Final Round Hedge Fund Interview Question

Q

quin8670

Hey Guys,

I have a final round interview at a hedge fund coming up and they asked me to make a presentation on NFLX and make a long/short recommendation on the stock and bonds.

I am much more familiar with valuing equities than bonds.

The NFLX bonds are rated BB and mature in 2017 with YTM around 8% and a coupon of 8.5%.

NFLX doesn't have a large amount of tangible assets so for the bonds to be redeemed in 2017 the company must still be in existence for bond holders to get their investment back. Now the company is doing very well but there is still some uncertainty given that the industry is moving towards a pure online streaming model and other competitors will likely try to enter this market (there are already competitors but larger competitors that are very tech savvy with deep pockets could enter). My question is, do most hedge fund high yield bond groups look for an investment like this? I thought most were more interested in distressed debt or in debt where they know the company has assets with real value that will ensure they get their investment back. The yield is fairly attractive assuming the company survives, but the company is just a middle man without a significant amount of tangible assets. Would it be ludicrous for me to make a recommendation saying to neither buy nor sell the bonds?

Also, I'm going to do a quick DCF model (haven't done it yet) just to see how many subscribers and how much rev per subscriber they would need to justify their current valuation (I will do some sensitivity analysis as well). My guess is that my analysis will shows that the stock is grossly overvalued. However, I usually shy away from shorting stocks with good fundamentals. Do you think they are looking for someone to actually make a long/short call as opposed to saying to just avoid it? Are most hedge funds willing to short NFLX? In prior interviews they have said they are a shop that doesn't worry about daily p/l and can take a longer term approach and some heat on some of their positions.

If my analysis shows the stock is overvalued do you think it makes sense for me to give a short recommendation? Just wondering if they are looking for guys to actually make calls as opposed to guys who always find the negatives and risks and don't make many calls.
 
DCF calculations for tech stocks are highly unreliable because of the variation between earnings. If you want to do a DCF model on PG or KO you are going to get some reliable answers because their earnings are predictable.

I would include a variation analysis on their earnings stream and compare it to a similar stock such as perhaps QCOM or SNDK (and go look at those charts and see what happened).

They are a first mover and have a current competitive advantage but it's not an advantage that can be sustained. Tech stocks have a very difficult time protecting their competitive advantage even when a patent exists. Do a bit of research on the situation RMBS has found themselves in. Without going into any deep analysis I would just look at the chart and see a bubble forming. Obviously, the HF wants an in-depth analysis but can the company sustain the move?

I have a feeling the HF is picking NFLX because they want to see if you are going to think outside the box or just fall in line and follow the crowd. I think the best answer you could come up with would be something along the lines of, "Yeah, it was a buy....about a year ago."
 
Quote from quin8670:


If my analysis shows the stock is overvalued do you think it makes sense for me to give a short recommendation? Just wondering if they are looking for guys to actually make calls as opposed to guys who always find the negatives and risks and don't make many calls.
More...

Overvaluation by itself is not sufficient reason to short a stock. And NFLX is not overvalued unless you are darn sure their earnings aren't going to keep growing at a rapid pace.

As for the bonds - it's a poor investment to lend a company like this money at 8%. If you are going to take the risk of a high growth company, generally it's best to do so in the stock so if you are right you make a high return. In the bonds if you are right you make 8%- whoopee do. If you are wrong you lose 50%+.

IMO the best answer here is to say that neither asset is a slam dunk long or short. No position in either of those two assets has a wide margin of safety.
 
you can always buy bond and short equity for a standard capital structure arb play. The hedging ratio is tricky. You can also buy stock and buy CDS protection as an opposite play. This will depend on whether you think bond is more overvalued (against its peers on a LIBOR spread basis) than equity.

Quote from the1:

DCF calculations for tech stocks are highly unreliable because of the variation between earnings. If you want to do a DCF model on PG or KO you are going to get some reliable answers because their earnings are predictable.

I would include a variation analysis on their earnings stream and compare it to a similar stock such as perhaps QCOM or SNDK (and go look at those charts and see what happened).

They are a first mover and have a current competitive advantage but it's not an advantage that can be sustained. Tech stocks have a very difficult time protecting their competitive advantage even when a patent exists. Do a bit of research on the situation RMBS has found themselves in. Without going into any deep analysis I would just look at the chart and see a bubble forming. Obviously, the HF wants an in-depth analysis but can the company sustain the move?

I have a feeling the HF is picking NFLX because they want to see if you are going to think outside the box or just fall in line and follow the crowd. I think the best answer you could come up with would be something along the lines of, "Yeah, it was a buy....about a year ago."
More...
 
Quote from quin8670:


If my analysis shows the stock is overvalued do you think it makes sense for me to give a short recommendation?
More...

I would suggest that your logical and creative reasoning is probably more important your recommendation.

I am not a bond expert, nor a company valuation expert. However, BP 1 year paper just went to 10.5% yield with 6 year BP paper at 6%. Pimco very publicly bought the 10.5% yield, calling this an obvious bet--on a company that has a 40% chance of bankruptcy according to its CDS market.

