Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Exchange Proposal – Analysis

Dundee Corporation (TSX: DC.A) has a preferred share series, Series 4, which trades as TSX: DC.PR.C. The salient features of the preferred share is a par value of $17.84, a 5% coupon, and a shareholder retraction feature which enables the shareholder to put the shares back to the company at par on or after June 30, 2016. The company has the right to redeem the preferred shares at $17.84 in cash or 95% of the market value of DC.A stock, or $2/share, whichever is higher.

I was going to wait for the management information circular to be released before definitively writing about this proposal, but my impatience got the better of me (in addition to me no longer being a preferred shareholder, which tells you what I think of the arrangement). James Hymas has written twice about this one (Link 1, Link 2) and his conclusion the was the same as mine when I read the arrangement: we both don’t like it.

Dundee announced they wish to change the terms of the preferred shares per the attached proposal as they do not wish to allocate what would functionally be a CAD$107.4 million cash outlay, puttable at any time by the preferred shareholders. The special meeting will be held on January 7, 2016 with the record date at December 3, 2015 (so shares purchased until November 30, 2015 are able to conduct business at the meeting with the typical 3 day settlement period).

Details of proposal

(ranked in my order from most important to least important)

1. Shareholder “put option” can only be exercised on June 30, 2019 (from the present date of June 30, 2016);
2. A consent payment for an early “yes” vote of $0.223 (one quarterly dividend coupon payment) and $0.1784 for the broker holding the shares!
3. Coupon goes from 5% to 6%;
4. Company will have redemption features above par (and at par at June 30, 2019) that realistically will not be triggered;
5. A “reverse split” at a ratio of 17.84/25 to adjust the par value of the preferred shares to $25/share making the math a little simpler;

The required vote is 2/3rds of the voting shareholders.

Analysis

Dundee Corporation is controlled by the Goodman family in a typical dual-class share structure. The corporation is a quasi-holding structure, with entities that are consolidated on the financial statements and some that are accounted for with the equity method. Thus, reading the income statement of the consolidated entity is not a terribly fruitful activity until one looks at the components. Most of the significant components are losing money. Considering that there are some heavy investments in oil and gas, and mining, this is to be expected. The best income-producing asset is the spun-off Dream Unlimited (TSX: DRM) which is a real estate development company. The take-home message is that the corporation as a whole is bleeding cash – about $25 million a quarter in 2015 to date.

Their balance sheet is not in terrible condition, but it is deteriorating – At Q3-2015 they reported $274 million in consolidated cash in addition to having a $250 million credit facility (with $93 million drawn) that expires in November 2016. However, most of the other assets are related to their heavy investments in the resource industry, which already received an impairment charge in Q3-2015, and likely to be impaired further.

So while it is very evident that Dundee will be able to pay their CAD$107 million preferred share liability when it is available to be redeemed on June 30, 2016 and beyond, the clause to extend the redemption date from June 30, 2016 to June 30, 2019 involves a pricing of significant credit risk over the incremental three year period, hence this deal being very unattractive for preferred shareholders – it is not entirely clear that the company will have any cash left to redeem the shares! The company does have the option to redeem the preferred shares in common shares of Dundee, but at this point the common shares might be worth under the CAD$2 threshold which is the minimum conversion rate.

Finally, the market does have valuation information on the other preferred share series trading – DC.PR.B and DC.PR.D – currently giving a 9% yield with no redemption possibilities – and this would suggest that the proposal of DC.PR.C, assuming a moderate “redemption” premium (i.e. with the shareholders receiving their money back in 3.6 years), would result in such shares trading at a minimum of 92 cents on the dollar, or roughly CAD$16.41 equivalent on today’s preferred share price (roughly a 4% price reduction on today’s CAD$17.00 trading price!). This assumes that there is equal “credit risk” with non-payment of dividends between now and the redemption date and no risk of receiving a lessened payment in 3.6 years – hence, 92 cents on the dollar would be a maximum valuation at present given market conditions.

Thus, the consent payment would need to be significantly higher than $0.223/share for preferred shareholders to be compensated for the extra three years of “holding risk” they are taking – my minimum estimate would be about $1.43/share for this to even be considered on par value, or $0.60/share when considering the existing market price of CAD$17. Taking the mid-point of this would be a $1/share consent payment. I would suggest that $0.60/share cash plus another $0.40/share in common stock be given for such a deal to be accepted. I’d love to see how the “fairness opinion” rationalizes this original deal being fair for shareholders – maybe fair for the company paying for the report!

