A bird in the hand is worth two in the bush. – J. Capgrave
“WSJ is controlled by shorties”, “This is another trick to trick retail investors to give up their shares” and “#FakeNews”. The recent WSJ article has incited vehement comments among stolid Mallinckrodt (MNK) investors, mostly criticizing and questioning the validity of the article. Based on historical records, WSJ articles may at times be written with a bias opinion, but the facts remain facts.
I believe that the number one question on top of every investor’s mind (even mine). The timing does not make sense. The company’s lawyer has just made a powerful case in the Appeal Court and the covenant breach is expected only in Q1 2021. Further, CMS in their argument of not causing irreparable damage has cited the prodding bureaucracy means the $640 million will be paid out over a long-drawn period of time. Apart from a terrible debt ratio, the company will still remain solvent and could potentially renegotiate a new opioid deal to relieve cash flow. So from a liquidity perspective, without $640 million coming due immediately, declaring Chapter 11 seems premature. Below, I explore several potential answers.
Possibility 1 – Management decided to throw in the towel
CMS, DOJ, Humana and opioid plaintiffs, everyone is hungry for a piece of the company. Coupled with poor business performance and lackluster pipeline, declaring bankruptcy does seem like an appealing route to strengthen the company’s balance sheet. It is the easiest way out for the company and management will continue to be gainfully employed. The executives have also benefited far more from the company. For example, the CEO, Mark Trudeau, sold $4 million worth of shares near an all-time high in 2015.
Further, management will benefit via a bankruptcy route with their recently approved retention bonus of ~$5 million. However, the retention bonus might become a contentious issue. If Hertz’s retention bonus is any indication, the $5 million may not be that easy for management to obtain.
Nonetheless, throwing in the towel will allow the management a sigh of relief from dealing with the current mounting issues. In the end, it’s the shareholders’ money at stake and management has <2% stake in the company.
Possibility 2 – Bankruptcy of SpecGx
The WSJ article lacks details. It only includes a generic statement: “Mallinckrodt PLC is preparing to file for bankruptcy as soon as within weeks”. There remains the possibility that the company is filing for bankruptcy for its subsidiary SpecGx. Last time, the company did not start the filing as there was uncertainty surrounding CMS verdict. Now, with the worst possible outcome playing out, management could have negotiated with plaintiffs and creditors on a new deal (in the works since March when CMS verdict was announced). If the uncertainties are resolved and the creditors give the green light, the company can potentially start the bankruptcy process. So, a bankruptcy filing for SpecGx instead of the whole company is a theory that does hold water.
However, the dent in the theory was a previous WSJ report did accurately point to a SpecGx bankruptcy a day before it was announced. The same journalist wrote both articles, Alexander Gladstone. So it is not a stretch to assume he has someone high level on the inside feeding him detailed information. And the term “Mallinckrodt PLC” was used accurately to mean the whole company otherwise SpecGx would be specifically referenced.
Possibility 3 – Management trying to force a final resolution within weeks
I have been seeing a lot of signaling from management to stakeholders, especially the opioid plaintiffs that they must agree to a new deal soon. The alternative will be bankruptcy where they will get limited cash upfront (secured bondholders will be paid out first) and most likely a very small piece of the newly reorganized company (versus 20% of the current company).
Profuse use of the term: “going concern”
One of the earliest signaling is the recent 10Q, the term “going concern” was used as a warning 11 times. In comparison, Hertz only warned of a “going concern” a mere 3 times in its 10Q published 12 days before it declared bankruptcy and 9 times in its 10Q after it has declared bankruptcy. It goes to show that management does not have to cite some pessimistic outlook that frequently. However, in doing so, management is shouting aloud that we are going to push the button, it’s your move.
Quote from WSJ – More than meets the eye?
“Mallinckrodt PLC is preparing to file for bankruptcy as soon as within weeks”
Source: WSJ article
Further, I believe the recent WSJ was another signaling by management. A first read of the above statement will convey the idea that the company is going to file for bankruptcy soon. But a deeper dive into the precise words being used reveals something deeper. The use of five words “as soon as within weeks” caught my attention. It is very strange to use “as soon as” with a relatively long timeframe like “weeks”. WSJ journalists have usually used that term to relate a bankruptcy timing within a week and rarely referred to a bankruptcy that far down the road (>2 weeks). I highly doubt they gotten the insights from rank and file employees, it is likely a leak from upper management. I believe this could be another signaling by management to stakeholders; come to a resolution soon or we are pulling the trigger.
Or maybe I am just overthinking?
High likelihood of Possibility 3
Unlike other companies that filed for Chapter 11, MNK is still generating decent free cash flow (~estimated $400m for 2020) amidst COVID-19 crisis. Interest payments are well-covered. The only immediate default possibility is the revolver loan, which Deutsche Bank indicated a willingness to extend and tweak the covenant if the company is willing to pay a higher margin and settle its existing major lawsuits. These factors do indicate a possibility for resolution on the financiers’ front, so the final choice is up to the opioid plaintiffs and potentially CMS (settle now instead of waiting for a verdict).
In summary, MNK remains a very high-risk investment. Management will very likely pull the trigger if there is no imminent resolution. As the saying goes, a bird in the hand is worth two in the bush. Fighting for scraps in a bankruptcy will be the worst possible outcome versus taking a reasonable offer on the table. Overall, I still hold firm to my belief that the stakeholders would make the right choice and come to a reasonable compromise.
Disclosure: I am/we are long MNK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.