With the recent plunge of all securities of Yellow Media (TSX: YLO) I have decided to get my feet wet in purchasing a small mixture of the C, D preferreds and some convertible debentures.
Suffice to say, this is not a low risk investment. These securities are trading as if very, very, very bad things are going to be happening to the company, if not outright bankruptcy. The winning condition for an investor at these prices is that the company does not declare bankruptcy in the medium term future.
The business story is quite well known. The company is in the throes of a massive reorganization from print to digital and this has created tremendous risk.
The solvency of the company will be tested around the 2013 timeframe, when they face maturities of some of their Medium Term Notes and their credit facility. The upcoming maturities of the Medium Term Notes between 2013 and 2016 are the following (noting the values are as of December 31, 2010 – the company has repurchased some of these notes):
– $130 million of 6.50% Series 9 Notes maturing on July 10, 2013 priced at par, for an initial yield to the noteholders of 6.50% compounded semi-annually
– $125 million of 6.85% Series 8 Notes maturing on December 3, 2013 priced at par, for an initial yield to the noteholders of 6.85% compounded semi-annually
– $297.5 million of 5.71% Series 2 Notes maturing on April 21, 2014 priced at $99.985, for an initial yield to the noteholders of 5.71% compounded semi-annually
– $260 million of 7.3% Series 7 Notes maturing on February 2, 2015 priced at par, for an initial yield to the noteholders of 7.3% compounded semi-annually
– $387.4 million of 5.25% Series 4 Notes maturing on February 15, 2016 priced at $99.571, for an initial yield to the noteholders of 5.31% compounded semi-annually
Yellow Media Inc. has in place a senior unsecured credit facility consisting of:
– a $750 million revolving tranche maturing in February 18, 2013; and
– a $250 million non-revolving tranche maturing in February 18, 2013.
Notably, the credit facility has a covenant of a minimum ratio of Latest Twelve Month EBITDA before conversion and rebranding costs to cash interest expense on total debt of 3.5 times. Obviously if the financial performance of the company continues to dwindle they will be compelled to pay this off before the MTN’s. They have $636M outstanding on June 30, 2011 in these facilities.
The difference in capital structure between the preferred series and the convertible debentures is relatively minor – the debentures are $200M of face value (maturing October 2017) which have priority over the preferred shares. The higher price paid for the seniority is reflected in the fact that an investor is likely to continue receiving coupon payments (until if/when the company defaults on its more senior debt).
Finally, with the sale of Trader Corporation and the net proceeds of approximately $700M, the company will have further financial flexibility to maneuver around its credit facility covenants and be in a position to use its cash to repurchase debt. At current prices, such repurchases will be highly yielding – for example, if the company did a dutch auction tender for its convertible debentures at 40 cents a piece, every million dollars tendered would save the company from $162,500 of pre-tax interest payments.
The other trading note is that the PR.C series of shares has a slightly lower coupon than the PR.D series (6.75% vs. 6.9%), but the PR.D has typically traded at or lower than PR.C prices. There may be a liquidity premium as there are more PR.C shares outstanding. In addition, spreads are quite high until the computer algorithms put in very small bid and asks and since other algorithms are hammering the bid this tends to create quite a bit of price gapping. The last trading note is that every fund manager on the planet will be embarrassed to show these securities in their quarterly statements, so the “window dressing effect” will likely mean that they will be jettisoning their securities before the September 30th date (3 days for trade settlement means they will be getting rid of them by early next week). Since there is a lack of liquidity in the preferred series, this has resulted in dramatic price drops.
I anticipate the common shareholders are not going to be too happy when their dividend will get severely cut again and diluted by the preferred share conversions. However, the company will have to take these drastic steps to save itself and to de-leverage. Deleveraging is always a very, very painful process when it is forced.
I highly suspect that an opportune time to catch the falling knife is very close. Stocks are most volatile at their highest and lowest points and this appears to be a low frenzy. Time to get my hands bloody.
Have you modeled their cash flows to 2013-2014 and see how they will cope with the maturities?
I have done quick calculations and if you assume they can refinance 50% of their 2013 maturities they will be ok. another assumption in my model is a 15% annual decline, may be too optimistic given their decline in the last few quarters, in their cash from the annualized level of $398 mil. any cash flow declines bigger than 35% and they will be in trouble by 2013.
I think going long pref A and B is good strategy.
I just need to get comfortable with their accounting policies and see if there is no funny numbers before buying into it. Have you looked at it?
I think C and D likely to be safe from conversion and I bet they will still get dividend. The company account from them as equity and in their covenants they are treated as equity so conversion will not accomplish anything for the company. Most likely that A and B along with the debenture gets converted to equity by March 2012 and common dividend will be zero, that is management will relent its stubbornness on their dividend policy.
another question, why the investment in the debenture? you are not getting any protection or safety as opposed to the preferred? well may be in the case of dividend cut you will still get coupon. however, you are most assured that the Debenture will be converted to equity while pref C and D will not. and in the worst case scenario both will get nothing in bankruptcy.
Assuming their credit facility goes to zero, there is an assumption they would have to roll over some of their debt. There of course is risk involved. I have done a model but am not sharing details, probably because somebody can identify more holes in it than a block of Swiss cheese.
Your understanding of the conversion features between the Pref A/B and C/D series is not correct and will lead to false conclusions. The two groups (A/B and C/D) have significant differences. Likewise for the debentures.
Are there secured lenders? Secured lenders can take a company to court to hasten bankruptcy proceedings.
The Medium Term Notes and credit facility are secured. The rest of them are not, but the convertible debentures are senior so if YLO does not pay interest and principal on them, holders can force a default.
Ha-ha, big announcement on the news reel this morning. Only the common share dividend was cut.
In view of the recent developments have you changed your mind? Any thoughts on the 2013 bonds?
I did say high risk, did I?
“Upon the downgrade of its credit ratings announced on August 4, 2011, Yellow Media became subject to a restriction contained in its credit agreement that limits the aggregate amount of excess cash that can be paid as dividends and for the repurchase of securities during any trailing 12-month period. As part of the amendments, Yellow Media is receiving a waiver of this distribution restriction in respect of the prior 12-month period.”
This may include preferred shares. Need to read documents.
This is why you never put large fractions of your net worth in these types of very risky issues – as the post says, if you play with falling knives, you get your hands bloodied just as I have!