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"As the junk market has rallied, pickings have been getting slim in the 10+% YTM category. Of the non-Caa/CCC rated names that regularly show up in my searches there are precious few I would want to own. However, Stonemor Partners (STON) 10.25% bonds due 2017 recently offered at 95 cents on the dollar in retail sized lots appear to be one of the rare attractive yield opportunities currently available. These bonds yield a bit over 11% if held to maturity and as much as 16% if they are called at the issuer's earliest opportunity. While STON bonds do not offer a material capital gain potential, I believe they are a solid value for yield oriented investors."

http://lifeinvestmentseverything.blogspot.com/2012/03/attrac...
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Brewer, what is the CUSIP on that Stonemor bond? FINRA doesn't find it under Stonemor.

Stonemor's financials looks truly ugly to me. Where do I begin? I take EBIT and add back depreciation to get EBITDA, and this barely covers debt interest. What is worse, they keep piling on more and more debt.

I don't see much free cash flow, which for a business of this type is extremely surprising and a flag for me that the business isn't well managed. How can a mature funeral business not have free cash flow?!

They pay a large distribution, and my immediate conclusion is they have no business paying any distribution at all. They should be paying down debt!!

To me it looks like this company is running into a wall. At some point they will fail some bank test on debt coverage and then we could get a liquidity crisis. If they manage that well I suppose they could get through it by cutting distribution and paying down debt. But when that happens these bonds will be on sale at 70% to 75% of par. 95% for unsecured debt of a company in such bad shape seems very expensive to me.

This is a negative article on Stonemor:

http://seekingalpha.com/article/316417-stonemor-dividend-uns...

In it he quotes S&P that the unsecured bonds would see only 10% recovery in a default. Above $28, I think I would short the equity. Train wreck is coming on this.
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I found CUSIP on a broker site: 86184BAB8.

The rest of what I wrote I think still applies.
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Stonemor's financials looks truly ugly to me. Where do I begin?

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As the linked blog post suggests, start with the management discussion in press releases and SEC filings, especially the discussion of "operating surplus." The big distortion that goes on in this company's financials is taht when they buy a property it has usually been trundling along under a management atmosphere best described as "benign neglect" at best (some of the stuff they have bought was from receivership/bankruptcy). The prior owners have been milking it for maximum cash flow and reinvesting minimal capital into teh property. So when STON buys a property there are usually highly accretive opportunities to invest incremental capital. One of the major ways to do this is to ramp up the "pre-need" sales program. When you are successful at bumping up pre-need sales GAAP requires you to recognize costs up front and put up significant working capital, while substantially deferring the profits embedded in the contracts you wrote. In many respects, this is quite similar to how statutory accounting works for a life insurer (a fast growing life insurer writing highly profitable business will commonly show large statutory accounting-basis losses). The management accounting attempts to remove the GAAP distortions.

I would also tell you that partnerships always look a little iffy from the creditors' point of view as they are usually full payout vehicles. That makes them weaker credits than they would otherwise be. I used to own this equity and it took some getting used to in never seeing them accumulate cash/equity, but it is the way a lot of MLPs operate (REITs, too). As an aside MLPs are a PITA come tax time due to the agony of K-1s.

I don't pay a ton of attention to the agencies, but S&P recently reversed itself, upgrading the bonds to B- and assigning a recovery estimate of 50 to 70% (going from memory here). I didn't see a huge change in the company's fundamentals (its a cemetary company fer gawds sake), so this may have been a methodology change on the part of S&P and therefore calls into question both the CCC rating/10% recovery and the B-/70% recovery. As usual, the agencies are "less useful" in junk land.
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I never pay much attention to earnings on these MLPs since mostly those are an accounting fiction anyway. But I live by the cash flow statement. Sure, I understand that capital improvements to neglected cemeteries eats up free cash flow. But how do you explain the fact that in two of the last four quarters they even have negative operating cash flow. That is something you just cannot fake.

