CHESAPEAKE ENERGY (CHK): RED FLAG OR WHITE FLAG?

The stock market took off last Friday Jan. 22nd like Space X’s Falcon 9 rocket, yet Chesapeake’s equity was left on the launch pad in the end, closing at $3.51, down 22% ytd and 82% yoy. The initial exuberance (+17% intra-day) at CHK cutting their pref dividends ($172mm in annual interest savings) gave way to the grave realization that all is not well, and time is is running out. Suspending the dividend on their prefs has been seen as prudent (prefs get paid after debt holders but before equity holders in a wind up). Notably, some of the pref dividend savings will be earmarked to buy back their secondary debt in the open market. Most CHK senior unsecured bond issues are trading distressed, wrapped around $30’s in price. Looking at a specific issue, the CHK 7.25% 12/15/2018 (senior unsecured) traded up to $40.00 for a yield of 47.5% . The bonds are rated B3/CCC+ with a recovery rating of 6 (the lowest rating, implying a recovery in the 0-10% band). This bond was trading above par for the first half on 2015 and only broke par to the downside in July 2015. CHK equity was at $10 when CHK 7.25% 18′ broke par (coincident with the common dividend being cut) and now sits at $3.51. Typically, one would expect the equity to massively underperform bonds on drawdown of this magnitude.  Part of the reason for the poor recovery rating on the CHK senior unsecured is that there is a lot debt with priority ranking ahead of it. The CHK 8% 12/15/2022 (2nd Lien), a $2.5bln benchmark size issue, is rated B1/BB- and traded at $46.25 for a yield of 24.55%. The recovery rating on these bonds is a 1, implying a very high recovery rate (>90%).

The debt load being carried by the top 60 independent oil & gas groups stands at $206bln, up from $100bln in 2006. Chesapeake has $9.8bln of this indebtedness versus $2.3bln in equity market capitalization. A full 1/3rd of the 155 energy names covered by S&P are now rated B- or below with a barrage of fresh downgrades in the offing by Q2 2016 (175 discrete global energy names in the case of Moody’s).

Oil had a strong rally off the lows last week, but US E&P players are being Ubered by OPEC at these prices. One can imagine Saudi Arabia relishing the death throws of “unconventional oil”. The Saudi’s have not had a good run either, downgraded to A+ in Q4 15′ and running a deficit approaching >15% of GDP ($90bln), largely due to lower profits from oil exports. That said, Saudi Arabia’s marginal cost of production is $3/bbl, versus $15/bbl for Iran, $73 for US “Shale” oil ($57 Gulf of Mexico) and $90 in Canada.

Chesapeake expected their negative cash flow for 2015 to be -$2.5bln with oil at $50 per barrel and natural gas at $3.00 per MMBtu. Not privy to projected numbers yet for 2016, but the price side of the equation is not helping at $31.5bbl and $2.12 MMBtu. Part of the solution is curtailing both activity and capex, both of which CHK has undertaken, and efforts continue. In Q3 2015 there were 16 active CHK rigs and there are currently 9 operating. To meet commitments for 2016 Chesapeake might be able to get there with 4-6 rigs. Capex of $280mm is expected in 2016. Interest costs will be $660mm for 2016 and there is a $500mm debt maturity due in March 2016, (CHK 3.25% 03/15/2016 which trades at $96.50). Chesapeake had $1.8bln in cash at the end of Q3 15′. Chesapeake’s $4bln bank revolver was re-negotiated into a secured facility in Q4 15′. Secured facilities further diminish the likelihood of senior unsecured  bondholders getting any substantive recovery in a tap out. As Le Fly has noted, banks generally like providing umbrellas when it is sunny, in the current environment, not so much. Chesapeake results for calendar 2015 will be out Feb. 24, 2016 with an expected $5.5bln loss for the year.

Unit operating cost have spiked 60% in the last decade for the industry overall and while cost cutting has allowed this number to come down to 46% (tightening staff and procurement) meaningfully deeper savings will likely require a deeper dive and could be more costly to implement.

