KCG Holdings merger arbitrage and should I invest in Virtu?

KCG Holdings (KCG) is due to be bought out by VIRT for $20/share cash. The meeting for KCG shareholders to approve is on July 19 (which at this point is practically a done deal). Over the past two days we had the following trading:

See that spike up to $20/share at the end of yesterday’s trading? I wasn’t expecting that! It is not financially rational to purchase shares at $20 unless if you believe there will be a higher bid for the company. At this point, however, a successor bid is simply not going to be happening.

A more reasonable $19.98/share means a 2 cent premium obtained over a week, which works out to about a 5.2% simple interest rate, assuming no trading costs.

I had some July call options so I figured it was a good time to dump the remainder of my shares into the market. There was a legal complication from one of the class action lawsuits that might require the company to obtain a 2/3rds shareholder vote of all non-insider owned shares and considering the general apathy of voters these days, that is not a threshold that I would want to bet my kidneys over.

Once the merger is completed then KCG’s senior secured bonds will be called away (at 103.7 cents on the dollar, while my purchases were a shade above 90 cents) and that will conclude one of the better investments I’ve made over the past 5 years. It took a lot longer to happen than I anticipated – had it occurred at select points over the past 5 years I had even higher amounts of leveraged option positions on this company (which sadly expired).

One thing I will miss about these bonds is that the 6.875% coupon I was earning was virtually guaranteed money to maturity. I will no longer see that.

The analysis for VIRT is a little more muddy – I expect some serious integration pain to occur after the merger is finished.  In the definitive proxy statement materials, however, I was very intrigued by the following table which illustrated the financial projections of a management restructuring:

So in the above, we had management projecting a 2019 estimated free cash flow of $132 million, which appeared to be sustaining for future years. This worked out to about $2 per KCG share, which VIRT is now purchasing for 10 times earnings.

Management projections are always on the optimistic end of things, so this is not likely to materialize as presented, but it still makes one wonder whether VIRT is worth investing in or not. I do not like their corporate structure (public shareholders have no control over the company and a vast minority of the economic stake of the firm) and I am inclined against it.

Teekay – the buzz from Seeking Alpha

There has been a considerable amount of bandwidth on the future outcome of Teekay and Teekay Offshore on the Seeking Alpha channel.

When you see this much bullishness on a public forum, watch out. The “news” (if you want to call it that) has already been baked in.

There is also a material amount of mis-information in some of the analysis presented on Seeking Alpha, including the J Mintzmyer analysis which got most of the flurry of TK/TOO posting started. There’s no point for me to argue about the fine details of the analysis here.

My original post about Teekay’s 2020 unsecured bonds of April 2016 still applies today – at a current price of 90.5 cents on the dollar they are in the lower part of my price range but not a wildly good buy as there is real risk involved. My initial purchase point was below 70 cents on the dollar back in early 2016. My only update to my April 2016 post is that I have long since offloaded my Teekay Offshore equity position – my optimism back then about TOO was considerably over-stated and when my own modelling changed, my price targets subsequently changed and I bailed out.

TK’s inherent value is primarily focused on their TGP entity (Mintzmyer got this correct, but grossly over-states the value of the company). Most of the discounting of TK unsecured debt’s value is that they are likely to offer guarantees to future TOO and/or TGP financings that would make it difficult for TK unsecured debtholders to realize value in the event of a Chapter 11 equivalent event (this would involve cross-defaults between entities and be incredibly messy to resolve). There is currently cross-default potential with TOO’s debt complex, not to mention that TK has made unsecured loans to TOO to bridge TOO’s liquidity situation. My general expectation is that there is a gigantic incentive for the controlling shareholder (Resolute Investments) to avoid a default scenario and would instead opt for a dilutive recapitalization instead, which would of course render TK unsecured debt maturing at par. I still think this partial recapitalization scenario is probable.

TK and TGP have announced dividends and distributions, respectively. The TK dividend surprised me somewhat as they are obligated to pay dividends by raising an equal amount in equity capital until a certain debt is paid off. TOO has been silent and they will likely be announcing suspensions in conjunction with some financing announcement in the upcoming weeks.

My assessment at present is that the only people that will be coming out of this with money are the debt holders. Such is life when oil is at US$45/barrel.