Ethics

What is unusual about this proposal is that the intermediary (i.e. in most people’s cases, the broker that holds the shares) receives $0.1784/share that is tendered in favour of the deal. This clearly will create a conflict of interest between brokers and their clients. Ironically if that extra $0.1784 were applied to the beneficial shareholder, the proposal might have stood a higher chance of passing.

These tactics are clearly anti-shareholder and a huge red flag against management that would propose such a scheme.

Conclusion

My recommendation is that DC.PR.C preferred shareholders reject the proposal. It needs to be sweetened further.

I did sell all my shares between CAD$17.20 to CAD$17.44 on the open market last week and am happy to be rid of this headache.

30 thoughts on “Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Exchange Proposal – Analysis”

  1. I did the same on the same rationale although it is possible the preferred shareholders will get a bump in consideration here much like they did when DC.A spun off DRM a few years ago.

  2. The management information circular is out today. Contains little new information. The reasons for the fairness opinion, suffice to say, were quite lacking in any quantitative rigour.

    I can’t envision who could possibly vote in favour of this other than conflicted brokers telling their clients that their shares are being voted for them.

  3. Horizon Kinetics (an institutional investor that previously had 13% of DC.A shares) filed that they now own 10.05% of shares (i.e. they sold 900,000 shares since they last filed a disclosure).

    DC.A is now at around CAD$5.60/share, down about 40% YTD. At the rate they’re going through cash, I can see why.

  4. DC.PR.C continues to trade lower – at around $16.25 now. Maybe somebody read the analysis on this site!

  5. Looks like that trade has already been exploited to the maximum by other smart people. No borrow on DC.PR.B. There’s 50k available on DC.PR.C!

  6. Assuming Dundee is successful with this extension, there is a pretty good case for long DC.PR.D vs short DC.PR.C over the next 3.5 years. There is a huge pick up in dividend and a big win if bankruptcy or if normalization in credit risk.

    The DC.PR.D could also just trade in line with the DC.PR.B all else being equal on the interconvertibility at that point.

    Even with the additional consent payment, the DC.PR.C is still implying trading at 90 cents on the dollar vs DC.PR.D at 40 cents and DC.PR.B at 60 cents.

  7. Sometimes you get lucky with market timing and this was one of those cases. DC.PR.C is down to $15/share.

    I wouldn’t ever play long/short pair with this simply because being able to reliably keep a borrow for a length of time necessary to see the returns come to fruition would be impossible.

    My guess is that the market is ratcheting down DC.PR.C under the assumption the vote passes (which would logically take them significantly below par value).

    If the vote gets rejected, it is quite possible the DC.PR.C owners are going to get quite a large slab of DC.A shares – right now a conversion would issue 21.3 million shares over the existing 58.6 million (Class A and B combined) and quite probably the actual amount would increase as the share price would decline as a result of an equity conversion announcement. Maximum dilution would be 48% (at a $2 conversion rate).

  8. I agree on the long/short because of the borrow.

    I really don’t think they would pay with common stock if there is a no vote. Management does own a lot of stock and they do think their NAV is north of the current book value (~$17) so for them to issue stock when they have liquidity seems unlikely.

    More likely they end up increasing the coupon or providing a bigger consent fee to get support.

  9. Given what the market’s currently saying, that consent payment is going to have to be a lot higher or that coupon is going to have to go sky-high!

  10. It will be interesting to see how the brokers react, after all, they will make as much money buying other shares for their clients portfolios, if they get fresh money to reinvest following redemption, than they will make with this consent fee. If I were an advisor, I would wait the 6 months and avoid having to explain why these babies dropped by 30 percent… When you can get brand new pref from Royal bank paying 5.5 pc , why bother trying to sell your client on a 6 pc from Dundee….

  11. If I were the advisor and actually acting on the best interests of the client, I would have sold the shares. I can’t see any scenario where somebody would want to have held the shares when the offer was made ($17 to 17.40-ish market value), precisely for the point you made – there are a ton of other income-bearing investments out there that involve a ton less risk for the same reward.