Investors should buckle up, it is going to be a rocky ride. Chesapeake has some high profile holders, including Carl Ichan who owns 10.98% of the equity (holding as at last reporting, but offside >$1bln). When Carl was an infant, in the mid 1930’s, Aladdin kerosene lamps were all the rage. If we ever needed a genie, it is now. JCG

Disclosure: No current exposure to CHK equity or debt. Vetting 1st lien debt of minority (30%) owned oil services/fracking holding, FTS International, FTSINT 06/15/2020, hedged via CHK equity short.

Chinese New Year, aka the Spring Festival, Chunyun to the Chinese, the Lunar New Year is almost upon us. Monday February 8th is the kick-off and festivities run until February 21st. The monkey is the 9th of the 12 animals in the Chinese zodiac. The Chinese also apply 5 elements (metal, water, wood, fire and earth) to the calendar. 1956 was the last Red Fire Monkey year (i.e. animal/element combination).

On an annual basis, the Spring Festival represents the largest human migration, with all that are able (health & budget) heading home to visit family (an urban to rural migration in most cases). This is like American Thanksgiving on steroids. A full 1/3 of Beijing 20mm residents are on the move. China has 14 cities of over 5mm with similar travel plans. 40mm + domestic flights and over 250k train trips across the country. The focus over the lunar new year is on home and family, rather than business affairs. Rituals include cleaning and giving gifts of money in red packets that are supposed to  bring  i) good luck and ii) long life to the family.

The PBoC have been busy. Short term liquidity facilities totalling 1.6tln Yuan (US$240bln) have been put in place. They have signalled a cut on the RRR is not likely before Chinese New Year, as many had expected. Much of the recent effort has been expended on stemming spec trade in offshore Yuan (CNH) which has brought it effectively in line with the onshore Yuan (CNY). Global market will get a much needed break from hanging on every sign of IBS from China. They will be both celebrating and praying for extra luck in this tricky monkey year ahead.

Don’t count out the Chinese due to a rocky 2016 start. Monkey contains metal and water. Metal is related to gold. Water is connected to wisdom and danger. The Chinese have a very healthy risk appetite. There is almost no limit to how much they will press. The biggest risk the Chinese face is that they get old before they get rich. I for one think they get rich. JCG

Less than 1% of submitted US tax returns are subject to audit  (0.86% in 2014).

The bad news is the primary statute of limitations for US federal tax audit has been doubled to 6 years from 3 years. This increases compliance costs clearly and has an effect on the eventual all-in audit cost. Mistakes are often repeated over tax reporting periods and interest and penalties will of course be accruing over a much longer period. Congress passed the Choice Improvement Act of 2015 which effectively overruled a Supreme Court ruling that capped the scope of tax audit to 3 years. There were select tax circumstances where the audit period was already 6 years, such as if >25% of one’s income was “omitted”. No statute of limitations applies if you never filed a return (the practical limit in these cases is deemed to be 10 years).

FATCA implementation has effectively made American living abroad un-bankable with few investment management options. The number of US Green Card holders choosing to relinquish their status is under-reported and growing.

There is a lot of commentary on the earnings recession the US is in the midst of, which could lead to an economic recession. It may be time to re-think a corporate tax amnesty to prompt the repatriation of foreign profits that has left trillions parked in the world’s financial centres (everywhere but NY). The spike in corporate debt issuance has been driven by many factors, stock buybacks being a particular area of folly it appears, but part of it has been the US corporation do not have cash liquidity in the jurisdictions where it is required to run their businesses in an optimal fashion. Tax inversions have been all the rage for several years (US to Europe in many cases) and with the Canadian dollar at $0.68 expect to see some headed North in 2016 (Corporate taxes in Canada are a full 13% lower than the US).

