Puerto Rico Bankruptcy: Uncertainty But Also Stock Profit Opportunity – Seeking Alpha

Puerto Rico opened a new "chapter" in distressed securities investing when it filed for court protection in early May. However, in this case it is not a chapter of the bankruptcy code such as Chapter 11 (which generally applies to companies) or Chapter 9 (which applies to municipalities). Because Puerto Rico is an unincorporated territory of the U.S., it was not eligible for traditional bankruptcy protection. Instead it filed under a new statute that was passed last year by Congress primarily to deal with the island's problems.

After years of economic decline, Puerto Rico is now in default on an estimated $74 billion of bond debt. On top of that, the Commonwealth has approximately $49 billion of pension obligations and an ongoing need for funds to provide basic government services. Because of special tax law provisions that exempt the territory's debt from not only federal taxes but also state taxes in every state, the bonds are widely held by investors across the country. Since the legal action is under a new law that has never been tested, there is tremendous uncertainty about how much creditors will recover and how long the process will take.

Distressed bond investors seem to be favoring either the territory's general obligation (or "GO") bonds or its bonds backed by sales tax revenues (known as "COFINAs") both currently trading around 50 cents on the dollar, and there are many other Puerto Rican bonds trading at even lower levels. But there may be opportunities for stock investors to profit from the island's restructuring as well, perhaps with less downside risk than in many of the bonds.

Our most recent newsletter details four public companies based in Puerto Rico that could benefit from stabilization in the island's finances. Those companies are detailed below, and an additional three three major insurance companies with exposure to Puerto Rican debt can be found in The Turnaround Letter. Learn more about these contrarian Puerto Rico investing opportunities.

Closing prices on May 31, 2017

Ambac (NASDAQ:AMBC) - At the most strategic level, the Ambac story is straightforward: an insurer of municipal bonds with an impressive new CEO that is strengthening the company's balance sheet, working off its obligations following its 2010 bankruptcy, reducing risks and building book value. Underneath is a highly complicated financial and legal structure that even most of Wall Street avoids as only a few analysts cover the stock. The shares trade at 63% of adjusted book value, and near their post-emergence lows. Much of the concern is related to Ambac's $276 million of exposure to the Puerto Rico General Fund debt and $2.1 billion in current exposure to Puerto Rican municipal debt. While the eventual costs to Ambac are unknowable, the company has established reserves that would cover the most likely outcomes. There could be an interesting opportunity developing in Ambac.

Assured Guaranty (NYSE:AGO) - Assured Guaranty is probably the strongest player in the bond insurance business. Its exposure to Puerto Rico is relatively modest, and it could buy up competitors if they falter. Management has been aggressively working to boost shareholder value through stock buybacks. The stock has performed well over the last few years, but it could rise a lot further.

Evertec (NYSE:EVTC) - Evertec, with sales of nearly $400 million, is a full-service transaction processing business similar to Turnaround Letter recommendation First Data Corporation (NYSE:FDC), with operations in 18 countries across Latin America. The company was created in 2004 as a unit inside of Popular, Inc. (the Puerto Rico bank), which still owns a 16% stake. Apollo Management bought a 51% stake in 2010, and then exited following Evertec's IPO in 2013. Despite the weak local economy, Evertec continues to grow its revenues and profits through both organic expansion and acquisitions. The company's debt is moderately elevated at 3.3x EBITDA, but management is committed to reducing this. Management appears capable and brings considerable experience from larger industry peers. At an attractive 9.7x EBITDA, this under-followed stock is worth a closer look.

First Bancorp (NYSE:FBP) - With $12 billion in assets, First Bancorp is Puerto Rico's second-largest local bank. Loan quality is a struggle, as non-performing loans are over 5% of its loan book, but this is largely offset by a high level of capital (its Tier 1 common equity ratio is 18.2%). First Bancorp's net interest margin is wide, at nearly 4.5%, compared to less than 2.5% at most U.S. banks. Several major shareholders have been selling, including the U.S. Treasury, which completed its sale under the TARP program as well as private equity firms Oaktree and Thomas H. Lee, and this has been weighing on the stock price. While there are definitely risks here, the stock's valuation at 67% of tangible book value (many banks trade at 100-200%) and 11.9x this year's expected earnings appears to be a bargain.

Disclosure: I am/we are long AMBC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Puerto Rico Bankruptcy: Uncertainty But Also Stock Profit Opportunity - Seeking Alpha