Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Amended Exchange Offer

You can read my previous analysis piece on the original exchange offer here.

Dundee Corporation has announced a revision to the exchange offer. This offer would have never been made if there were sufficient votes to accept the original exchange offer (2/3rds of votes required).

The management information circular has not been posted yet, but James Hymas beat me to the punch to providing some of his always excellent analysis on anything relating to preferred shares.

My own quick summary is: the deal stinks less compared to the original offer, but it still stinks.

The revised terms of the amended offer compared to the original exchange offer include:

– The removal of the $0.223/share consent payment for shareholders voting yes to the proposal before a specified date.
– The ability to redeem 15% of the issue on June 30, 2016 and a further 17% of the then-issue (i.e. another 14.45% of original issue size) on June 30, 2018January 31, 2018;
– An increase of the dividend rate from 6% to 7.5%;
– Granting of 0.25 warrants to buy DC.A stock with a strike price of CAD$6.00 with an exercise price of June 30, 2019 (which will be listed on the TSX).

Closing Market Prices for Reference

DC.A: $5.95/share (no dividend)
DC.PR.B: $12.00/share (11.9% yield)
DC.PR.C: $14.43/share (6.2% yield)
DC.PR.D: $9.50/share (11.8% yield)

Analysis

The meeting date has been postponed to January 28, 2016, but shareholders of record on December 3, 2015 (per the original exchange offer) will have a vote on the matter. They chose to keep the original record date – a revised record date would include shareholders that were more willing to buy into the terms of a sweetened exchange offer.

By far and away the most important provision is the removal of the $0.223/share consent payment. This consent payment introduced the concept of a prisoner’s dilemma where if you believe the deal was going to pass, you would be incentivized to vote in favour of the deal despite how bad it was.

Without a prisoner’s dilemma, there is no incentive to voting yes for a marginal or mildly adverse offering (which was the only way the previous offering had any chance of passing).

This deal still stinks, but the removal of the $0.223/share carrot will remove votes in favour because (and this is my personal speculation) most of the shareholders are angling for the June 30, 2016 redemption.

So now, shareholders can vote against the proposal and face no “punishment” of having missed out on a consent payment.

Notably the consent payment for the intermediaries is still in effect – brokers will receive $0.1784/share for each vote in favour received by January 21, 2016 and $0.0892 by January 26; so if you are indeed in favour of this bad deal, it would be in your best interest to vote your shares at the actual meeting so the company doesn’t have to pay out consent payments to third parties!

The ability to redeem 15% of the shares on the original June 30, 2016 redemption date is “nice”, but not of material economic consequence. The subsequent tranche (14.45% of the original offering size) on June 30, 2018January 31, 2018 is long-dated enough that credit risk considerations come into play (for instance, the company’s credit facility would have to be renegotiated at this point and you would expect their subsidiaries would actually start making money at this point).

The increase of the dividend rate to 7.5% reflects the very weak trading performances of the other two preferred share issues (yielding nearly 12% at current prices). James Hymas has done a much better job than I could explaining the quantitative details of this component. Credit risk, especially by redemption time, becomes a huge factor in properly determining the course of action for this exchange offer. Dundee is good for a June 30, 2016 redemption through the unused portion of their credit facility. After this, who knows?

I will attempt to ballpark a valuation of the warrants. The company stated the warrants would be listed on the TSX if the exchange offer is accepted and this would give preferred shareholders a venue to liquidate for immediate cash proceeds. While the historical volatility of Dundee common shares as of the past 30 days has been around 80%, their at-the-money options currently trade at an implied volatility of 42%. Using Black-Scholes valuation (which is not the best way to value long-dated options, but is good enough for paper napkin purposes such as this post) we get an option value of $1.84/share, or about 46 cents per preferred share (as each share would receive a quarter warrant).

Using some more formal methods involves different results – if you are that bullish on Dundee’s common stock, why bother playing around with the preferred shares when you can simply buy the common shares or even the other preferred shares?

Doing some simple sensitivity analysis, if Dundee traded to $8 (25% higher) between now and the January 28, 2016 special meeting, the implied value of the warrants per preferred share would be approximately 83 cents (50 cents intrinsic value and 33 cents time value), assuming implied volatility doesn’t drop (in reality – it would slightly). 83 cents does not come close to mitigating the capital losses that have occurred between the initial offering (when shares were trading at CAD$17) and when the exchange offer was proposed. Right now preferred shareholders are sitting on a $2.60 drop in market value and this exchange offer will come nowhere close to compensating them even with the increased coupon and partial early redemption rights.

I also find this statement to be amusing:

The determination of the Board of Directors is based on various factors, including a fairness opinion prepared by GMP.

Apparently the original exchange offer was fair, but the amended one is as well! Is there any offer that wouldn’t be considered fair by GMP?

Conclusion

Preferred shareholders have an even easier decision this time around – vote against the offer. It is still terrible compared to the existing Series 4 preferred shares.