Ted Cruz thinks the IRS should be abolished, which should fully open the debate on a simplified tax code, with a flat tax as the anchor. The municipal bond market will of course watch developments closely. One thing is near certain, the US is going to need a much bigger debt ceiling. JCG

We have had many first’s in 2016, with the latest being the long standing record for the highest gold:oil ratio ever recorded. Currently at a 37 handle, an elevated ratio of how many barrels of oil an ounce of gold can procure “normally” portends danger. Prior spikes have served as tombstones for rocky times in global financial markets. The gold leg of this ratio is holding in fine (neutral from a statistical perspective, over a decade observation period), especially in light of the seemingly never ending strength in the USD, over the last 18 months in particular. The gold:oil ratio over the 1968-2016 period now has a 4 handle, measured in terms of standard deviation. A betting man would argue that the ratio resolves itself largely via a rally in oil from here (gold typically rallies with oil,  although one would expect at a slower pace given the weak tether). VaR based stress testing does have its limitations, admittedly, but 4 sigma events are “rare”. In terms of daily observations, a 4 std. dev. move would be observed once every 43 year (twice in a lifetime). Many risk management models both test and report to a 99% confidence interval which equates (on a 1-tailed basis, typically the cpty’s “risk leg”) to a 2.33 standard deviation move. History does not repeat, but it certainly does rhyme. Standard deviation readings of this magnitude lead one to question the normality of the distribution being studied and on this metric oil is also the squeaky wheel. ‘Fat tails” can only explain so much in the end and despite both the geopolitical and technological developments bringing the nitrous to the supply side of the equation, global oil demand still exceeds 1,000 gallons a second. Gold mining stocks have not been this cheap, on traditional valuation metrics, since gold was $300 per ounce. There appears to be a thumb on the scale. Place your bets. JCG

In the midst of today’s maelstrom, Anheuser-Busch InBev SA/NV (bond ticker ABIBB) launched the 2nd largest corporate bond deal ever. Proceeds are to assist with the formerly announced SAB Miller acquisition. From initial sizing talk of $30bln, they printed $46bln across 7 maturities with an order book in excess of $110bln:

3 year fixed, $4bln at T+85 (US Treasuries +85bp). 5 year fixed, $7.5bln at T+120. 5 year FRN, $7.5bln at 3mth L+126 (Libor +126). 7 year, $6bln at T+150. 10 year, $11bln at T+160. 20 year, $6bln at T+190 & 30 years, $11bln at T+205.

The bonds were trading 5-10bp tighter across all maturities in the gray market late pm NY time. As they say, feed the ducks when they are quacking! There is no convenient lay-away plans for bonds. There will be a liquid repo market in the various tranches of this bond deal given the size for accounts that want to impart leverage, but the bulk of the buyers will be cash buyers.  Assets had to be sold to make room for this giant high grade (ABIBB is single A rated) bond issue. A portion of the sales effected were equities and an asset allocation shift of this magnitude may be behind some of the equity market downdraft evident on the day.

The North American high grade CDX Index (125 equal weighted credit default swaps on investment grade entities) widened 4bps to close at 102.8bp today. This is the first close above 100bp since 2012. JCG

Note: The largest ever bond issue, $49bln, was launched in Sept. 2013 by Verizon (8 tranche deal). VZ printed off a smaller order book of $101bln.

The South African Rand (ZAR) did not have a good 2015 (down 25% versus the USD), but the 2016 kick-off has been especially unkind. There was an fx flash crash in early Monday trade in excess of 9% to just under 18.00 per USD  in the cross before ZAR recovered to mid 16’s to be only down 2.3% on the day. A move of this magnitude is very rare (last seen in 2008 on this currency cross). South Africa has a population of 52mm and has the 2nd largest economy in Africa (US$350bln GDP), behind Nigeria. South Africa is China’s largest trading partner in Africa and export to China make up 37% of South Africa’s exports. Beijing is 11,700km (7k miles) from Johannesburg yet you can fly direct 3 times per week. Hundreds of Chinese companies, both state-owned and private operate across South Africa.

Mrs. Watanabe (Japan retail) has been given the blame for the poor ZAR positioning where stops were hit and margin calls ensued. We will see when the tide goes out who is naked, but if retail is behind it, big lumps. Tokyo Financial Exchange reported that margin trade positions in ZAR had doubled over the last 6 months to over 260k contracts. I can confirm Japan retail involvement in the cross, but the scale seem too large to not involve professionals (CTA/macro funds). Jan. 11th was also a Japanese holiday today, “Coming of Age Day”, making the 7am Tokyo time downdraft even more peculiar.