I am more a statistics guy than a company analyst. If I were in your shoes, I'd look at the options (vol and skew and especially the teeny puts) and the CDS market to see if the world expects NFLX to collapse. If you are a math whiz you could calculate the implied future stock distributions from the options, and a % chance of a bankruptcy from the CDS market and the options. Even if you don't have the modeling skills to calculate market implied %, you should be able to get valuable qualitative data from the comparative implied vols of the 2 delta puts, as well as from the comparative prices of the CDS strip out in time.

If the bond yield is high, and CDS/options prices are low, you could suggest hedging your bond exposure by buying puts or CDS, to lock in a lower risk, yet still high yield return. Another potential would be to suggest buying the convertible bond instead of the regular bond--not sure where you'd find the yields and terms on the converts though.
 
Damn Jerk. Hit the OP up for the name of the HF and get your butt in there and apply for that job :D

Quote from Jerkstore:

I would suggest that your logical and creative reasoning is probably more important your recommendation.

I am not a bond expert, nor a company valuation expert. However, BP 1 year paper just went to 10.5% yield with 6 year BP paper at 6%. Pimco very publicly bought the 10.5% yield, calling this an obvious bet--on a company that has a 40% chance of bankruptcy according to its CDS market.

I am more a statistics guy than a company analyst. If I were in your shoes, I'd look at the options (vol and skew and especially the teeny puts) and the CDS market to see if the world expects NFLX to collapse. If you are a math whiz you could calculate the implied future stock distributions from the options, and a % chance of a bankruptcy from the CDS market and the options. Even if you don't have the modeling skills to calculate market implied %, you should be able to get valuable qualitative data from the comparative implied vols of the 2 delta puts, as well as from the comparative prices of the CDS strip out in time.

If the bond yield is high, and CDS/options prices are low, you could suggest hedging your bond exposure by buying puts or CDS, to lock in a lower risk, yet still high yield return. Another potential would be to suggest buying the convertible bond instead of the regular bond--not sure where you'd find the yields and terms on the converts though.
More...
 
Quote from quin8670:

Hey Guys,

I have a final round interview at a hedge fund coming up and they asked me to make a presentation on NFLX and make a long/short recommendation on the stock and bonds.

I am much more familiar with valuing equities than bonds.

The NFLX bonds are rated BB and mature in 2017 with YTM around 8% and a coupon of 8.5%.

NFLX doesn't have a large amount of tangible assets so for the bonds to be redeemed in 2017 the company must still be in existence for bond holders to get their investment back. Now the company is doing very well but there is still some uncertainty given that the industry is moving towards a pure online streaming model and other competitors will likely try to enter this market (there are already competitors but larger competitors that are very tech savvy with deep pockets could enter). My question is, do most hedge fund high yield bond groups look for an investment like this? I thought most were more interested in distressed debt or in debt where they know the company has assets with real value that will ensure they get their investment back. The yield is fairly attractive assuming the company survives, but the company is just a middle man without a significant amount of tangible assets. Would it be ludicrous for me to make a recommendation saying to neither buy nor sell the bonds?

Also, I'm going to do a quick DCF model (haven't done it yet) just to see how many subscribers and how much rev per subscriber they would need to justify their current valuation (I will do some sensitivity analysis as well). My guess is that my analysis will shows that the stock is grossly overvalued. However, I usually shy away from shorting stocks with good fundamentals. Do you think they are looking for someone to actually make a long/short call as opposed to saying to just avoid it? Are most hedge funds willing to short NFLX? In prior interviews they have said they are a shop that doesn't worry about daily p/l and can take a longer term approach and some heat on some of their positions.

If my analysis shows the stock is overvalued do you think it makes sense for me to give a short recommendation? Just wondering if they are looking for guys to actually make calls as opposed to guys who always find the negatives and risks and don't make many calls.
More...


PE 60 about....yeah, I don't think I'd call you stupid for shorting the stock, and try to buy the bonds with some cds protection. Should be a piece of cake, and straight forward.
 
Thanks for all the input everyone.

You really think buying the bonds with CDS protection is a good play?

I know very little about the CDS market - mainly because the quotes aren't easy to get.

I would think that a play of that nature would be priced fairly efficiently in the market.

I will have to try to find some quotes for prices of the CDS protection.

NFLX only has 200M outstanding in debt, would a sizable CDS market even exist for this?

It would be interesting to see how long the CDS contracts are for: 1 year, 2 years, 5 years, until the debt matures...

Say for example, if a CDS existed that offered protection until the bonds mature in 2017 - any idea how much this protection would cost?
 
its threads like this that make ET a great place.........

anyways, do you know anymore about what type of firm this is? May greatly influence the type of answer you give
 
Good advice up to the point about "neither asset is a slam dunk..."
The want an opinion and if you sit on the fence, they'll toss you out the door.
My 2 cents: any company with no proprietary competitive advantage is not a good investment for the long term. The best they can hope for is being acquired by a bigger company hoping to get in the game fast (a la google).
You said it your self in your first post: there are bigger companies, etc.
All that said, based on info provided, I am short the company, but might buy the bonds in the hope that they will be around in one form or another.

Quote from Ghost of Cutten:

Overvaluation by itself is not sufficient reason to short a stock. And NFLX is not overvalued unless you are darn sure their earnings aren't going to keep growing at a rapid pace. ..
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