Q2-2017 Performance Report

Portfolio Performance

My very unaudited portfolio performance in the second quarter of 2017, the three months ended June 30, 2017 is approximately +0.6%. The year-to-date performance for the 6 months ended June 30, 2017 is +19.3%.

My 11 year, 6 month compounded annual growth rate performance is +18.2% per year.

Portfolio Percentages

At June 30, 2017 (change from Q1-2017):

20% common equities (-4%)
28% preferred share equities (+8%)
31% corporate debt (-7%)
4% net equity options (+1%)
18% cash and cash equivalents (+3%)

Percentages may not add to 100% due to rounding.

USD exposure: 52% (+2%)

Portfolio is valued in CAD (CAD/USD 0.7714);
Other values derived per account statements.

Portfolio commentary

All things considered, the nearly flat performance was a good indicator of a relatively boring quarter – there was very little theatrics to discuss. Major portfolio decisions include liquidating my KCG Holdings equity stake, and retaining the equity options until the last possible nanosecond before expiration. I will promptly liquidate the position if the market is acceptably close to the USD$20.00 cash buyout number (or I will just wait for the transaction to proceed). This will result in an effective liquidation of another 4% of the portfolio. I also have another 4% position in their senior secured bonds which will be called out after the transaction completes, which should be around July 21st (after the quarter-end). The net result of these transactions are that the portfolio is effectively 25% cash and I have no idea where to deploy it beyond VGSH (USD) and VSB.TO (CAD) – at least with those I get paid around 125 basis points to wait.

Sadly my entries into the VGSH/VSB.TO short-term fixed income vehicles has been incredibly lacklustre – with continued threats of rising interest rates, even these short duration vehicles are taking a minor hit of capital value – an inexpensive lesson that yield is rarely risk-free.

I took a single digit percent position in a company trading well under tangible book value and earning positive income and cash flows during the quarter. I estimate when the market wakes up to this position (there has been little if any analyst coverage, nor has there been any public exposure to it at all) it will trade up to double its present value. I won’t write about this one until it appreciates or my original investment thesis is incorrect. There is a credible reason why there is still price pressure even at the depressed levels. The company has spent most of its public life trading around 25% higher than what it is trading at right now.

This was my first new common share position in over a year. I’ve been close to pulling the trigger on some other ones but they didn’t quite reach the correct price point.

I also took a non-trivial stake in DRM.PR.A preferred shares. I’ve been in and out of this over the past couple years, but this time I suspect it will be a staple position for quite some time. It only requires 33% margin so it is not too much of an anchor to keep, especially since the spread between the margin rate and the dividend rate is huge. This is effectively a “cash parking” vehicle until they get called away by the parent company (I was expecting this to happen quite some time ago). When it happens I will have the problem of more capital going from a near-guaranteed 7% tax-preferred income to 1%. It is my hope that management continues to ignore this issue (other than paying quarterly dividends). I wouldn’t buy it at the current premium.

That’s about it for the quarter.

In terms of price movements, there were three items which caused negative portfolio movements. Genworth MI took collateral damage with regards to the collapse of Home Capital Group, but has swiftly recovered from reaching a low of about $30.50/share. At that level, Genworth MI was in the low end of my price range, but it wasn’t low enough that I would re-purchase shares. Conversely, it is too cheap to sell at present prices. So I will be waiting and continuing to collect 44 cent quarterly dividends until the market decides that the equity is worth more.

Teekay Corporation unsecured debt also significantly declined to reflect the calamity that is hitting their offshore division, but I do not believe the underlying value of this debt is compromised by virtue of the value of their natural gas division. This was the primary detractor from my portfolio performance this quarter. At a YTM of 13%, investors have a decent risk/reward situation at current prices.

The third detractor to performance was the Canadian dollar – as it appreciates, although I appreciate the purchasing power, it does detract negatively on my US dollar components. Since my portfolio is nearly 50/50 CAD/USD, each percent the Canadian dollar rises means a half percent drop in my portfolio value.

Finally, Gran Colombia Gold announced they will be redeeming 5.7% of their 2020 senior secured debt outstanding at par. I will be pocketing the cash and looking forward to future payments – this series of debt is first in line, secured by a gold mine and an investor can be patient to collect on the debt. Although I do not have a place to deploy the cash, I look forward to receiving the payment and reducing my concentration in this particular debt issuer (I purchased most of the senior secured debt at around 55-60 cents on the dollar). The two relevant risks here are the political stability in Colombia (which is not bad at present) and the price of gold continuing to meander at its present level – or go higher. 75% of the free cash flows from the company have to go towards redeeming the senior secured debt due in 2020, so over time I will expect to get paid back.