Unconventional monetary policy (QE) has resulted in medicated markets across the globe, but fx is the one area where market views can still reverberate as the transfer mechanism is more direct. FX turnover is >$5tln per day, it is a 24-hour market and >90% of turnover is speculative in nature (approx. 7% trade related). Central banks are the classic non-profit maximizing market participant. As we have seen with the PBoC and China’s attempt to slow the pace of depreciation in the RMB, fx intervention can only go so far. The South African Reserve Bank (SARB) have fx reserves of approx. $50bln (less than 1/2 of China’s,GDP adjusted). The other tools at SARBs avail are being employed to stem the downdraft where we saw a 25bp rate hike to 6.25% in Nov. 15′ with a more meaty 50bp expected before the end of Jan. 2016. Other factors are at play as well in the case of South Africa. The President, Zuma fired his Finance Minister, Nene in December which sent the ZAR reeling 5% when unknown van Rooyen was briefly appointed (the post now manned by Gordhan who held the post 09′-14′).

The markets that really matter of course in this high stakes game are the US and China. The tectonic plates are large and moving in opposite directions with the Fed expected to hike another 25bp by the end of Q2 16′ and the PBoC expected to cut the RRR (Reserve Requirement Ratio) up to 3 times by 50bp on each occasion over the same time frame. There will be tsunami waves. Trade accordingly. JCG

Few topics elicit more controversy that the merit of gold/precious metals in ones investment mix. In a measured fashion (i.e. 3-5% portfolio weighting), I think there is a place for it. GLD was up almost 3% the week of January 4th, in year of our Lord 2016, the worst starting week in global financial markets on record, ever.

The risk diversification merit of gold is sometimes overlooked as the “gold bugs” can be quite overbearing in their views (as in butterfly net crazy), causing people to dismiss the asset class outright. In sizing what is a reasonable allocation, a good starting point is the estimated value of all gold above ground which is $7 tln (171,300 tonnes, a 68 ft. cube for those visually inclined) divided by global household net worth of $250 tln gets you to a 2.8% weighting. Annual production is a scant 2860 tonnes (1.7% of the gold market) versus 20% under “official control”, making the actions of the worlds central banks more important, on balance, that mine supply. The largest central bank gold holdings at present are the US (8133  tonnes, 73% of their fx reserves), Germany (68%), IMF, Italy (66%), France (66%), China (2%) and Russia (14%). India is the 11th largest holder  (6%). China’s, in particular, has been adding voraciously but gold still makes up < 2% of their foreign currency reserves, versus a global average of 10%.

Gold is very topical is Asia and it is highly prized as a store of wealth. Of global demand, China accounts for 29%, India is 25% and the USA is 5%. Almost all excess refining capacity for the last several years has been expended converting “good delivery” LBMA 400 troy ounce (12.4kg.) bars to the 1kg format preferred in Asia. China is also the largest gold producer at 450 metric tonnes (16% of global production).

Ray Dalio agrees, in moderation, and his $189bln Bridgewater fund owns Barrick (ABX), GoldGorp (GG) and Silver Wheaton (SLW). As as aside, the combined market cap of these three is approximately the same as Tesla (TSLA).

GDX, Market Vectors Gold Miners ETF is a good option to garner exposure to gold mining equities (mid and large cap) which offers a levered play on the price of bullion. GDX has a 17.5% weighting in Dalio’s three favoured names noted above and include a who’s who of the sector (53% in the top 10 names). GDX is large ($4bln+), liquid and has a 53bp MER. My current gold allocation is a bit underweight at 2% of assets and is invested in Fidelity Select Gold Portfolio (FSAGX). FSAGX is small (<1bln) and more expensive (90bp), hence if GDX was an available option it would be my ETF of choice. GDXJ, Markets Vectors Junior Gold Miners is another option for those seeking the higher beta exposure to juniors/small cap exploration focussed players.