As I have disclosed in my prior post, I sold out my DC.PR.C position between $17.20-$17.44/share in late November/early December. I’m a spectator at this point.

Update January 9, 2016: The initial part of this post had the second redemption date as June 30, 2018 when it should be January 31, 2018. The above has been corrected and the 5 month difference does not materially change the above analysis.

7 thoughts on “Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Amended Exchange Offer”

  1. A bit surprised at the terms of this new offer. Given how it seems people are angling for the retraction.

    At current prices though, I think it is a decent gamble, you have a $3.4 upside if the vote failed vs a similar price drop if this thing passed (0.075 / 0.119 * 17.84 = 11.15 – back of the napkin math assuming all 3 series should have comparable yield and ignoring the retraction feature).

  2. Market reaction was +15% (to $16.60) which I thought was double what it would do on the opening, but is this because investors are now pricing in the probable rejection of this proposal (and thus being back to square one with a June 30, 2016 redemption?).

    Still quite happy to be out regardless.

  3. Obviously, there’s a function for folks like Canaccord and GMP – but they are complete failure and absolute waste of $ when it comes to helping the issuer get out of this type of situation (think IBI group). While I couldn’t find the voting details of the IBI group amendment, it looks like it was barely passed with 68.5% of vote (calculated based on % voted – which was 71.2% of all debentures represented at the special meeting and consent fee issued).

    I’m rather surprised that a lot of investor seems to follow what’s going on and do the ‘right thing’.

  4. I enjoyed buying it back at $13 three weeks ago and selling it today. It works out to about a 12% YTM from here which maybe is good enough for some and not others. It should still be voted down (on the merits) but I imagine they got some big holders to agree and it’s possible there is some big cross ownership between DC.PR.C and DC.A so investors might be acting in their best interest to approve.

  5. Wonder if Sacha or anyone here follows shipping companies, I’m looking at Navios Maritime Holding and its various subsidiaries. With debt maturity beyond 2018 and company still generating cash – the perpetual prefers looks like a screaming buy at 16 cents on the dollar.

    Shipping companies got hammered indiscriminately even though tankers rate has been holding up (NM is in dry bulk which is very bad, but even its tanker subsidiaries are getting killed though to a lesser extent)

  6. The shares of DC.PR.C have been trading at 17 with very heavy volume for the last two days. Do you believe it to be an arbitrage play because the market has decided that the new offer will be rejected or that someone is actually buying the thing because he believes the new offer is worth more than 17?

  7. A favourable mention for the Dundee pref’s in Broadview’s annual shareholder letter….

    http://www.broadviewcapital.ca/wp-content/uploads/December-2015.pdf

    Positioning and New Ideas for 2016:

    It is not for lack of trying that we have not materially increased our net exposure of late. We have growing stacks of new files on both our desks. Most definitely there will be wonderful opportunities to make money from recovering stock prices from amongst these piles.
    In a previous letter we mentioned Dundee Corp (DC-A), as an example of the sort of things we were looking at as a way to wade into the stock market wreckage and pull out some treasure. So far we have not bought any stock in Dundee as we have been unable to gain confidence that the value of its book is meaningfully higher than the stock price. Admittedly, we are running it through the wringer using brutally conservative assumptions.

    Our work on the company led us to its balance sheet. The majority of the company’s capital structure, apart from the equity, is preferred shares (or “prefs” as they’re commonly known). This is an asset class of which we have never fully understood the appeal. At the issue price, prefs are inferior to senior debt given the lack of covenants or defined maturity and inferior to equity as you get no real upside. For your trouble you get around 5% or 6% annual return. No thank you.

    Now with Dundee’s preferred shares being cut in half, we completely understand the appeal. These things are great! We are now owners of all three series of Dundee preferred shares (DC.PR.B, DC.PR.C and DC.PR.D) with yields in the double-digits. While our draconian assumptions have left us undecided as to whether or not the equity of Dundee is a bargain, there is no objective scenario under which the prefs are impaired.

    The management of Dundee (or more accurately the previous management) has destroyed a great deal of value through poor investments. We are confident that under its new CEO this era has come to an end and the company will cease pouring capital into far-flung resource ventures. In order for the value of the prefs to be called into question, Dundee would have to re-double its previous efforts at chasing a failed dream across the globe. It is our firm belief that this will not happen.

    We mention this investment(s) to illustrate that a) we are actually doing something even while hidden under a pile of coats and b) investing can follow an unusual path. We started with Dundee’s equity and ended up with the preferred shares as that is where our research took us. Being objective, open- minded and free of investment constraints led us to what we believe will generate a very solid return for our investors. This is not dissimilar to our investments in the distressed convertible debenture space which continues to yield some very compelling opportunities. We think the flexibility we have, both by mandate and by mentality, is a major advantage particularly in more challenging markets.

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