Yellow Media – are they done?

Yellow Media (TSX: Y, and thankfully no positions in equity or debt) reported today what can only be described as a near-disaster of a quarter.

The elephant in the room is what will be (after May 31, 2017) $295 million of 9.25% senior secured notes which mature on November 30, 2018. About 95% of this debt is owned by Canso Investment Counsel Ltd., who also owns 23% of the company’s equity.

In other words, the corporation’s future, short of a surprise turnaround in financial results, completely depend on what Canso’s intentions are. Presently they are able to extract a 9.25% coupon out of the corporation via the senior secured debt and I very much think they would be reluctant to relinquish what is a first-in-line cash stream.

There is a $107 million issue of 8% unsecured debentures trading on the TSX (TSX: YPG.DB) which is also about 30% owned by Canso (maturing on November 2022). The power of this class of securityholder is much more tenuous than it was before Yellow’s recapitalization (in other words – at 98 cents on the dollar it is trading too high given the risk profile). The conversion rate is at CAD$19.04/share which is has little value at the existing equity price of CAD$5.80/share.

The financial situation at Yellow has deteriorated and although they project $50-55 million in free cash flow for 2017, their revenues are continuing to decay and this trend is likely to continue as they morph into a digital consulting firm.

Since their market cap (after today’s 25% decline) is $160 million, it might appear the stock is cheap from a market cap to free cash flow basis. But this is a total illusion for two reasons. One is that the enterprise value of $562 million makes it expensive in light of the decaying free cash flow. The second and more powerful factor is Canso’s control motivation. The return opportunity for shareholders is going to be quite stunted, absent of some surprise takeover bid (doubtful, but this is up to Canso) simply because Canso has too much power and ability to extract capital in what is a financially unfavourable position to Yellow.

This is going to hurt the minority equity holders.

The business story is simple and everybody knows it – Yellow Pages used to be the business Google of the offline world. It is no longer.

No positions, not interested in any unless if somebody wants to sell me that senior secured debt, but sadly Canso owns most of it.

2017 British Columbia Election Prediction

This article is entirely political, so for those of my readers who care about finance and not politics, please disregard everything below.

Prediction is an activity that is subject to a lot of error. Most pundits issue predictions and there is usually little social consequence for getting them wrong, so they make as many as possible and then stick to the ones they got right as a sign of their prognostication abilities. So I’ll thump my chest and say that I saw Trump getting elected despite the fact that he was a 3-1 odds against of winning (if you were to put money on it).

So far my political predictions in my year-end 2016 report have been quite poor – I predicted incorrectly most of the federal budget actions and I completely failed to predict Kevin O’Leary’s surrender in the Conservative leadership contest (I initially predicted he would take it in the first ballot, but this was under the presumption that his French wasn’t as bad as the media made it sound to be – but it indeed was!).

It is quite clear to me right now that my original prediction (at the end of 2016) of the BC NDP winning 20 seats or less in the upcoming election is going to be incorrect. Just how incorrect is going to depend on the volatility of who shows up to vote tomorrow.

Overall notes

The NDP’s campaign has performed better than my expectations. It hasn’t been perfect, but my original expectations were them campaigning on matters relating to social justice which would have appealed to some narrow niches within their party but not appealed to any wide swash of the electorate in order for them to win. Instead, I saw this:

These sorts of “bread and butter” issues are ones that can relate to people that otherwise would not be voting or worse yet, voting against you.

In particular, what got my attention was the initial battle on the issue of the toll bridges. The BC Liberals promised to cap tolls to $500/year as a measure of ‘affordability’, while the NDP a few hours later promised to eliminate them entirely.

While this in itself might not sound like anything special, it was a sign that (whether accidentally or purposefully) the NDP knew what they were doing politically – they knee-capped the BC Liberals on this topic and got them to shut up about transportation entirely across the region, which normally should have been a strength of the BC Liberals. This was the first data point that suggested to me that the NDP were running a good campaign.

As the federal Liberals demonstrated, a good portion of the voting public do not prioritize the status of the fiscal balance until it begins to hit them directly in their pocketbooks. The BC Liberals are smart enough to know that fiscal conservatism is not a strong political selling point when times are good and they wisely chose to focus on other matters.