Another thing that bothers me is that the book value either goes sideways or gets even more negative. Assuming you do these pre-sales and need to set up asset accounts to hold payments for later revenue, then set up liabilities for future maintenance, you would at least expect a profitably run business to be increasing its book value in the process. After all if you don't defer more revenue than expense, what is the point of the transaction?

Something else that bothers me is their corporate presentation fails some basic honesty tests. For example on page 28 they show cash inflows and outflows associated with each sale. They conveniently neglect the 15% to 20% sales commission from the cash outflows. To me that reflects a mindset here that the investor is a smuck, and they just need to bury the investor in enough complexity to make skepticism disappear.

So I have a business here:

- with negative book value, where the book value never goes up
- accumulating ridiculous amounts of debt that they barely cover from EBITDA, and this appears to be getting worse
- with negative *operating* cash flow in two of the last four quarters
- all distributions appear to be covered by issuing new partnership units, at least that is the way the cash flow makes it look

To me this all looks like a train wreck ready to happen. Distribution should be cut to pay back debt. We'll see.
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To me this all looks like a train wreck ready to happen. Distribution should be cut to pay back debt. We'll see.

***************************

Difference of opinion makes a market. They have been public since 2004, IIRC, so if they haven't imploded yet...
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Brewer, I love that you put this one out for consideration. Honestly what the bond world needs is more idea generation. There just aren't enough novel new ideas going around to examine. Of course you are right there are two sides to every trade.

Some more food for thought on Stonemor: follow management's incentives by looking at the incentive distribution rights they take from each distribution. Management takes as its general partner fee 15% of every distribution above 51.25 cents. But what is really shocking is that management will get HALF of any distributions above 71.25 cents per share.

So management has every incentive here to grow grow "grow" by any means possible in order to enrich themselves by taking ever steeper management fees from distributions. But management has NO DOWNSIDE RISK on the actual partnership units. So management gets all the upside, but they take no capital loss if the company fails. Management's incentives are NOT aligned with unit holders.

Consider further that the management of this company sold off most of their remaining units in the company as part of a capital raising in 2011.

To me this looks like a failure of the Board of Directors to set up the right incentive system, and the management is essentially milking the carcass while assuming none of the downside risk. In a Chapter 11, they will just restructure the company and re-issue 15% of the new units to themselves as "incentive" to continue with the business.

It all looks like a giant cynical mess to me.
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But I live by the cash flow statement. Sure, I understand that capital improvements to neglected cemeteries eats up free cash flow. But how do you explain the fact that in two of the last four quarters they even have negative operating cash flow. That is something you just cannot fake.

Interesting that you seem negative on this company, when on Newpark, you were dismissing the negative operating cash flows http://boards.fool.com/newpark-4-convertible-29896533.aspx?s...

Is there a difference I'm missing?

AJ
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Some more food for thought on Stonemor: follow management's incentives by looking at the incentive distribution rights they take from each distribution. Management takes as its general partner fee 15% of every distribution above 51.25 cents. But what is really shocking is that management will get HALF of any distributions above 71.25 cents per share.

**********************

This is standard issue with pretty much every MLP I have ever seen, including many "blue chip" ones. Part of the deal and fully disclosed to every investor in every MLP. A case could be made that this inentive structure is ideal for the public LP interest holders as it strongly incents management to do exactly what the public holders want: rause the payout.

As for not suffering a capital loss if they get the distributions cut off, what do you think their GP interest will be worth if the distribution gets cut?
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aj, I maintain that Newpark's negative cash flows are temporary, whereas Stonemor's are systemic and probably permanent.

What I discovered was that Stonemor's incentive system is seriously messed up. The management owns almost none of the units, having sold those off in 2011 in a secondary. They make a lot of upside from incentive distribution rights as the general partner. So management has NO incentive to enhance per unit book value, per unit earnings per share, or any metric other than the distribution. Even those earnings are up over time, earnings per share are strongly down over time.

