Description

Ok. So before someone throws a rotten tomato at me please read at least through the first page. I may be early on this so don’t be upset if you lose money at first.

Delphi is the world’s largest Tier I automotive supplier with 2004 sales of 28 bn dollars and they make all kinds of products: from engines to engine management systems, to radios, to fuel cells, to connectors to whatever you want other than body panels or seats or wheels.

50% of revenues are to GM, 39% to non GM and then they have an aftermarket business that is growing. Non GM sales are 1.2 bn to Ford, 942 mln to Renault, 883 mln to VW, 872 mln to Daimler, 726 mln to PSA and 500 mln to each of BMW, Toyota and Fiat with the remainder being small amounts to a large number of customers.

As most of you know the Auto sector is in the absolute crapper right now. The news could not be worse (actually it could but not by much): GM and Ford on the verge of downgrade to junk, production cuts looming, overcapacity, rising interest rates, high gasoline prices, high healthcare expenses, rising raw materials charges, earnings cuts etc etc etc.

At Delphi in particular there is an SEC investigation an FBI investigation the CFO was recently fired and there are no financial statements, stock at 52 week lows and the Chairman retiring; all very negative things. The SEC and FBI investigations are regarding some shady transactions between Delphi and a Michigan turnaround firm called BBK in which Delphi sold inventory to BBK and then bought it right back after the quarter; this looks like an Enron special w/ the barges in Nigeria. Also under investigation are some payments made to GM that happened to “make” GM’s quarter and the booking of some transactions w/ EDS (also a GM spinoff.)

Now lets talk about the financials.

950 mln in cash
212.5 mln expected from Johnson Controls in summer of 2005 as proceeds from sale of battery division
3,200 mln in debt
4.4 bn dollar underfunding in the pension plan
2,100 mln Market Cap which can be used for at least a 300 – 500 mln equity like issue
2004 free cashflow ~ 176 mln after 600 mln in cash pension contributions
2005 free cash-flow of neutral to negative 100 mln. Co. expects positive free-cashflow. Street expects slightly positive FCF.
Past 4 year avg free cash flow 312 mln after similar cash contributions to pension plan
Additional liquidity could come from
Further dividend cut ~ 50 mln
Non-core division sale


The company also has 3 billion in untapped bank availability which is the key to the whole thing. A 1.5 bn revolver maturing in June 2005 and a 1.5 bn term loan maturing in 2009. You may think that in reality then Delphi only has 1.5 bn in availability but you would be wrong b/c with a high degree of probability what is going to happen is that the banks will ask for security (will get secured) and the revolver will be extended for another year albeit at a smaller size. During the last month Delphi announced that the banks had given it covenant relief in the form of lowering the Fixed Charge Coverage Ratio, Extending the time to filing their Financials to June 30th 2005.

Presently I believe the most attractive part of the capital structure are the 6.55% bonds maturing June 15th 2006 trading at 94 with a yield to maturity of 12.3%. It is a 500 mln issue which the company can pay out of cash that it has on the balance sheet. If for some unforeseen reason the Co burns through 1 bn in cash on the balance sheet, the bonds can be repaid from borrowings from the term loan and most likely from the renegotiated revolver.

Furthermore, if you follow the sector you will know that Ford is currently in negotiations w/ Visteon, its supplier spinoff, in order to alleviate Visteon’s problems. So far, to tide Visteon over Ford has given them 25 mln in cash per month plus 150 mln in capex help while they find a permanent solution. The problem for both GM and Ford is that they can’t operate w/ out these suppliers so it is reasonable that some amount of help would be forthcoming in the event of severe financial distress.

The rest of the capital structure trades:
Price YTworst
DELPHI CORP 6.55 % 6/15/2006 94.000 12.27 %
DELPHI CORP 6.5 % 5/1/2009 85.000 11.227 %
DELPHI CORP 6.5 % 8/15/2013 75.000 11.192 %
DELPHI CORP 7.125 % 5/1/2029 71.000 10.439 %
DELPHI TRUST II 6.197 % 11/15/2033 52.000 12.356 %
DELPHI TRUST I 8.25% 15.7 13.%

A couple of observations that are readily apparent from this is that the preferreds should be trading much wider or the Bonds much tighter considering that the preferreds are sub to the Bonds and the dividends can be stopped for 20 quarters and could be another trade idea within the capital structure.

The way to lose money on this trade is quite simple; the Company files for protection which based on where other automotive suppliers’ bonds are trading would represent a 30 to 40 point drop from here. The probability of this company filing within the 14 months of the proposed investment I estimate to be less than ¼ of 1pct. If anyone can find an example of a company with this liquidity profile filing within 14 months I would be extremely interested in talking to you .

Catalyst

The catalyst for these bonds to start moving in the right direction are:

End of portfolio hedging. The severity of the auto tradeoff has caught a lot of people off guard and they are hedging their GM exposure by shorting whatever they can find including Delphi. The other catalyst is that shorting bonds that yield 12% is not cheap b/c you have to pay the coupon and you lose money every day by the accretion from the current price to par.

Filing of financial statements by June 30, 2005. Delphi is expected to file its 2004 10K on that date which should normalize its reporting and make investors more comfortable by definition.

Resigning of 364 day revolver also expected by the June 30 date. I expect the banks to renew this facility on a secured basis and on a more limited scale ~ 750 mln or something like that for the revolver.