The portfolio underperformed the S&P 500 slightly, while outperforming the TSX. I do not invest for relative returns, but psychologically it always feels better to know that somebody is losing more money than I am. The portfolio in the last quarter has also underperformed my 11.5 year CAGR (Compounded Annual Growth Rate), but this is to be expected given my very risk-adverse positioning at present. I will warn readers that my +18.2% CAGR is likely to decline in the upcoming quarters as making a percent or two each quarter is below the +18.2%/year benchmark.

Outlook

Crude oil markets are trending significantly lower than what most participants thought would be happening. This is having a significant impact on most Canadian oil and gas companies, whom have been continuing to address leverage matters. While prices imply there is pressure, it is not yet at a crisis point that it was back in February 2016, but if the prevailing trend continues, it definitely appears that there will be some more fractures in the Canadian oil and gas space due to excessive leverage levels. There may be opportunities in the debt market at this point (witness the calamity hitting Teekay right now).

In the USA broad market, the S&P 500 is dominated by the top 10 companies (Amazon, Facebook, Google, Netflix, etc.) and when extracting out those liquidity high-flyers, we have a market that is treading water and some targets of opportunity are starting to emerge that have value-like characteristics. However, the US federal reserve is slowly tightening the screws in terms of loose monetary policy and this most certainly will have a continued dampening effect on equity valuation as the cost of capital continues to rise. They are doing this slowly as to not trigger a market crash, but most participants should be alerted that the 30-year treasury bond, currently at a yield of about 2.8%, is not rising despite the rising-rate environment. This is something to be very cautious about.

The Bank of Canada also spooked the markets in the second week of June when they were making public noise about increasing the interest rates. Although I do not predict they will take much action, if any, until the corresponding long bond rates rise, this may have the effect of putting a bottom on the slow and steady decline of the Canadian dollar. Clearly the commodity markets are not helping Canadian currency, and if there is some sort of return in commodities, then the Canadian dollar would actually be better positioned for a rise.

In general, I continue to remain bearish. Although this stance has not been in correspondence with the major indicies (which have risen considerably), my portfolio continues to generate a positive return while remaining extremely risk-adverse at present time. I am of the general belief that index investing continues to dislocate pricing in the market from true value and this trend is not likely to abate until such a point that it is identified that pouring capital in a non-price discriminatory vehicle is not a prudent way to invest money – instead, it is diversifying through obscurity and not achieving true risk reduction.

I am finding it very difficult to invest cash in this environment. It is painful to wait, but waiting I will do.

The average maturity term on my debt portfolio is just a shade over 30 months. This will continue to lower as my issuers go down to maturity. I am not interested in long-duration bonds at all at the moment.

I project over the rest of this year, if things go to a reasonable level of fruition, that I will see another 2-3% of appreciation, while taking little risk. This is also assuming that I do not see further candidates for investing the non-trivial amount of cash in the portfolio. Nothing imminent is on the horizon. My research pipeline has been bone-dry.

To put a polite summary to my investment prospects, I feel stuck. Little in the pipeline and little of inspiration. Waiting is not popular, but it will allow me to preserve capital for the time where it will be more appreciated.

(Update, July 17, 2017: After doing my internal audit, the quarterly performance was revised from +0.7% to +0.6% for the quarter. The year-to-date was revised from +18.7% to +19.3% due to a rather embarrassing formula error on the tracking spreadsheet. The changes are reflected in the numbers above. The 11.5 year CAGR remains unchanged.)

Portfolio - Q2-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
11.5 Years (CAGR):+18.2%+5.9%+8.2%+2.6%+5.6%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%
Q2-2017+0.6%+2.6%+3.1%-2.4%-1.6%

Home Capital – Don’t know why it is trading up

The power of Berkshire is strong – why would shares of (TSX: HCG) go up when the acquisition price is so dilutive to existing shareholders (selling 19.9% of the company for CAD$9.55 and another substantial chunk of equity at CAD$10.30 to a 38% ownership interest) and the company cannot even obtain a better rate on a secured line of credit than 9%?

