On June 14, 2020 Pyxus International Inc stock traded at $2.91 per share. The next day, the company filed an 8K that announced it had filed for a Chapter 11 prepackaged bankruptcy. The value of the shares dropped to 98 cents before sliding further. Right now they trade around 40 cents. If the prepackaged restructuring is accepted, the existing shareholders will split $1 million, which works out to roughly 11 cents a share.
Pyxus International Inc postmortem
I always hate having to do a postmortem on an investment because it means I was wrong, but it’s way more useful for everyone involved instead of doing the more common practice of deleting the original post and pretending you never invested in it in the first place.
Somehow it has been almost two years since I first wrote about Pyxus International Inc Second Lien Debt. I was of the opinion that they had a decent core tobacco business that operated in a commodity industry with a declining user base and an over-levered capital structure. But they also had an interesting kicker from their budding investment in CBD and legal marijuana. Given the leverage, I thought the equity was too risky but the second lien notes represented a decent reward to risk ratio. The second lien notes were trading at ~97 cents on the dollar and represented an ~11 percent yield 2 years ago.
The theory was that even if there was a bankruptcy the total debt to EBITDA was ~7x on a TTM basis, which wouldn’t have been a bad multiple for an enterprise value and I would be happy to convert my second lien notes to equity given the CDB/marijuana kicker.
Perfect timing for a short entry: Pyxus International Inc Stock since then
It turns out that I had perfect timing for a short position. October 9, the day I originally posted, was the exact peak of Pyxus International Inc’s stock price.
Unfortunately, I did not short the stock [fun note: given the cost to borrow stock to short Pyxus International in the past year a short seller could have had perfect timing but still possibly lost money on the trade].
Instead I bought the second lien notes.
Based on the 8K that announced the prepackaged bankruptcy, the senior notes have the option of receiving new senior notes that are priced at L+1000bps or may be repaid in full in cash if adequate financing is secured. The second lien note holders get their choice of 2 percent of the face value of their notes paid in cash or their prorata share of the new common equity that is issued post-bankruptcy, diluted by the equity incentives given to the DIP (debtor-in-possession) lenders and management’s bonus pool.
So mission accomplished: Pyxus International went bankrupt and I was in a position to be the proud new owner of post-bankruptcy common stock.
I didn’t wait around to be issued my prorata share of the common stock. The second lien notes were still trading hands for ~10 cents on the dollar so I sold them to a willing buyer and took the capital gain loss to minimize this year’s taxes.
Why I didn’t stick around
There are a number of reasons why I didn’t take ownership of the post-bankruptcy Pyxus International Inc stock. The biggest reason is the annoyance of looking at that big of a loss when I was playing in the middle of the capital structure. It’s just not worth the mental bandwidth to wait around for years to see if your original thesis turned out to be correct. It reminds me of the story from the WSJ last year about a guy who waited 11 years to break even on the Bear Stearns stock he bought.
The other reason I sold, besides the tax savings, was quite simply because my original thesis was wrong. If I had been right, or at least had the potential to be right within a reasonable time period, the second lien notes would have traded hands at 50 to 70 cents on the dollar. With them trading hands at 10 cents on the dollar it means the post-bankruptcy common stock of Pyxus would have to increase ten-fold before I broke even.
It wouldn’t be unreasonable to see the post-bankruptcy stock double or triple simply because it’s still a stub stock given all its debt. It’s basically a call option with a 4.5 year maturity date. But a ten-fold increase is probably a pipe dream.
What went wrong with Pyxus International Inc
You can have decades of experience successfully investing but you’ll still make mistakes. The particular assumptions I made 2 years ago that turned out to be wrong:
The tobacco business couldn’t string together a successful season to save their life (or the solvency of their business as it turns out). Prior to my purchase of the second lien notes the company’s performance had been lumpy but they could generally put up about $100mm in EBITDA on average, which was enough to support the debt load. Unfortunately, when they really needed to maintain that EBITDA level in order to refinance their debt they had 2 bad years in a row.
The cannabis business did not flourish as quickly as expected. I admit, I thought we were at a tipping point for legalizing marijuana in the US. We seem to have lost momentum and the overbuilding that happened with all the pure-play marijuana producers has come back to bite the industry. It seems like every other month there was announcements of grow facility closures and sales. This process is healthy for the industry in the long-term, but it’s horrible timing for any investor in the space.
The pandemic turned off the credit taps for marginal businesses. Prior to the pandemic the risk appetite and yield chasing of investors was some of the most aggressive I’ve seen. There were terrible companies getting credit at ridiculously low spreads [as a tip: whenever you see an uptick in convertible notes offerings you’re probably not getting paid enough to play in the junk space]. However, once the pandemic hit every source of credit immediately turned into a turtle. They were trying to figure out what kind of hits their existing books would take and were only willing to lend to the largest and most defensible names. Pyxus International was not one of those names.
I didn’t play high enough up in the capital structure for adequate downside protection. This one is more of a thought experiment for me and most people reading this instead of practical advice. In the case of Pyxus International you pretty much had to be a bank or other financial institution to get invited to buy into the senior notes. It was only the second lien notes and common equity that was easily accessed by a non-financial institution. In retrospect I should have thought a little bit more about why the senior notes were priced little differently than the second lien notes. Given the primacy of payout and the slightly greater than 3 to 1 size difference in amount of notes between the second lien versus senior there was a pricing discrepancy between the two. Regardless, the main point for future investments is to remember that only a very small minority of investments are completely bad. Usually it’s only their price that makes them bad. If you can invest higher up in the capital structure you might be able to turn the situation into a good investment.
Up in smoke
Given the relative illiquidity of the second lien notes I treated this as an investment instead of a trade and held onto it as it kept falling in price. I thought the market was wrong so I didn’t bail. The only saving grace on this is that the position size was small, as is always appropriate for an investment versus a trade.
I think the legal marijuana market will mature and prove lucrative for whoever happens to end up the dominant player, but it will be a decade down the road before anyone has an inkling of who will be the Philip Morris of marijuana. To make this the perfect comedy of errors for me, I hope it’s Pyxus International Inc