    RY’s last pref offering is a 5yr rate reset, at +453bps over 5yr bond rates, with a 5.5% coupon for the first five years. And if RY stops paying their dividends, I hope you’ve got some guns and ammo…

  12. I’m just shocked how the banks are coming out with prefers with coupon of 5.5+ and reset 450+ bps …….

    Makes me wonder if skeleton is coming out of the closet soon

  13. On selling the DC.PR.C for clients, while we could do it (likely owning less than 10k shares) at those prices, if you owned say 300k shares across your client accounts, you probably couldn’t and might be better off holding on to all your client shares and voting against the proposal. You might even want to buy more to increase the chances the exchange offer fails!

  14. The last day to do transactions where your shares could be voted was November 30.

    If one assumes that the vote fails and that DC management is not going to convert to common shares, at a purchase price of CAD$15 you’d be looking at a 19% capital gain over half a year’s time.

    Looking at the volume traded, I also agree unloading 300k shares would not be easy. There were some non-trivial bids with size (there were 10k bids out there at times) during the month of November and the first week in December before that just evaporated (almost coincidental with the posting of my analysis!).

  15. They have not filed that news release with SEDAR.

    I think they are starting to realize what trouble they are in. With their common share chart looking like a ski slope, I bet you others have sensed that if they can’t cough up CAD$107 million for a well-known upcoming liability, what makes shareholders think they will be able to pay for the rest of their cash-burning businesses?

  16. Shares down to $13.30 or 75% of par value. Wow! Dundee Common is down to $4.50/share as well. Talk about shareholder disgust demonstrated in the open market.

  17. The news release this AM suggests Dundee is going to sweeten the offer. It also suggests the proposal is in serious danger of not getting enough positive votes. So….why did the C shares drop so far today? I would have thought this was good news.

  18. I wonder if there was a prevailing feeling amongst the C holders prior to today that the extension vote was not going to pass. So when Dundee indicated this AM that they are open to improving the terms, the C shares sold off on the assumption/fear that the extension is now much more likely to pass?

  19. Obviously, each scenario is different. But it looks like they don’t have the votes and may have to sweeten it a lot. A simple extension didn’t get the vote passed for IBI Group / Boyuan’s debentures. Given how the thing got slaughtered, I can even see some who voted yes has second thoughts.

    Question is, at the current price, does the risk-reward ratio justify a gamble on a NO vote to bet on a substantially sweetened offer or withdrawal of the offer (in 2nd case, you can ask for your money back at par)?

  20. There is a substantial amount of game theory going on here, involving the following variables:

    1. Will there be enough (2/3rds of voters) voting to support the deal?
    2. If not, is it close enough that there is an inducement to get it over the 2/3rds threshold?
    3. If not, will the corporation bite the bullet and do an equity conversion, or will they sit and wait until June 30th and see what happens over the next 6 months if there are more favourable circumstances (or heaven forbid, things get worse)?

  21. Given the level of fear in the preferreds right now, I suspect that Dundee would have to improve the terms to such a degree that they will decide not to bother and just pay it off in cash in 2016 as originally planned. They have plenty of liquidity to accomplish this. They won’t pay in shares.

    I think the fear of financial ruin at Dundee is a bit ridiculous. They have $90 Million of corporate debt at the parent company level, and almost as much cash. So the only net debt is the three preferred share issues, with a face value of about $220 million. Half of that is in the B and D shares that have no fixed maturity date, so will cause no financial stress to Dundee. The remaining preferred is the C with a face value of $108 million. Backing this is about $1.2 billion in investments much of which is liquid and publicly traded. The idea that they are “bleeding cash” is also way overblown. The great majority of the losses that Dundee has suffered in the past couple years has been from asset writedowns due to falling values in the resource sector. These are real value declines but they do not draw cash from the parent company. Dundee has six operating subsidiaries whose cash losses they are responsible for. Of these the current loss is about $19 million per quarter as I calculate it. Not good but not a catastrophe for a company with $1.2 billion in asset value. The company is working to reverse these and has been making progress.

  22. Rod, you will like this.

    Dundee corp common is up about 30% this year (yes that’s over the last two days). It might have something to do with the vote on Thursday but also there is some chatter on one of their private portfolio positions, TauRx.

    Here is the link:

    http://www.wsj.com/articles/singapore-developer-of-alzheimers-drug-plans-u-s-ipo-1451543494

    Dundee owns 5% as of September 30 and values the position at $68m CAD.

    I find it interesting that the common is up so much but the prefs have hardly moved in comparison, especially the DC.PR.D.

  23. It looks like the move in Dundee must be related to TauRX. I happen to think there was already a lot of value in Dundee. The prospects for a large increase in value of TauRX is just extra.

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