Choosing individual gold mining names can be perilous given the high degree of idiosyncratic risk. One name that John Hathaway, CFA Co-Manager of Tocqueville Gold Fund, consistently recommends is NovaGold (NG). NG’s primary asset is a 50% share (Barrick owns the other 1/2) in the Donlin gold project in Alaska, which is hands down the best potential new mine in the world. In terms of scale (39mm + ounces, 27+ year mine life) jurisdiction (USA baby) and grade, nothing comes close. The project is in the permitting stage and production will likely not start before 2019. Barrick offered $1.6bln for NovaGold in 2006 when gold was $600 an ounce. NG declined Barrick’s advances in 2006 and their market cap now stands at $1.35bln with $1,100 gold. The USA bought Alaska from Russia in 1867 for $7.2mm which equated to 2 cents per acre. The deal was nicknamed “Seward’s Folly” after then Secretary of State William Seward who penned the deal. Seward was accused of having bought snow but a short two years later in 1869 gold was discovered, as was oil decades later. While mining conditions are harsh this far North (pic of Agnico Eagle’s mine in Nanavut, Canada), I’d take them any day over Congo.

James Grant, publisher of Grant’s Interest Rate Observer refers to gold as nature’s own bitcoin and holding gold outright has become both easier and less costly over the last number of years. GDL, SPDR Gold Trust at >$20bln is the big daddy ETF in the category and the the most cost effective means for most investors to gain exposure to the gold price. Gold, in physical form can also be held in your IRA. The two providers in the USA that I recommend are APMEX and Gainsville Coins. In a taxable account, gold is taxed as a collectible (26% tax on gain).

The performance of both individual mining stocks and precious metals funds has been deplorable on 1, 3 and 5 year horizons. Barrick (ABX) is up 14% ytd 2016 but the 1 year is -20%, 3 year -35% and 5 year -26.5%. FSAGX 5 year -20%. TGLDX (Tocqueville Gold Fund) 5 year -21%. Wading in at this juncture is contrarian. Keep allocations light. JCG

Note: Alaska facts from Tim Marshall’s “Prisoners of Geography” (2015).

Unless you are in a target retirement fund like Vanguard Target Retirement 2035 (maturity matching your target retirement date), you need to undertake a periodic review of your IRA (Traditional and Roth) and 401K investments. The New Year is a good time to review. While my IRA account will never rival Mitt Romney’s, I expect my legacy IRA (1/3 Roth, 2/3 Traditional) to throw off a good portion of my retirement income (2-3 times my cost of living adjusted Social Security) in just over 20 years time.

Q1 2016 @Firehorsecaper IRA portfolio & weighting: HEDJ (WisdomTree Europe Hedged Equity ETF) 17%,  DXJ (WisdomTree Japan Hedged Equity ETF) 16%, HDV (iShares High Dividend ETF, 3.8% yield) 16%, QQEW (NASDAQ 100 equal weighted ETF) 5%, PFF (iShares U.S. Preferred Shares ETF, 5.9% yield) 16%, BBN (Blackrock Taxable Municipal Bond Fund, closed end fund, 7.9% yield) 16%, DSL (DoubleLine Income Solutions Fund closed end fund, 10% yield) 9%, SLRC (Solar Capital Ltd., a high yielding BDC, 9% yield) 5%. Overall asset allocation 54% equity / 46% “alternative” fixed income.

ETF’s have taken off in popularity over the last few years and fees are typically much lower than comparable mutual funds. Many expect long-only mutual funds to go the way of the Dodo bird, over time. “Smart-beta” has been the a fast growing ETF sector and now stands at $400bln with traditional index ETFs at $1.8tln. Smart beta ETFs have attracted $65bln in assets in 2015 with a whopping $18bln (28%) allocated to Wisdom Tree’s DXJ (currency hedge Japan) and HEDJ (currency hedged Europe).

The largest ETF in the “Traditional”category is State Street’s SPY with $183bln in AUM. Perhaps more surprising than its size is the average hold period of less than a week. VOO is Vanguard’s S&P ETF offering and at $40bln it is growing for 2 reasons, i) Cost, 5bp vs 9bp for SPY and ii) Structure, SPY is a UIT (Unit Investment Trust) meaning units can not be re-hypothecated, whereas VOO is an ETF. Securities lending fees are passed through to the ETF holder and VOO is more capital efficient for institutional accounts as they can rely on cross-product netting for margining purposes with their PB (Prime Broker).

