rating is of sufficient quality and from sources VALENS considers to be reliable including, when appropriate, independent third-party sources. However, VALENS is

not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall VALENS have any liability to any

person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or

outside the control of VALENS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation,

communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without

limitation, lost profits), even if VALENS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ANALYSIS,

financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of

opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation

of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS,

MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY VALENS IN

ANY FORM OR MANNER WHATSOEVER.

VALENS’ credit analyses are opinions as to the creditworthiness of a debt obligation of the issuer, not on the equity securit ies of the issuer or any form of security that is available to

retail clients. It would be dangerous for retail clients to make any investment decision based solely on VALENS’ credit ratings. If in doubt, you should contact your financial or other

professional adviser.

Documents

HOLT Template Jan 12 2005 - CFA Society