'Go short' Six Flags' 7.25% convertible preferred Piers: Lehman report

By Rebecca Melvin

New York, May 15 - Lehman Brothers equity-linked analysts suggest going short Six Flags Inc.'s 7.25% convertible preferred Piers, which mature in 2009, as well as shorting two-year CDS protection.

Given the negative net worth of the theme park operator, there is some uncertainty about the redemption of the 7.25% convertible preferreds, especially in light of Delaware corporate law, under which capital repayments are prohibited when the capital of the company is impaired, the Lehman cross-asset strategies analysts said in a report Thursday.

The Piers debt is among the shortest-dated paper of the company, but it is also most junior in the capital structure.

"We estimate that if the company achieves an EBITDA of less than $255 million in the four quarters leading into August 2009, and the same debt level as now of roughly $2.4 billion, the capital of Six Flags would be impaired within the parameters of the law," the report states.

Lehman finds the preferreds to be over-valued by around 20% to 25% under that scenario. But if the company achieves an EBITDA above $255 million, then the preferreds have a significant upside, the report said.

"We suggest going short the Piers and hedging the position through CDS through the following trade: short the $1.5 million notional two-year CDS protection, short the $1 million notional of Piers," the report stated.

As background, the report provided a corporate structure chart. Six Flags has 19 fully owned parks and two partnership parks in Texas and Georgia where it has limited partner interests. The company established a new management team toward the end of 2005 after Red Zone acquired a 12% stake.

Financially, the company has been under continuous stress from falling EBITDA and cash flows as well as high leverage. The total leverage based on 2007 EBITDA stands at about 11 times, excluding the Piers, the Lehman report said.

"Given the slowdown in the economy, we expect financial stress to be sustained as least in the medium term, especially because of the limited flexibility afforded by the high leverage."

"While management has provided guidance indicating expected EBITDA of $270 million in 2008, our fixed-income analysts expect EBITDA to be close to $227 million."

Over the next two years about $568 million of preferred instruments and bonds become due, and generating cash for these payments will be a major priority for the company.

"We think it is highly unlikely that the Piers will get repaid till the company has a capital surplus. Since it is difficult to forecast when the company will have a surplus and therefore be able to pay the holders of the Piers, we use a probability based approach to determine fair value," the report said.

To do this Lehman assumed that the CDS curve was fairly priced and reflects the default probability of Six Flags. We also assume that the company will have a capital surplus within the next five years, if it does not file for bankruptcy in the interim.

Based on the payoffs, the Piers have about 25% downside from present levels and fair value is about $10.43.

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