ETFs are increasingly being used by institutional accounts for asset allocation purposes. Good Harbor Financial LLC is one of the biggest ETF portfolio managers in the US which in 2014 moved to semi-monthly re-balancing from monthly to mask their often multi-billion dollar re-allocations between equity and fixed income ETFs (5-10bln across half a dozen ETFs).

The analytics for the DIY ETF investor have never been better in terms of diversity or cost. The one consistent criticism of DIY is that the steady hand at the wheel often heads for a puke over the side when the waves measure a multiple of your boat. For those willing to monitor more actively, there are sites like etfreplay.com (warning: more addictive than Minecraft for adults) which allows you to build, back-test and manage your own ETF driven investment portfolio. Monthly re-balancing ideally, but if you are in the best 4 of 12 ETFs you will rarely be trading more than 1-2 ETFs per month. Moving average filters (200 day moving average, or others of your choosing) direct you to ETF products like SHY (1-3 year Treasury ETF) when all hell breaks loose. There is also  etfdb.com which has both a free and paid version for research purposes. Note: Not personally affiliated with either, just a happy subscriber, as I am to IBC’s Exodus service.

Speculative trading is fun and can be lucrative, but most are not wired to handle the inevitable drawdowns inherent in the trading strategy for all your chips. Prudent asset allocation and the power of compounding are important drivers for your very long term investment goals. It is the hamburger versus steak trade, or for the vegans the iceberg lettuce versus arugula trade. JCG

Note: Citizen of the world asset allocation. A US based investor would typically exhibit more home country bias and have the equity component more USA weighted. The “go to” funds in the Vanguard family would include VTI (Total US Market ETF), VNQ (US REIT Index) and VYM (High Dividend Yield ETF) with upwards of 1/3 of overall portfolio weighting in VTI as a core holding.

Solar is a big, and getting bigger, exponentially. 2014 saw 45 GW of capacity installed globally, 2015 will see 50+ GW and from 2017 onwards 70+ GW, as far as the eye can see. Coal’s cremation oven may be nat gas powered near term, but the PATH Act of 2015 which extends the US tax credits for “renewables” by 5 years puts a lot of wind in the sail of both wind ($35bln over 5 years) and  solar (+38bln) installations.

SunEdison, equity ticker SUNE, is the the world’s largest renewable energy development company. The company develops, finances, installs, owns and operates renewable power plants, delivering predictably priced electricity to its residential, commercial, government and utility customers. SunEdison is one of the largest renewable energy asset managers and provides customers with asset management, operations and maintenance, monitoring and reporting services.

As a play on the sector, I recommend owning SunEdison (disclosure: long equity & vetting purchase of Series A 6.75% Perpetual Convertible Preferred Shares). Other names that get discussed as if they are independent include TeraForm Power (TERP) and TeraForm Global (GLBL) which are publicly listed, SunEdison sponsored YieldCos. The YieldCo model was used by SunEdison to broaden the menu of securities available to yield starved end investors (MLP 2.0). In addition to 3rd party sales and warehouse drop-downs, the YieldCos give SunEdison another outlet for on-going deal financing. Of SunEdison’s $20.7bln in assets at the end of Q3 15′, $5.5bln are housed in TERP and $2.9bln are with GLBL. A confluence of events, including too much too soon in terms of planned growth (6 GW backlog), ill-timed acquisitions (Vivint, et al) and tightening financial conditions almost resulted in a “lights out” scenario for SUNE equity holders in Q4 15′. The stock recently traded sub $3 from a 2015 high of $32 and currently stands at $6.51 ($2bln market cap). SunEdison is a complex company for certain, and one must put in the hours to understand the subtle nuances, both stand alone and versus peers.

There are a few factors that could give new investors pause when considering allocating fresh capital to the renewables sector via SunEdison.

1.) Hedge fund involvement. Hedge funds are all over this trade, via various components of the capital structure like its the head table at a Robin Hood Foundation dinner gala.

