Description

Hi, guys –

OVERVIEW

KTP is a contrarian securtity with speculative appeal that is mispriced and if you squint hard enough it's maybe got some … “margin of safety” is too strong, but it's probably not a zero.

Contrarian: This is a trust wrapper around some JC Penney perpetual bonds. I don't think I need to bloviate about how out of fashion (hahaha!) retail is. The common is down 93% from its peak and 66% over the last 12 months, is that contrarian enough?

Speculative Appeal: ~15% yield with commensurate opportunity for capital gains should it be thought that JCP will stick around.

Mispriced: KTP is trading at a 15% discount to the bonds underlying the trust for no fundamental reasons that I can see. (This moves around of course, and is at the lower end of the range since I've been paying attention.)

CAVEATS

This should be regarded as a note, not a writeup, as a trade idea, not as a thesis; I'm not going to provide much or anything by way of corporate overview or financials and will outsource the credit analytics to the debt markets. The idea rests on two premises:

1: KTP is a straight passthrough. Prospectus is here: https://www.sec.gov/Archives/edgar/data/894356/0001068238-99-000076.txt

2: The bonds that it wraps, the 7.625/2097, cusip 708160BL9, are pari passu with the rest of J.C. Penney's senior unsecured debt.

Usually I apologize if I'm wrong, but if I'm wrong about either of these, I'll say “Thank you!” to whoever points it out instead.

BACKGROUND

Retailers have had a tough time lately, and JCP is no exception. Things have just been terrible. On the other hand, JCP has adequate working capital and no sizable maturities until 2023. There's $1B in equity, the stock is trading around book, and the crack retail analysts and Merrill Lynch are forecasting $375MM in FCF for next year. JCP actually reported positive same-store sales this quarter. Finally, this is an industry-wide challenge, and thus a “you don't have to outrun the bear” situation; a Sears implosion, for instance, would be helpful to JCP.

Here's a term structure from as of yesterday's close so you can see where things are trading:

2023 is the big year, that's when the senior secured debt & JCP's $1.6B term loan come due.

THE SECURITY

KTP is a trrust that holds $100MM par of JCP 2097 bonds. As far as I can tell, it's identical to holding the bonds yourself, except tha the trustees will manage things in bankruptcy. There are no fees. This isn't a TRUPs, there's no grace period for missing payments or anything like that.

THE IDEA

Thanks to the 15% discount to the underlying bonds, KTP is close to but not quite a free option. 1 year total return upside should this return to it's 52 week high is >80%. More importantly, this level of distressed pricing provides some kind of (squishy) downside protection. Per Moodys, recovery for senior unsecured debt & retail debt is 37%. I'm going to provide a bunch of tables that illustrate KTP returns for different recovery rates and time to default; recovery rates on the left, time to default on the top.

Gross $ Returns

At $1.9 coupon and $25 par:

% Returns for the bonds at $60

So we can see that at $60, the 2097's are pricing in the possibility of an early and painful default. I agree that's a possibility, I'm not claiming this is mispriced.

% Returns for KTP at $50

Now you have to get into the upper left of the table before things start getting embarrasing. If there's some sort pre-pack in 3 years that shafts the senior unsecured, you'd actually do OK.

% Returns for KTP at $45

Let's see how things look if KTP trades down 10%:

At that level, if JCP can manage to hold things together until the 2023 maturity wall, there's no way to lose money, and historical recovery rates make you whole or better regardless of default timing.What I'm getting at is that, at $12.50 I think this is a good deal, should it trade down 10% without good reason it becomes really juicy.

SUMMARY

That's pretty much it. At $12.50, KTP is embedding a really dark view of not just default timing, but of default recovery. If it were a preferred, $12.50 wouldn't be dumb. But it's not. At least I hope it's not. And that's why I think the opportunity exists. This was sold to retail. I'd ordinarily take that combination of “Trust” + “$25 Par” to mean “preferred”.

OTHER STUFF

PFH is the same thing, except even a bit cheaper. This wraps $50MM of the bonds; I'm including it in the summary numbers. I'm adjusting the price for $0.40 accrued to get a clean price. This is a fixed income trade, not an equity investment. It's extremely price sensitive. If KTP goes up 10% I might not stick around.

JCP is widely covered, and you can find some discussion of the trusts on SeekingAlpha.

As always, apologies for the formatting.

Yours,

Bowd

Catalyst

Coupon, maybe they'll make plan for the Christmas season.