Tuesday, March 8, 2016
Being punished for doing the obvious: Peabody Energy Corp edition
But Peabody Energy is particularly stretched.
Here - courtesy Thomson Reuters - is a price chart for the 6% coupon Peabody debt due November 2018. Its a large issue with almost 2 billion at face value outstanding.
The price is 3. That is 3 cents in the dollar.
The yield to maturity is 266 percent.
If Peabody survives without a restructure this piece of debt will make you over thirty times your money.
Obviously the debt market thinks that Peabody is dead. Dead parrot dead.
Go tell that to the equity market.
This is Peabody stock yesterday courtesy Yahoo Finance.
Yes the stock was up 40 percent.
And if the company survives it is vanishingly unlikely to be a thirty bagger.
So it is kind of obvious that you should be long the debt, short the equity. It is very hard to construct a scenario where you lose.
Except that it was darn obvious 100 percent ago in the trade.
So here is what happened. Some wise-cracking hedge fund put on the trade, long the debt, short the equity. Can't lose except that they did lose.
They are getting smashed.
The debt has come down rapidly from 25 to 3 wiping out the long side of that transaction. The equity has doubled.
And our hapless manager - having been perfectly rational - is left nursing some sore losses.
A general comment
This is happening all over the energy complex at the moment. Debt and equity markets disagree and the disagreement has got wider and wider.
There will be some very bruised arbitrage managers this week.
Very bruised indeed.
PS. Disclosure in order. We have a few of these trades on in tiny size. We are down low-single-digits this month. We are not enjoying it. But we are enjoying it far more than the soon-to-be-out-of-work manager who decided to put the Peabody trade on.
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