Unfortunately for the NDP, they failed to keep a laser-like focus on the affordability section of their platform after approximately the two week mark in the four week campaign – they got distracted and somehow they seemed to lose focus while they attempted to also battle the left side of their flank (the Green party). They did not, however, commit any huge errors this campaign like they did in 2013 (the infamous reversal of policy position on the Kinder Morgan pipeline by Adrian Dix being the key example).

The BC Liberals, for the most part, ran a very predictable and I might say cautious and boring campaign. Being in government for 16 years to date, it is difficult for them to make any sort of “change” argument. That said, they have significant messaging strengths in the BC interior geography (natural resource development and jobs) and they still appeal generally to the older electorate (property-owners and those generally with money).

Their messaging beyond the track record, however, is a bit muddy. For instance, on their website, we have the following mish-mash of platform points:

I realize that only opposition researchers and media will be scouring political parties’ webpages for information, but this gives a general sense of what the BC Liberals are trying to focus on (short of the odd obsession over ride-sharing, which is probably the only bone thrown to millennial voters).

The Greens’ strategic objectives were obvious from the very beginning of the campaign and their goal is to expand out in Vancouver Island to elect 4 MLAs (this will qualify them for official party status and entitle them to various privileges that they otherwise don’t have in their current situation). Their other objective is to be the balance of power in a minority government situation, but that part is out of their control – it depends on the BC Liberals and NDP very narrowly balancing each other’s seat count.

The Greens’ primary marketing point is that they’re not the other two parties. It’ll be enough to get them another seat, but not much more. A lot of their candidates across the province are paper candidates – for instance, they have somebody running in a Richmond riding that actually lives in Castlegar. Without having credible candidates on the ground, their vote share will bleed to the NDP.

Projecting voter turnout is the key task in this election prediction. Who is motivated to vote, who will they vote for, and for what reasons?

Polling

In 2013, polling agencies had the NDP up approximately 45-37 and the actual result of the election was the BC Liberals winning 44-40. This was a huge “miss” in terms of polling agencies failing to predict the outcome of the election. It is also instructive that final election numbers has a huge amount of inherent volatility that make the “margin of error” a theoretical and not a practical figure.

In 2017, the big difference is that the polling agencies are showing a tight contest provincially – both major parties are around the 40% mark, with the Greens sitting around 15-20%.

The message is not whether these polls are correct, but the message that unlike 2013, the race in 2017 is significantly closer, which tends to increase voter turnout.

In reality, I’d venture (this being a gut instinct feel) that the +/- factor in polls is around 5%, and would suspect the BC Liberals and NDP are indeed gravitating towards 40% each.

BC Interior (24 seats)

I believe the BC Liberals have a significant edge in their messaging and policies concerning the BC Interior. The population is also more aged, has higher homeownership levels and is the bread-and-butter of the BC Liberal party support from the Social Credit days. The old influences of union workers are fading away which works against the NDP, especially as NDP platforms have become more focused on urban issues. Thus, I only see the NDP winning swing ridings such as Skeena and Columbia River-Revelstoke. Ridings such as Cariboo North, Kamloops-North Thompson, Boundary-Similkameen, Fraser-Nicola (Harry Lali’s nomination victory was a disaster here for the NDP) will go BC Liberal. The biggest question mark I have is Columbia River-Revelstoke – if the NDP lose this riding they will have zero chance of forming government.

You can also see evidence of the relative importance of the interior ridings in some BC Liberal campaign spin:

This is probably a rare piece of political advertising that appears to be truthful.

There are 24 ridings (out of 87) in the interior, and 18 will go BC Liberal and 6 will go NDP.

Vancouver Island (15 seats)

On Vancouver Island, the main contest is between the Green Party and the NDP in certain southern Vancouver Island ridings. The Greens will win Oak Bay-Gordon Head, and Saanich North. Cowichan Valley has been the other riding that has generally been considered a swing riding between the NDP and Greens, and I believe this will go NDP, along with the rest of the island short of Parksville-Qualicum (which will be the sold riding remaining BC Liberal on the island). Courtenay-Comox stands a good chance of swinging back to the NDP and I will note this is contrary to most public predictions.

There are 15 ridings in Vancouver Island, and 12 will go NDP, 2 Green and 1 BC Liberal.