Greenlight Capital’s Einhorn has had the longest standing involvement from the long equity side with a 4%+ stake in SUNE. David certainly has drunk his share of the cool aid on this story, some would assert via a funnel. A $34 sum of the parts valuation may need to get pared but even 1/2 that at $17 is a near triple from here. The interweb has his Q3 Shareholder Letter laying out why Greenlight remains long.

Appaloosa Management’s David Tepper recently disclosed a 9% + stake in TerraForm Power (TERP) via both equity and senior debt and is taking an activist role. Sifting through the two missives sent to date it is difficult to see Mr. Tepper’s end game, yet. SUNE, as Sponsor and an equity holder in TERP has little incentive to drop down lower quality assets to TERP. When assets are funded via SunEdisons 4 available warehouses via drop downs the company retains the right to buy the assets back within 5 years and the YieldCo has right of first refusal (via call rights). What is likely over time is that SunEdison creates a 3rd YieldCo, TerraForm Resi to house US residential renewable assets which Tepper sees, rightly so, as lower quality vis-a-vis commercial (typically investment grade), government (printing press) and utility (regulated) customers.

2.) The degree and swiftness of the recent stress evident in SunEdison’s debt security prices. SunEdison has total debt of approx. $12bln, of which $4-5bln is full recourse. SunEdison has $1.9bln Convertible Senior Debt. In August 2015 the company issued $650mm of Convertible Perpetual Preferred Stock with a par value of $1,000. The ticker for the prefs is SDSNP and the cusip is 86732Y208. The prefs closed last Friday at $424 (15.9% yield), up 8% from the previous close and well off recent lows of $200 (33.75% yield for those that caught the bottom print, with a going concern assumption of course). When the prefs were issued in August 15′ SUNE was trading at $14.68 and the initial pref conversion price was set at $17.62. The company has the right to convert holders to SUNE equity after Sept. 6, 2020 if SUNE trades at >130% of the $17.62 ($22.91) for 20 of 30 consecutive trading days.

3.) Short interest in SUNE >40% float. SUNE has a traded float of 271mm shares and 119mm are held short. Rather than naked shorts, I believe the bulk of the short positions were put on as a hedge against the convertible bonds, previously noted. Convertible arbitrage is meant to be a “market neutral” trade whereby you buy the convert and short the amount of shares you expect to eventually be converted into. Busted or broken converts, as they are also referred, is a speciality segment of the distressed market. The bonds tend to trade much more like bonds and less like an equity hybrid once the equity trades <50% of the conversion price. SunEdison’s earlier maturity converts have a conversion price in the mid teens and the most recent convertible prefs at $17.62. While not in the prudent category, trapped longs (of the convert) might consider covering their equity short and letting the convert run once the stock gets real legs on  an executable medium term strategy and the nitrous provided by the Path Act 2015 passage (soon to be forthcoming).

Those preferring to “buy the blob” rather than selecting individual names can buy the Guggenheim Solar ETF TAN which tracks the MAC Global Solar Energy Index (the top 10 names make up 62%). This is really the only game in town in terms of size (just shy of $300mm) and volume averaging 200k shares per day. I have some issues with TAN in that it only has a 37% USA domiciled solar weighting, and it includes Solar City (SCTY) at a 4.8% weighting. I’m in Chanos’ Kynikos Assoc. camp on SCTY, where he is short. He is offside on his SCTY short, but claims he would short more if there was sufficient borrow available. Chanos nailed the VALE short early (2012) from the mid 20’s in price terms and I rarely fade his high convictions short positions.

The US has a vested interest in being the global leader in the renewables space. The Department of Defence (DoD) is the biggest single energy user in the country (Army, Navy, Marine Corps, Air Force and Coast Guard) and is one of the largest consumers of energy in the world. Expect to see a wave of new government contracts in this space. Many green projects have been completed and more will be put to bid to both modernize and improve the efficiency of military installations both at home an abroad. Military housing, long privatized, but effectively credit wrapped through the Basic Allowance for Housing (BAH) annual appropriation from the US Federal Government is another large potential growth pocket. Even Mr. Tepper could get his head around that risk profile. JCG

The Federal tax code of the US is complicated, >70,000 pages at last count (Trump thinks it is 700,000). After having briefly fully repealed their estate tax in 2010 the US re-instated, retroactively in 2011. The top Federal bracket is 40% for estates >$1mm. The exemption was set at $5mm which is indexed to inflation (standing at $5.43mm for 2015). Because of the high level of the exemption for Americans ($10.86mm per couple), only 0.12% of taxpayers (1 in 833 on passing) pay Federal estate taxes. In 2014, the IRS collected $17.5bln in Estate Taxes, less than 1% of total tax receipts which eclipse $3tln.