They managed to sell $1.2 billion dollars of commercial mortgages between 97 to 99.61 cents on the dollar, which leaves the question of how much their residential portfolio is worth. How can this investment by Berkshire and the line of credit be good for anybody but Berkshire, or more specifically anybody but common shareholders?

Now that short sellers have been crushed to death, I’m going to guess the next month or so will likely represent the “top” of their stock price. Borrow rates are 75% right now so I’m not touching it.

Book value with this stock purchase, FYI, goes down to under CAD$20/share. So even on a price-to-book metric, HCG is almost trading like a regular mortgage provider – except with the very relevant fact that their cost of capital is well above what they can receive in mortgage interest! How they plan on making money by issuing 5% mortgages and loaning money from the credit facility at 9% or 10% is beyond me. Maybe they’ll make it up on volume!

There is absolutely no reason why Genworth MI should be trading up 10% on this news either. They are in much, much, much better financial shape than HCG, and shouldn’t be trading at less of a discount to book value than HCG is!

Stress in Canadian oil and gas

I wrote earlier this year about the downward slopes of Canadian energy companies and six months later, nothing appears to have changed – the trajectory for most of these companies continues to go down.

Commodity pricing is also highly unfavourable – WTIC crude is at US$43/barrel as I write this and the CAD/USD exchange is around 75 cents on the dollar.

So at these price levels, there are going to be plenty of companies that will find it very difficult to make any money.

What hit my radar today is Cenovus (TSX: CVE) taking a hit after their investor day presentation – their CEO is calling it quits at the end of October and planning a $4-5 billion asset disposal. The stock is down to about CAD$9.20/share – noting they raised $3 billion in capital back in April at CAD$16/share when they purchased back their 50% of their partnership in the Foster Creek/Christina Lake projects. Those shareholders must be feeling pretty “steamed” right now, having experienced a 42% depreciation on their capital in a few months.

In their presentation, they stated that the company is break-even at US$41/barrel. You can be sure that if present pricing stays at the current levels, there are going to be a lot more medium-cost producers that are going to start feeling the pinch on their balance sheets – the “bunker down and wait for better pricing” strategy only works when your rivals are out of money and you’re sitting on a treasure chest. Right now, everybody has enough liquidity to last another year or so before things really start hitting the fan.

Equity holders, in addition to feeling already light-pocketed, should continue to worry as debts rise and creditors start taking more and more of any available cash flows out of these corporations.

And as readers know, when there is desperation in the financial markets, that’s usually a good time to invest money. But now still doesn’t feel like the right time.

Amazon – Whole Foods

This is a rambling post with thoughts and no coherency.

Amazon and Whole Foods are two companies are at a larger market capitalization than what I normally would research, but I do take interest in the business strategies involved.

Here in Canada, there have been two retail developments in the larger player space over the past decade – the collapse of Target’s entry (despite a few billion in capital invested in the venture), and the merger of Loblaws and Shopper’s Drug Mart. The consolidation of Shopper’s Drug Mart has been more successful for Loblaws than I originally thought it would be. The collapse of Sears Canada was inevitable and I generally do not consider this significant other than another multi-decade titan fading into dust. Walmart Canada and Costco appear to be untouched at present. Amazon’s presence in Canada is still considerably limited and this is likely due to a function of geography and scale (most of the stuff gets shipped out from the Greater Toronto region).

I do notice that Loblaws (via Superstore) is trying to get into the digital presence – they do have parking stalls that are reserved for online ordering pickup and I am fascinated to see how that process works out (I have not used their service).

So I am asking myself what Amazon is trying to do with the Whole Foods merger and I think it is a reasonable gamble on their part. First, the chain itself is profitable and although their margins have compressed like a typical grocery store chain (it is a miserable industry to compete in), they do have excellent mind-share and geographical presence in upper-scale urban areas.

Amazon is trying to expand its retail physical presence and one area where they do not compete in currently is food – the question is whether they are trying to invade this space (i.e. going after Costco directly) or whether they are using it as a shipping hub (which in this case, they paid a lot of money for what are effectively large-scale post office boxes). I also do not believe that remaining in the premium food space is going to continue to be economically viable since the proliferation of other chains (e.g. Market of Choice, Metropolitan Market, to use a couple West Coast analogies, but even a franchise such as Trader Joes should be quivering at Amazon right now) is continuing to cut away at Whole Foods’ dominance. Using this analysis, Whole Foods’ decision to sell out was probably a good one for their shareholders, but the strategic benefits to Amazon still remain at the “reasonable gamble” stage. It must be nice to be able to throw US$13 billion in pocket change (they have $21 billion in cash and equivalents on their balance sheet as of March 31, 2017) at something and see if it sticks.