They are doing extremely bad things to the Stonemor entity (e.g., too much debt, dilution to pay distributions, and permanent negative operating cash flows) because they have no personal downside if the company fails. They get all the upside from increasing distributions, and none of the downside if they slip up and force a bankruptcy. Therefore management's incentives are NOT aligned with unit holders.

In fact, in this sick system we have in the US, management is probably rewarded for bankruptcy by taking 15% of the company in Chapter 11 as their incentive to continue on.
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Brewer, this is NOT the typical MLP situation. In the typical MLP the general partner owns extremely significant numbers of the units of the partnership. This is to align their incentives with those of unit holders. In most MLPS, the Incentive Distribution Rights are icing on the cake.

Let's take a look at a specific example. Consider an MLP ETP and its general partner ETE, which trade as separate symbols. Look at the major holders for the limited partnership ETP and you see clearly that ETE sits there with 50M+ units. The general partner has significant skin in the game. If they do something adverse to the interests of the unit holders they suffer from those bad decisions.

In Stonemor's case, the IDRs appear to be the main compensation for management, and management has essentially divested itself of the partnership. At least the disclosures I found suggested that management owned very little of the partnership.
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aj, I maintain that Newpark's negative cash flows are temporary, whereas Stonemor's are systemic and probably permanent.

Thanks!

AJ
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I think that we will probably have to agree to disagree on this one. Yep, they sold off their LP interests and retain only the GP interest. But I don't think the incentives are any different than they have always been: raise the distribution. Ultimately, that is all the public LP investors care about and it is all the GPs care about. I don't see a misalignment of interests, and I don't see any change in management behavior between when they owned LP interests and now that they don't.

As for cashflow, etc., I believe that this is a business whose economics are not well described by GAAP and therefore a concentration on stadard metrics is highly misleading. The way to show massive cashflow would be to stop doing pre-need sales and let teh business run off (this is what life insurers do when they get into trouble). Do you really believe that such a course would be building value for this business? Quite the opopsite, IMO.
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In a normal MLP, the incentive of a general partner who holds significant units in the partnership is to maintain the health of the partnership. You do that by increasing earnings per unit, book value per unit, and keeping debt at a manageable level. If you fail to do those things and push the company into bankruptcy, then your units become worthless and you lose a lot of money.

In Stonemor's case, who cares if they push the company into bankruptcy? After all, it's your money that they are going to lose. Stonemor's management loses nothing if they push the limited partnership into bankruptcy. So what a great deal for management. Heads they win and you win. Tails they win and you lose. They have no risk. They put all of the risk on you.
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Like I said, I doubt we will come to an agreement. Short the equity if you have the courage of your convictions...

That said, I think that you are getting lost in distinctions without difference. MLP buyers are chasing yield, pure and simple. So all they really care about is that the distributions be high and rising. The GP has the exact same interest due to their IDRs. All this kerfluffle you keep raising about book value, etc. is irrelevant.

We could get into covenant protections, etc., but since you have made up your mind that management in this case is evil, it seems like a waste of time.
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If I like to fly in fast airplanes, I want a pilot who can do two things:

1) Fly fast

2) Keep the airplane in one piece so we get to fly another day

Any time you have a situation where the pilot has incentives to fly the airplane fast, but doesn't feel a need to keep the airplane in one piece, you have a problem, particularly if you are inside the airplane. :)

By analogy, I maintain that an MLP like ETP with general partner ETE is built to give the general partner strong incentives to keep ETP in good shape. If they reach for too much distribution and "crash" the company, ETE's huge unit holdings in ETP become worthless. This incentivizes them to *both* reach for higher distributions *and* keep the company intact.

I maintain at Stonemor there is an incentive to reach for distributions, and insufficient incentive to keep the company from crashing. At Stonemor, the pilot is flying the plane remotely, and if goes down no big deal to him he will just get a new airplane and fly again.

If you don't see the difference between those two cases, ouch, what can I say. Happy flying. :)
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