The endgame for Pinetree Capital

Long-time readers will know of my investment in Pinetree Capital Debentures (TSX: PNP.DB) and the various amounts of volumes written on this company in the past, probably more than anywhere else on the internet and if I may modestly say so, in higher quality.

The debentures caught my eyes when the underlying company blew their debt-to-assets covenants and while having questionable asset quality, they still had enough blood that could be squeezed from the stone which would flow through to the bondholders.

So far this has been the case – purchasing my 70 cent stones has yielded one dollar blood droplets, plus a generous annual coupon of 10%. In addition, security is granted on all assets of the company, so even if things went wrong, there was a first-in-line claim to picking what was left of the carcass.

By virtue of going from $54 million in debt to about $10 million presently, I’ve had over 80% of my initial position redeemed in cold, hard cash. There’s a bit of residual that I continue to hold. I had an order set to liquidate the position above par, but I am content on riding it until maturity (or CCAA proceedings, whatever the case may be!).

This brings me to my latest post on the company, which is subsequent to their third quarter release. The information contained in the news release is relatively useless for analysis purposes, but their financial statements on SEDAR are much more relevant and I will quote some of the material.

First of all, they were in breach of their covenants and failed to cure them and were under forbearance with a committee of debtholders. This has now passed and the company’s debt-to-assets ratio is once again under 33% (it is approximately 28% as of the end of October). As a result, the debtholders no longer have any direct control of the company’s operations.

What will follow is a simple mathematical exercise in terms of the cash requirements of the company vs. their capacity to actually pay it.

The company still has about $9.8 million in secured debt to pay off, which matures on May 31, 2016. They have an approximate $0.5 million coupon to pay off on November 30 and assuming no further maturities, another $0.5 million in May 2016.

They are sub-leasing their offices and paid somebody $1.55 million so they could get rid of their lease. $1 million is to be paid in Q4-2015, and the remainder on February 1, 2016. They pay about $0.6 million/year for their lease so they gave somebody a 2.5 year inducement on a lease contract that expires on December 2023. They vacate their office effective February 1, 2016. It is not known where they will be moving to, but one can reasonably expect that Pinetree Capital can be run out of a lawyer’s office in the near future instead of a 9,928 square foot behemoth employing less than 10 people.

The company’s burn rate otherwise is $0.8 million/quarter, so operationally they will spend about another $2 million, plus likely professional fees if they are going to do anything financially sophisticated (like liquidating their tax losses!).

So their total cash requirements to May 2016 is likely to be around the $14 to $15 million range – $10.8 million for debenture principal and interest payments, and the rest of it the usual G&A and professional expenses that all publicly traded companies must incur.

In terms of their ability to pay, they had $2.3 million cash on the balance sheet at September 30, 2015. We know they redeemed $5 million in debentures (plus $0.2 million interest) in October, so this functionally put them at a negative $2.9 million balance.

Level 1 assets included $14.2 million in equities – likely consisting of PTK, APS and AAO equities. They do have a minor amount of PRK and LAT, but disposal of these equities will prove to be difficult given the lack of liquidity.

Let’s pretend they liquidated enough Level 1 assets to pay the $2.9 million residual (or they were actually successful in liquidating some of their Level 3 assets, which would be a minor accomplishment). This leaves them with $11.3 million in Level 1 assets remaining to bridge a $14-15 million expense requirement over the next 7 months.

In other words, even if they were to get perfect liquidity on their Level 1 assets the next half year, they still are going to be short on cash.

The remaining assets are Level 3 assets, which total $24 million. However, most of these assets are private investments and hints of what these are can be dredged through previous press releases. SViral was a $5 million investment that nothing could be heard of over the past year in terms of that company’s operations (indeed if any exist at all).

Keek was a slightly more transparent case as it is publicly traded. Pinetree had invested $3 million in their secured notes and they cut a deal to sell them for an undisclosed amount of money. Did Pinetree receive 100 cents on the dollar? Or did they take a slab of equity that they can’t possibly choke through the marketplace?

Due to management not disclosing any information at all about Pinetree’s investment portfolio, one can only guess what else is in there. However, as the year-end audit comes closer, the auditors will have to determine whether management performed a proper test for asset impairment (IAS 36 for those in the accounting world reading this – I am an accountant, after all!) – i.e. is the book value as stated on Pinetree’s books actually what the fair value of those assets are? I would find it very difficult to believe that a $5 million equity investment in SViral is still worth $5 million presently.