In terms of how this will impact Canada, it will not be clear until we see what happens in the USA – in Vancouver, there are five Whole Foods stores (and a couple of them were purchased from a company that marketed the stores as “Capers” which started quite some time ago).

So the questions here:

1. Is Amazon trying to augment its food offerings online (which generally have been lacklustre and expensive?)
2. Is Amazon trying to use Whole Foods as a moderate geographical footprint in major urban centres? What is the benefit of having more geographical pick-up locations instead of at-home delivery?
3. Is Amazon just bored and looking to invade another market where they are not dabbling in as one huge experiment? They tried this before with the Amazon Fire phones – RIP (and this also was the final nail in the coffin for Blackberry’s BB10 operating system, which I am still lamenting over since it is soooooo much better than Android).

All things considered, I still don’t think Costco has anything to worry about, but definitely this market space is getting quite cozy.

No positions in any of these stocks. Amazon does look like, however, it will need to raise another 15 billion in debt financing, which they should have no trouble doing.

Dividend suspensions – Aimia, and soon-to-be Teekay Offshore

Aimia (TSX: AIM) suspended their common and preferred share dividends today. While this decision could have been entirely anticipated, the market still took the shares down another 20-25%. If you read between the lines from my previous post on them, this should not have been surprising. Nimble traders that were awake around 9:40am Eastern Time could have capitalized on an intraday bounce, but the current state of the union is likely to be short-lived since the company still has to figure out how to work its way out of a negative $3 billion tangible equity situation and pay the deluge of rewards liabilities. This will probably not end up well.

And in a “tomorrow’s news today” feature, it is more probable than not you will see Teekay management finally tuck in their tails and suspend dividends entirely on Teekay (NYSE: TK) and distributions from common and preferred units of Teekay Offshore (NYSE: TOO). When the announcement will be made is entirely up to management but it will likely be before the end of the month. What is funny is that I called it a couple weeks in advance (post is here), while it took a Morgan Stanley analyst a few days ago to actually cause a significant market reaction in the share price while everybody rushes for the exit. Teekay Offshore unsecured debt is now trading at 17% and with their preferred units still at 12%, it doesn’t take a rocket scientist to figure out what’s going to happen next – they desperately need a few hundred million in an equity infusion and they will be paying for it dearly.

As a bondholder in Teekay’s unsecured debt, I’m curious to see how management will bail themselves out this time. Since I do not believe they are interested in losing control, I still believe the parent company’s unsecured debt looks fairly good since there isn’t much ahead of it on the pecking order in the event of an unlikely liquidation event.

State of the Canadian Debenture Market

I find the Financial Post’s compilation of Canadian exchange-traded debentures to be a very handy list to refer to. It is not comprehensive (there are a few issuers here and there missing) but for the most part is a full snapshot of the market environment.

Looking at the list, I think it is a very good time for Canadian companies of questionable credit quality to be issuing debt. Most of the debt on this list is trading at yields that do not properly represent (my own evaluation of) their risk.

Accordingly my research time is increasingly on the equity side of things in the non-indexed space. A great example of my readings included the Kinder Morgan Canada prospectus, worthy of a future post!

With regards to the debentures, I’ve sorted the debt by yield to maturity and decided to arbitrarily cut things off at 8%:

IssuerSymbolCouponMaturityYTMPithy Notes
Discovery AirDA.DB.A8.38%30-Jun-18118.28%Way behind secured debt, no control
Lanesbourough REITLRT.DB.G5.00%30-Jun-2259.10%Insolvent
Gran Columbia Gold CorpGCM.DB.U1.00%11-Aug-1843.99%81% mandatory equity conversion
Primero MiningP.DB.V5.75%28-Feb-2021.85%Operational mess, solvency issues
Argex Mining Inc.RGX.DB8.00%30-Sep-1919.07%Illiquid, no revenues!
Toscana EnergyTEI.DB6.75%30-Jun-1817.27%Senior Debt to cash flow is high
Gran Columbia Gold CorpGCM.DB.V6.00%02-Jan-2015.14%I own this
Westernone EquityWEQ.DB6.25%30-Jun-2013.94%Likely equity conversion June 30, 2018
Entrec Corp.ENT.DB8.50%30-Jun-2113.02%Cash flow negative, senior debt high
Temple HotelsTPH.DB.D7.75%30-Jun-1711.78%One month to maturity
Difference CapitalDCF.DB8.00%31-Jul-189.56%Payback not certain
Temple HotelsTPH.DB.E7.25%30-Sep-179.47%4 months to maturity
Fortress PaperFTP.DB.A7.00%31-Dec-199.22%Never figured them out
Temple HotelsTPH.DB.F7.00%31-Mar-188.11%How much $ does Morguard have?

I really don’t see anything worth locking capital into in this table at present prices. I do own one of these convertible debentures, but it is at a price where I would not buy (or sell) – my purchase price is from much lower prices and it is the only debt on this list that gives a warm and fuzzy “secured by all assets and nobody can step in front of me” arrangement.

I also note that the table is missing Yellow Media and Grenville Royalty which are both trading at 9% and 16%, respectively, but they are both unattractive for various reasons.

High Frequency Trading Gone Nuts

Attached was a rather amusing ticker-tape of the bid/ask in a particular stock that I track:

So the algorithm is to raise the asking price a random and rising value from roughly 14-16 cents a share, increasing range, each and every second.

Just imagine if you were the programmer doing this and accidentally got the code mixed up so you were doing the OPPOSITE. Good programming has many layers of fail-safes to prevent this malicious code from ever breaking through, but once in awhile these result in flash crashes. Knight Capital on August 1, 2012 was another famous example (blowing up their own firm on a single trading day).

If you are the counter-party on these incidents you have to react very quickly to take advantage of errant trading. It is rare when this happens. Mistakes like this also affect illiquid products much more.

Mad Retail Muppet – on Aimia debt

Daniel Austin has transitioned to a new site, the Mad Retail Muppet. On his first post in his forays with Aimia’s corporate debt, I am happy to bring his site to your attention.

I’m sure the 10 or 20 human visitors here will find excellent reading on his site.

I’ll add some value by saying:

* Aimia’s 2018 debt matures on January 22, 2018 and will likely mature. Their 2019 debt matures on May 17, 2019 and has a 5.6% coupon. They’re not actively traded via IB, but via Questrade they are currently being asked for at 84 cents (or YTM of 15.3% – noting these are the regular bonds and not the strip bonds). Retail bond pricing typically incorporates a VERY healthy price spread over what should be the existing market price (i.e. an institutional investor would likely get at least a couple cents better pricing, thus a higher YTM).

* The YTM of this debt issue should give you an idea of what I think about the preferred shares, which are trading at a yield of roughly 11% at present (AIM.PR.A/B).

* Taking a $456 capital loss (pre-tax!) on this debt transaction is a very low tuition cost. It’s even less than the cost of a typical 3-credit course at my old university!

* Daniel’s deferred revenue/cost analysis is spot-on: if Aeroplan members go on a Home Capital Group-style bank run on their Aeroplan accounts, Aimia is hard-pressed to pay – such is the perils of investing in a company with a negative tangible equity of some $3.1 billion! This alone is a major reason why I would not touch anything in this corporation’s capital structure.

* It’s obvious Aimia has another choice they will execute on in the future – watering down their rewards pricing. Legally speaking, if they were to double the price of all rewards, what recourse does the consumer have?

Let’s check the terms and conditions

In particular, you acknowledge and accept as a condition of continued membership that:

1. Aeroplan Miles have no monetary value whatsoever and cannot under any circumstances form the basis of a monetary claim against Aeroplan.

5. Aeroplan assumes no liability to members whatsoever by reason of the termination of, or amendment to, the Aeroplan Program, in whole or in part, the addition or deletion of reward partners (including Air Canada), limitations on the availability of flights or seats, changes made by Aeroplan Partners to their terms and conditions, or any change made in accordance with sections 6 to 8 below.

Looks like the program (similar to Air Miles) is an unregulated confidence game – the only recourse Aimia has to watering down their product (or Air Miles) is the loss of consumer confidence. Not much of a remedy.

As a side note, I’m anxiously awaiting my $100 gas gift card in the mail.