City of Vancouver (11 seats)

In the City of Vancouver, the prevailing issue is affordability and while this means homeowners vs. renters, the geography of past elections only allow a swing in a single electoral district – Vancouver-Fraserview, which should probably go NDP. The rest will remain the same. There is an outside chance of Vancouver-Langara going NDP, but the components of the electorate will not be enough to swing the seat to the NDP.

There are 11 ridings in the City of Vancouver, and the NDP will win 8 and the BC Liberals will win 3.

Fraser Valley (9 seats)

The geography here includes Pitt Meadows, Maple Ridge, Mission, Kent, and Langley to Hope. I do not think there will be any surprises south of the Fraser River. North of the Fraser, the two selections I have that run contrary to consensus is that the NDP will win both Maple Ridge-Pitt Meadows and Maple Ridge-Mission, although I do not give these predictions with huge conviction.

There are 9 ridings in the Fraser Valley, and the BC Liberals will win 7 and the NDP will win 2.

Metro Vancouver minus Vancouver (28 seats)

The specific question is who wins Burnaby North, Coquitlam-Burke Mountain, Port Moody-Coquitlam, North Vancouver-Lonsdale, Delta North, Surrey-Fleetwood and Surrey-Guilford.

The geography of these areas suggest that the electorate of these sub-urban ridings will have the influence to decide who gets to be in government. There are competing variables in play – transportation was a big one (most of these ridings are heavily influenced by the Port Mann Bridge toll and motorists that want to vote for shorter commutes, whether by car or TransLink), affordability (renters vs. owners), and perceptions of economic competency (jobs, jobs, and jobs). It is difficult to juggle these influences on the overall electorate. Political parties have likely done their statistical research to attract their target demographics on these topics.

In the 2015 federal election, we saw firm evidence that voter turnout from people between the age 18-34 turned out when previously they would not before. Judging from my experiences in that election, predominantly these voters went (federal) Liberal as there was a desire for change.

Survey data (e.g. Reddit, polling and so forth) would suggest that the average younger individual will be voting NDP or Green. And in the event that they are in a riding where the Green party is not a realistic contender, they will probably vote NDP if they do indeed vote.

Question: Will this same millennial voting wave take over provincially? This is the key to the election and one where I have no insight on until looking at things retrospectively. I do not have a good intuitive grasp whether Christy Clark or John Horgan have actually been able to galvanize the average millennial voter.

Polling with regional splits indicates the NDP has a significant advantage in the Metro Vancouver area, but I take these sub-regional splits with a grain of salt for various reasons. All it indicates to me is that the race is competitive.

Factoring in everything, I am going to venture that the NDP will take 15 of the 28 sub-urban seats, while the BC Liberals will take the other 13.

Conclusion

NDP – 43 (41%)
BC Liberals – 42 (42%)
Green – 2 (15%)
Others – 0 (2%)

This is a low conviction prediction. I’m probably wrong. The numbers don’t really add up for me (which is the first sign that my election modelling is not right). The BC Liberals have a higher popular vote because their interior and Fraser Valley victories are going to be what might be a bunch of narrow victories in the Lower Mainland for the NDP. Also despite this prediction, I view the odds of a minority government to be very slim.

We’ll see tomorrow what happens.

Another Canadian Finance website of quality

Reminiscences of a Stockblogger (I don’t know his real name) has an excellent post on identifying what makes your edge in the marketplace. His performance has been excellent and his following paragraph resonates with me:

I think I have put up enough years of out-performance to tentatively conclude I have some sort of edge. Its still possible that I don’t; maybe I will blow up yet and these past years will prove to be a statistical aberration. But as times goes on those odds become less likely.

His performance is exceptional when you consider the number of positions he has in his portfolio – I run a much higher concentration than he does. It could be that my historical performance is simply a fluke.

Versasen – Bought out

Verasen (TSX: VSN) is a relatively boring utility company that had some exposure to a LNG project in Oregon (among other businesses that are less exciting). They’ve been on my radar since early 2016 but I opted for other investments at that time since there were other risk/reward opportunities.

Today they are being bought out by Pembina (TSX: PPL) in a merger that makes strategic sense. The premium over the previous day’s closing price was approximately 22%, depending on whether you can get cash or stock in the transaction.

Pembina is a huge corporation and they trade at a market cap that is well above my normal investment range.

It is always sad to see research candidates where you’ve dumped a few hours learning about the company, industry, competitive advantages, etc., go by the wayside, but that’s life in finance. Onwards to the next target.