Foreigners (non-residents, also known as non-resident aliens for tax purposes) are often ensnared unknowingly in USAs “Death Tax” as it is widely known, as the exemption is a paltry $60,000 of US situs (the place to which for purposes of legal jurisdiction or taxation a property belongs) assets. Relief is available to those residing in countries with dual taxation treaties with the US, where in many cases an exemption equivalent to American levels are granted (albeit on a US situs to non US situs asset ratio in some cases).

What follows are some practical and legal solutions for the rest of us (non Americans without tax treaty benefits), naked of cover and massively long the global reserve currency US$. As always, please consult a professional in estate planning matters, as the sands are always shifting with respect to global tax policy.

Jack Bogle, as a supporter of passive indexing does not see the value of Financial Advisors (FAs) as being their stock picking acumen.  To Jacks mind, FAs should be utilized to marshal the best advice with respect to tax efficiency, risk management, estate planning and owning the appropriate amount of insurance. The inherently unfair thing about estate taxes is that the amount of estate tax paid depends on the quality of the estate planning advice received.

Minimize U.S. Situs Assets:

The rules on what constitute U.S. Situs assets are peculiar. US$ cash held is a Bank is not US situs and hence not subject to estate taxes. US$ cash held with a Broker-Dealer is US situs and subject to estate tax, making the home for both your emergency fund and the cash component of your investment portfolio clear. Put your US$ cash in the Bank. Tangible property (cash/collectibles) held in a US safe deposit box are US situs and subject to estate tax.

Equity investments (shares of stock) in a US Corporation are US situs, subject to US estate taxes. The largest investment houses such as Vanguard and Blackrock (i-Shares) have a ready made work around for those fond of garnering their equity exposure via low cost ETFs. The issuing domicile of the ETF determines the situs for estate tax purposes. Vanguard’s London Stock Exchange (LSE) listed S&P 500 ETF, VUSD is over $12bln in size and trades 1mm + shares per day. My favourite ETF is iShares IWDA, also LSE listed, which tracks the MSCI World Index of 23 developed markets (57% US weighted) with 1643 constituents. The added benefit of iShares IWDA is the dividends accumulate instead of attracting withholding taxes (wht). Foreign stocks listed on US exchanges (ADRs) owned by a non-resident are not subject to US estate tax.

US Treasuries are not subject to wht and are not deemed to be U.S. Situs for estate tax purposes.

Real assets – Real estate is US situs and subject to estate taxes. If it forms a large part of your estate putting a non-recourse mortgage on the property might make sense. I’d rent my clothes if I could …..just saying.

U.S. Qualified Domestic Trust (“QDOT”):

Setting up a trust is another solution which effectively defers US estate tax until other solutions arise (i.e. spend it, gift it, anything but pay it to Uncle Sam blindly). The cost, from a reputable provider, is less than most assume. This often packaged with a will, an irrevocable life insurance trust (ILIT) and a healthcare directive, all good things to address while we are healthy and mentally sharp.

Insurance:

Term life insurance, to cover the unforeseen, is a good idea. Someone in good health in their 40’s can purchase $1mm of 15-20 year term for approx. $800-$1200 per annum.  Structured properly, in concert with the above noted life insurance trust, the life insurance payout is both tax free and avoids probate.

Retirement accounts:

These assets pass to heirs via beneficiary forms so ensure your primary and secondary beneficiaries have been properly assigned.

Summary:

It is not just seaweed that gets you to the ripe old age of 86 with aspirations of 114, financial peace of mind for you and yours counts for a lot too. JCG

Note: mm denotes million