BZH Valens Credit Analysis – Weak cash flows, limited liquidity levels, and poor market capitalization indicate that credit markets are understating credit risk

• Cash bond markets are materially understating credit risk with a cash bond YTW of 3.744% relative to an Intrinsic YTW of 5.824%, while CDS markets are understating credit risk with a CDS of 240bps relative to an Intrinsic CDS of 379bps. However, Moody’s is accurately stating BZH’s fundamental credit risk with their B3 credit rating, one notch lower than Valens’ HY2 (B2) rating
• Incentives Dictate Behavior™ analysis highlights that management’s compensation framework focuses them on all three value drivers, as well as debt reduction, which should lead to Uniform ROA expansion and increased cash flows available for servicing debt obligations. Furthermore, management members are material holders of BZH equity relative to their average annual compensation, indicating they are likely aligned with shareholders for long-term value creation. Moreover, management members have low change in control compensation, indicating they are not incentivized to seek a buyout or sale of the firm, limiting event risk
• Earnings Call Forensics™ of the firm’s Q3 2017 earnings call (8/1) highlights that management is confident about the sustainability of adjusted EBITDA growth and gross margin expansion, as well as the sustainability of recent pricing improvement
• BZH currently trades near historical highs relative to UAFRS-based (Uniform) Assets, with a 1.1x Uniform P/B. At these levels, the market is pricing in expectations for the firm to experience a dramatic operational turnaround, indicating that downside risk is likely elevated