Home Capital / Equitable Group Discussion #2

A few news items which are salient as this saga continues:

1. Home Capital announced a HISA balance of CAD$521 on Friday, April 28 and a GIC balance of $12.97 billion. On May 1, this is $391 million and $12.86 billion, respectively (another $220 million gone in a day). Their stock is down 21% as I write this.

2. Equitable announced their quarterly earnings and are up 35%. This was a pre-announcement as they previously stated they would announce on May 11, 2017. They announced:

* A dividend increase.

Between Wednesday and Friday, we had average daily net deposit outflows of $75 million, with the total over that period representing only 2.4% of our total deposit base and with the most significant daily outflows being on the Wednesday. Even after those outflows, our portfolio of liquid assets remained at approximately $1 billion.

Obtained a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of Canadian banks, including The Toronto-Dominion Bank, CIBC, and National Bank (“the Banks”). The terms of the facility include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility, and an interest rate on the drawn portion of the facility equal to the Banks’ cost of funds plus 1.25%. This interest rate is approximately 60 basis points over our GIC costs and competitive with the spreads on our most recent deposit note issuance, and as such will allow us to continue growing profitably.

So their credit facility cost $15 million to secure $2 billion (relative to $100 million for HCG), lasts two years (relative to 1 year for HCG), and also have a standby charge of 0.5% (which is 2.0% less than HCG), and a real rate of interest of approximately 3% (compared to HCG paying 10% for their outstanding amount, and I’m assuming the Bank’s “cost of funds plus 1.25%” works out to around 3%).

I haven’t had a chance to review their financial statements in detail yet. But securing two billion on relatively cheap terms like this is going to be a huge boost to their stock in the short run.

Very interesting.

Genworth MI (TSX: MIC) is also down a dollar or 3.5% today, which is more than the usual white noise of trading. It dipped even lower today.

Administrative note on the site

I have enabled full-text RSS feeds of the site’s posts (instead of just a summary). You will no longer have to click-through your RSS readers in order to view articles on this site. While I am curious who is reading the content on this site, there are RSS readers that are now smart enough to just download the whole content and display it for their readers. I don’t run advertising, but if you are one of those silent viewers, it would be mightily appreciated if you just write a comment saying “hello” and where you initially heard of this site since I get so little traffic from Google for the past few years (one of the consequences of not giving them advertising money). Don’t get me started about the rest of social media either!

I have also updated some site links on the right hand side concerning other Canadian Finance authors. My criteria is that the writer’s name be known and that they’ve written at least four decent pieces in a year. Sadly the quality of writing on the internet has decreased significantly over the years and I do not expect this trend to abate.

DREAM Unlimited and Birchcliff Preferred Shares – cash-like with higher yield

I’ve written in the past about DREAM Unlimited 7% preferred shares (TSX: DRM.PR.A) and the situation still applies today. They, along with Birchcliff 7% preferred shares (TSX: BIR.PR.C) are the only holder-retractable preferred shares trading on the entire Canadian stock market.

They are both trading slightly over par value.

In the case of Birchcliff, the preferred shares only become retractable on June 30, 2020. As such, the implied yield to retraction is around 6.14% (assuming CAD$25.50/share and not factoring in the accrued dividend). You would receive eligible dividends over the next three years and a capital loss upon retraction. The underlying corporation, while somewhat leveraged, is quite well positioned if you assume the North American natural gas market is not going to evaporate. There is also some upside catalyst to the business fundamentals (not to the preferred shares!) if North America finally gets a liquefied natural gas plant on the Pacific Coast, but this is not likely to happen since price spreads have narrowed significantly over the past couple years.

Liquidity on Birchcliff preferred shares is not the greatest – but if you float an ask at the ambient price level you will likely get hit a few hundred shares at a time.

In the case of DREAM, the premium is not extreme when factoring in the amount of accrued dividend (at the closing price of $7.29/share, implies a 6.88% yield with a risk of an immediate capital loss if the company decides to redeem at $7.16/share). It has been quite some time since they have traded at a discount to par, and this is likely due to scarcity of shares – shares outstanding have decreased from 4.87 million at the end of 2015 to 4.01 million at the end of 2016, and this trend is likely to continue. Holders are probably waiting for the inevitable call by the company to redeem the preferred shares. But until this happens, holders receive an eligible dividend of 7% on their preferred shares.

