Pinetree Capital Debentures – Buying a dollar for 80 cents

The ongoing saga of Pinetree Capital (TSX: PNP) continues.

After coming to an agreement (after what functionally amounted to a financial game of chicken when management “blinked”) with over 2/3rds of the debenture holders in a very private setting, management has been ousted, and a new agreement has been put in place that grants debt holders security over the assets of the entire company.

There is also a provision to repurchase debentures as follows:

On or prior to July 31, 2015, the Company shall reduce the aggregate principal amount of the outstanding Debentures by at least $20,000,000 by redeeming outstanding Debentures and, at the Company’s discretion, repurchasing outstanding Debentures up to a maximum principal amount of $5,000,000 pursuant to a normal course issuer bid.

There will likely be some market action in the upcoming months as the company attempts to repurchase its debt. Of course by doing so the price will get closer to par value. There is also a redemption to equity feature which has been opened by the debtholders, as the following language was inserted into the indenture agreement:

The Initial Debentures will be redeemable prior to the Maturity Date in accordance with the terms of Article 4, at the option of the Company, in whole or in part from time to time, on notice as provided for in Section 4.3 for the Redemption Price. The Redemption Notice for the Initial Debentures shall be substantially in the form of Schedule B. In connection with the redemption of the Initial Debentures, the Company may, at its option, and subject to the provisions of Section 4.6 and subject to regulatory approval, elect to satisfy its obligation to pay up to one-third of the aggregate principal amount of the Initial Debentures to be redeemed by issuing and delivering to the holders of such Initial Debentures, such number of Freely Tradeable Common Shares as is obtained by dividing such amount by 95% of the Current Market Price in effect on the Redemption Date. If the Company

The company will have the choice of either paying out the debtholders in cash, or by issuing equity, or a combination of both up to a one-third allocation of equity, depending on what the market price is.

Management will be compelled to dispose of securities from the newly constructed investment committee, which consists of two directors that were nominated by the debenture consortium:

The Company shall adhere to the decisions of the Investment Oversight Committee, except in cases where the Company’s board of directors has overruled a decision of the Investment Oversight Committee. For greater certainty, the Investment Oversight Committee has the power to override a decision of the Company’s management to purchase or dispose of any securities and to make a binding decision to dispose of any security now held or that may be held by the Company in the future, provided that such decisions are subject to the approval of the board of directors of the Company.

In addition to having a net asset value above the market value, in addition to an anticipation of an equity conversion, the equity of Pinetree has risen. It will likely rise to a point that reflects a modest discount to NAV, and the company is required to disclose its audited financial statements by the end of March.

Pinetree’s two largest holdings, Sphere3D (Nasdaq: ANY), and POET Technologies (TSXV: PTK), have done quite well and will likely provide cash for paying off debtholders.

Finally, lest the company gets its balance sheet out of position, it is required to have a debt-to-assets ratio of 50% up until October 31, 2015 and then afterwards it will go down to 33% as per the original covenant. This will assure the debtholders will be in the driving seat until they are paid off in full. If the company defaults on these provisions, the debtholders will set terms of forbearance and will likely be in a position to be paid off no matter what, as at this point there will only be $35 million outstanding and being first in line to collect.

The conclusion is obvious: barring a collapse in Pinetree’s (admitting they are less than AAA quality) holdings, the original thesis as presented holds true. Debtholders will very likely get the chance to get out at par and collect a very happy 10% coupon in the meantime. The fact that debtholders now have a general pledge of asset security over the entire company is icing on the cake – it does not give Pinetree any maneuvering room until they are paid off first (i.e. by pillaging debtholders by putting somebody ahead of line with them – see Armtech Infrastructure for the end of that sad saga).

I will discount the fraud scenario as it is perfectly obvious by the February 19, 2015 SEDAR disclosures that debentureholders got a very good look at the corporation as they made their negotiations. I would expect the audited financial statements to be published in mid-month. The only accounting decision of any substance would likely involve a valuation allowance offsetting their currently existing tax asset of $13 million (this would have an impact on their NAV, but this can get unlocked in some other transaction of substance).

The maturity date for the debentures are May 31, 2016, but effectively debtholders will know the game is over by October 31, 2015 and the market will treat the debt at that time as more or less being a done deal (i.e. at least 95 cents on the dollar, if not more for the 10% interest accrual).

With the conservative assumption that debtholders will get 95 cents on the dollar, it looks like from existing market prices (roughly 80 cents), an investor will achieve a 20% capital gain and another 10% interest coupon between now and whenever they get cashed out. I’ll call that a 30% reward for little risk at this stage of the game.

It is really a sad story for me as I cannot think of any other place where capital could be allocated for such a good risk/reward situation. I am riding the coattails of some financial institutions that have their vested interests in total alignment with mine – i.e. taking the reins of the underlying company to ensure we are paid back. Backing up this claim is the following clause inserted into the indenture:

The Initial Debentures are direct secured obligations of the Company, and rank senior to all other indebtedness for borrowed money of the Company. In accordance with Section 2.12, the Initial Debentures rank pari passu with each other. Notwithstanding anything else to the contrary in this Indenture, no additional Initial Debentures and no additional series of Debentures shall be issued under this Indenture or under indentures supplemental to this Indenture.

I have little opinion on the equity other than that it should trade a shade below net asset value, plus some amount for the implied value of the future capital loss carryforwards for an inspiring acquirer of Pinetree. Unlike Aberdeen International (TSX: AAB), new management at least has the ability to show they pretend to care about shareholders instead of using the publicly traded vehicle as a personal enrichment device.

This might be my last post on Pinetree Capital as the story appears to have come to a close, but “never say never” in these very strange and weird capital markets we live with.

Disclosure – Long on a non-trivial position of Pinetree Capital debentures.