9:20 Todd Westhus, Founding Partner, Chief Investment Officer, Olympus Peak Asset Management LP: Todd Westhus is the founder and CIO of Olympus Peak Asset Management. Westhus was a managing partner at Perry Capital focusing on credit and special situations between 2006 and 2017. Before Perry Capital Westhus cut his teeth at Avenue Capital Group working on distressed opportunities in troubled industries such as airlines, automotive, chemicals, paper and packaging, and gaming. Todd has a B.A. in economics and biology from Duke University.
Idea: Short in unsecured Western Digital bonds hedged by a long position in senior secured bank debt. This isn’t a practical idea for ordinary investors. The underlying investment thesis relies on a deterioration in Western Digital’s financial condition. So, we will use a short position in WDC as a proxy to determine the success level of this thesis.
Benchmark: Short position in S&P 500 ETF.
Thesis: “Both cyclical and secular forces are working against the company. In our opinion the best to express this negative thesis towards Western Digital is not to outright short the equity but rather to have a long short position elsewhere in the capital structure. We are long senior secured bank debt ( trading for 99% of par) and short unsecured bonds (trading for 97% of par)” said Westhus. Basically Westhus is using a credit bet which has a maximum downside of 2% to bet that Western Digital shares will go down dramatically. This way if he is wrong his maximum loss would be only 2% whereas he can still generate double digit returns if WDC shares decline dramatically. Westhus believes Western Digital’s HDD business is under the threat of SSD. Half of Western Digital’s business is HDD and the other is SSD but they are a smaller player in the SSD market where prices have been collapsing over the last 5 quarters (they fell 25% last quarter alone). Inventory levels are at historically high levels and continue to increase. Westhus thinks we are about to see the effects of this on WDC shortly through even more declines in SSD prices which will shrink WDC’s gross profit margin to zero (currently it is at 21%). The fundamentals of the stock are moving in the opposite direction of WDC’s stock price and this can’t go on forever and sets up well for negative bet against the company which operates in a very volatile industry. WDC lost 50% of its SSD market share over the last 5 years, so competition is fierce in this segment. Westhus also said that Western Digital has the worst balance sheet in the industry and its cash balance is declining quickly (currently at 50% of its 2017 level). In short, Westhus believes Western Digital is managing a “melting ice cube business” and making expensive and unsuccessful acquisitions to counter this. To make the matters worse Westhus expects China to start investing heavily in this industry which means the future of this industry is bleak in terms of high prices and profit margins.
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