Likewise with Birchcliff, liquidity with DREAM preferred shares is not good. However, there is usually daily activity on the shares and the spreads are typically within pennies. In a financial panic, however, that liquidity might fade and in a quick trading situation you might get a price a percent or two below par value.

There is conversion risk – the company can choose to redeem the preferred shares in DREAM equity, to a minimum of $2/share or 95% of the market price (which is the standard 20 business day VWAP, 4 days before the conversion provision, as defined in section 4.09 on page 68 of this horrible document). With the common shares trading at $6.60 and the business fundamental not being terrible, the risk seems to be quite low that preferred shareholders will leave this situation with anything less than par value.

I have some idle cash parked in both instruments. I consider them a tax-advantaged cash-like instrument and do like the fact that they are margin-able at IB (Birchcliff at 50% and DREAM at 33%!). This is much better than putting the money in a Home Capital Group GIC (earn 2% fully-taxable interest income AND have the privilege of losing principal when they go insolvent)!

Does anybody out there know of any similar situations that relate to US-denominated preferred share securities that are “cash-like” in nature?

KCG cost of capital calculation

I will warn this is a very dry post.

The merger arbitrage spread with KCG has narrowed considerably.

When the $20 cash merger was announced the shares were trading at $19.75. There is little chance of the deal falling through or there being a superior offer.

Today KCG is trading at $19.88. The estimated close of the merger was reported to be “3rd quarter 2017”. The assumption is the mid-range, or August 15, 2017.

So there are 3.5 months until the deal closes.

12 cents appreciation is 0.6% over 3.5 months, which over the course of 3.5 months implies a 2.1% annualized rate, not compounding. This also excludes trading costs.

Because I had a small cash deficit in my USD account and a surplus in CAD, I’ve sold some shares at $19.88 to make up the shortfall. I placed it at the ask to minimize trading costs, which turned out to be 29 cents per 100 shares.

What’s interesting is my trade got hammered away, 100 shares at a time, approximately 2-4 seconds apart per trade. Interesting algorithms at play here.

I also believe Virtu (Nasdaq: VIRT) will have a more difficult time with the integration of KCG than they originally anticipate. The company cultures are significantly different and while the merger makes sense on paper, in practice it is going to be quite different. KCG was also dealing with a non-trivial data migration program on their own, from New Jersey to New York City and these sorts of technical details require highly skilled individuals to pull off without causing trading blow-ups. It might take them a year to get things stabilized after the merger is finished. KCG had huge growing pains of its own after it was reverse-takeovered by GetCo.

Home Capital / Equitable Group discussion

Home Capital (TSX: HCG) collapsed 60% on news that they are in the process (not obtained!) a secured credit facility for a 10% interest rate, and a 2.5% standby rate for the unused portion. They also announced that customer deposits have collapsed in recent days.

Needless to say, this is a huge amount of interest to be charged and the market’s reaction is fairly indicative of this being a very, very negative event for the company.

(Update, April 29, 2017 – This is a little late, but the company confirmed the secured credit facility on April 27, which including the $100 million commitment fee, means an effective rate of interest of 15% for a $2 billion borrow, or a 22.5% rate for a $1 billion borrow. The ex-chair on television said it was secured 2:1 by mortgage loans and is front-in line. Yikes!)

Equitable Group (TSX: EQB) also has collateral damage, down approximately 17%. Are they next?

No positions.

Home Capital Group, Equitable Group

Home Capital (TSX: HCG) and Equitable (TSX: EQB) have been hammered today as a result of fallout of the Ontario Securities Commission allegations that certain Home Capital Group executives have contravened the various regulations. They continue to perform damage control, today announcing their CFO (who was under the OSC investigation) will be stepping down and other various board changes.

Borrowing rates for Home Capital spiked to 26% today. Equitable, which normally has been an inexpensive borrow, had its cost to borrow rise to 2.75%.

Implied volatilities on options for HCG is also very expensive at present, around 110% for near-dated options and around 90% for a couple months out. EQB does not have options trading on their shares.

There has been an avalanche of media coverage (both in print and social media) about Home Capital and their woes. They have been pushed down to about 25% less than tangible book value.

This spill-over has not occurred to Genworth MI (TSX: MIC) at present.