My gut instinct says the real value of this Level 3 portfolio is worth about 25% of what management says it is, but without any real disclosure of the components, who knows?

One thing I do know, however, is that management has a huge incentive to ensuring that reported value is kept as high as possible, because they don’t want their assets to fall to the point where the debt-to-assets covenant (33%) gets breached again! My calculations show if they had to impair $6 million of their $24 million in Level 3 assets (without any offsetting gains in their remaining Level 1 asset investment portfolio), they’d once again breach the debenture covenant and have to go through the charade of curing the default.

There are a couple other options for Pinetree and both of these have been discussed before.

One is that in their indenture agreement they are allowed to redeem up to 1/3rd of the debentures in the form of Pinetree equity. The equity redemption of the remaining debentures would dilute existing shareholders by a significant fraction at current market prices (6 cents per share).

Another solution is a monetization of the capital losses the company has incurred to date in a financial transaction. Pinetree has had the dubious distinction of losing half a billion dollars in its investments over the past few years and these tax losses can theoretically be monetized by some sort of recapitalization transaction. Using a theoretical capital gains tax rate of 13% and a willing partner buying the tax credits at 40 cents on the dollar would suggest there’s about $20-25 million left to be harvested here after legal expenses. This is really the only reason why I’m holding onto the secured debt.

Either way, management is still going to be financially creative to get their debt albatross off their backs. It still does not look good in any manner for the equity holders and the debtholders will actually face some risk in terms of getting paid their due in cold, hard cash.

Disclosure: Still holding onto some of those debentures!

7 thoughts on “The endgame for Pinetree Capital”

  1. I’m curious if you guys have looked at DGI.DB.A? The company just announced a redemption of 75% of the debentures for stock (the remaining 25% of debs will remain outstanding) and they trade at 43 with pro forma leverage not looking awful. Unfortunately, its not a great business and there is probably no borrow available on the common.

    I also own some of the TPH debentures. I feel a bit better with Morguard at 30%+ of the equity and the recent rights issue getting done.

  2. Thanks for that PDF link Sacha….for the life of me I cannot find the path to it on the TMX website….where is the “debt instruments” link found?
    I like WEQ.db and WEQ.db.c… is the link to there latest Q3 report conference call…definitely worth 30 minutes of your time.

    I also have TPH debentures as Safety mentions above….Morguard has been picking them up for quite a while, info available at Canadian Insider. TPH.db.C 8% yield, is trading at around 95 and matures 12/16, IMO relatively safe, yielding 13% at maturity.

  3. DGI as you pointed out is not a great business – even after they have “retired” $32 million in their convertibles in exchange for nearly all the equity in the company, they still have an undesirable debt situation – i.e. $44 million ahead in a credit facility that will be re-negotiated sometime in 2016 with the appropriate covenants, coupled with their marginal profitability (although it is profitable, they’ve done a reasonable amount of cost-cutting).

    I wonder why they just didn’t rip off the entire band-aid and redeem the whole slab of convertibles and get it over with. Maybe they just want to punish shareholders again with another equity redemption?

    I don’t see TPH debentures as compelling at existing prices. I’ve reviewed the company in the past and while the rights offering and the control equity stake are a reasonable sign that the corporation won’t go belly up (yet), I’m not comfortable with them.

    WEQ debentures I’ve had in the past, but I’ve divested them some time ago.

  4. On DGI, my understanding is they are apparently far along in talks to replace the credit facility with an asset based lending facility and a term loan and the partial redemption of the converts was something all parties they negotiated with demanded. It’s a potentially a high risk, high reward situation if $20-25m in EBITDA and a 4x multiple can be achieved in 2016. As for why they didn’t rip off the whole band-aid it could be based on who owns the debs and what they wanted. They will control the equity after a 75% or 100% redemption.

    On TPH, you have some protection I think with covenant on the TPH.DB.F which constrains the debt some what as a percentage of the appraised value of the properties. At the very least the value is better than what it was before the rights issue and before Morguard’s involvement.

  5. On DGI, I highly doubt they can keep the $20 mill EBITDA as they don’t seem to have a strategy on growing revenue. Don’t expect a good multiple on a declining business, Yellow still languish in the teens. Refinance the debt should not be an issue with 75% of the conv. debt going off the books.

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