Category: Equity

Gran Colombia Gold’s confusing capital allocation strategy, part 3

(Part 1 on June 12, 2019; Part 2 on November 16, 2019)

Gran Colombia Gold (TSX: GCM) raised CAD$40 million in an equity offering priced at CAD$5.60 which included an additional 3-year warrant to purchase stock at CAD$6.50/share. The offering was initially announced on January 27, 2020 when the stock closed at CAD$5.74, so when you include the price of the warrant, it was a fairly steep discount. The stock was halted mid-day when they announced the offering and it surprisingly did not tank the stock (that day – there was about another hour of trading left when they re-opened the stock).

According to the January 27, 2020 release, “The net proceeds of the Private Placement will be used for general working capital and corporate purposes, including repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.“, which continues the theme of selling stock to repurchase warrants (very confusing).

The reality is that I suspect the Marmato mine project is going to be really, really, really expensive and they just want to vacuum up as much cash as possible while the going is good, and gold remains at relatively elevated prices (although I will no profess to knowing whether gold’s existing US$1,574/ounce price is going higher, lower or staying steady, but it is under the per-ounce cash costs of their main Segovia mining operation). Shareholder value (let alone issuing a dividend) be damned!

What got my interest, however, is the decision made when the offering closed on February 6, 2020:

Gran Colombia also announced today that it will use a portion of the net proceeds of the Private Placement to redeem 30%, equivalent to US$19,162,500, of the aggregate principal amount outstanding of its 8.25% Senior Secured Gold-Linked Notes due 2024 (the “Gold Notes”) (TSX: GCM.NT.U) on March 31, 2020 (the “Redemption Date”), reducing the aggregate principal amount outstanding to US$44,712,500. The redemption price will be equal to 100% of the aggregate principal amount of the Gold Notes redeemed plus the Applicable Premium calculated in accordance with the provisions of the Gold Notes Indenture, currently estimated to be approximately 10%. Further details, including the actual amount of the Applicable Premium, will be announced later in March as it gets closer to the Redemption Date. The balance of the net proceeds of the Private Placement will be used for general working capital and corporate purposes, including potential repurchases of the Company’s listed warrants (GCM.WT.B) under its normal course issuer bid.

Considering that a non-trivial amount of my portfolio is in these notes, I took interest in this decision. They are using about CAD$28 million of the gross CAD$40 million in proceeds of the equity offering to close out some of these notes, which to my calculations, are effectively at a 16% coupon rate at current gold prices. A fairly good capital allocation decision if you ask me, although they easily have justification to retire the whole batch of notes if they wanted to!

The reason why they did what they did is simply because once the 30% of notes are redeemed, it releases security on Marmato – the notes will then only be secured by the Segovia mine operation. In light of its current production, I will be happy to continue collecting coupons and having the quarterly redemptions proceed until I get cashed out.

I have no position in GCM equity nor do I anticipate having any in the future.

Finally, this creates a capital allocation strategy issue for me in terms of where to re-deploy the cash. It really was happy earning a very low risk 16%, but sadly no longer.

Atlantic Power – just a matter of time

When a company pays back debt, its enterprise value drops (or more specifically, the cash generation which leads to debt paydown is the cause of the enterprise value decrease because EV is market cap minus net debt, but I’ll insert this in before somebody comments on my illogical statement!). All things being equal, when material amounts of debt are paid back and the underlying entity is cash flow positive, it should eventually reflect an increase in market capitalization. This process sometimes takes a long time.

Atlantic Power today announced a revision to their credit agreement, which dropped the interest rate payable by another 25 basis points (to LIBOR plus 250bps), and if they can get their leverage ratio to less than 2.75:1 then it will go down another 25 basis points further. Atlantic Power had US$400 million in term loans outstanding in September 30, 2019 so this will result in somewhat less than a million a year in annualized interest rate savings going forward.

Reading credit agreement amendments (original April 13, 2016) might not be exciting, but sometimes a few nuggets of information here and there come out which are interesting. Section 2.15(d) of the agreement has the following debt paydown table:

The term loan component is extended to April 2025 which completely eliminates short term credit risk. The de-leveraging is mostly finished. The question is when the market will start to price in equity appreciation – after 2022 the company still has 12 power plants that are under power purchase agreements and generating considerable amount of cash flows.

When a CFO quits

Looking at Stuart Olsen (TSX: SOX). It’s been on my radar simply because I see their name in the fitness facility that I so happen to exercise in. They also (or likely one of their subcontractors) apparently botched up the concrete job in the City of Richmond’s new swimming facility, which needless to say, is not good for them.

Here is a relevant timeline:

September 9, 2019: SOX’s CFO resigns:

Stuart Olson Inc. (TSX: SOX, SOX.DB.A) (“Stuart Olson” or the “Company”) today announced the departure of Daryl Sands, Executive Vice President and Chief Financial Officer.

“I would like to thank Daryl for his over 14 years of service and wish him well in his future endeavors”, said David LeMay, Stuart Olson’s President and Chief Executive Officer.

The Company also announced the appointment of Dean R. Beacon as interim Chief Financial Officer.

…

Stuart Olson has commenced a search for a new Chief Financial Officer.

January 8, 2020: New CFO hired.

CALGARY, Jan. 8, 2020 /CNW/ – Stuart Olson Inc. (TSX: SOX) (“Stuart Olson” or the “Company”) today announced that it has completed its search for a new Chief Financial Officer.

Effective January 9, 2020, Bharat Mahajan will assume the role of Executive Vice President and Chief Financial Officer. Mr. Mahajan replaces Dean Beacon who has held the position of interim Chief Financial Officer since his appointment was announced on September 9, 2019.

Mr. Mahajan is a Chartered Professional Accountant and brings over 28 years of senior and executive level professional experience to the Company. He has a proven track record of generating value as a Chief Financial Officer. Most recently, Mr. Mahajan held the role of Chief Financial Officer at Daseke, Inc. (“Daseke”), the largest owner and leading consolidator of specialized transportation in North America. Daseke acquired Aveda Transportation and Energy Services Inc. (“Aveda”) in 2018. At the time of the acquisition, Mr. Mahajan had been the Chief Financial Officer of Aveda and was asked to take on the same role with Daseke on completion of the transaction.

“I am pleased to welcome Bharat, as our new Executive Vice President and Chief Financial Officer. His financial expertise and extensive accounting leadership experience in public companies will strengthen our abilities to execute on our growth and diversification strategies,” said David LeMay, Stuart Olson’s President and CEO.

January 24, 2020: New CFO quits, old interm CFO comes back.

CALGARY, Jan. 24, 2020 /CNW/ – Stuart Olson Inc. (TSX: SOX) (“Stuart Olson” or the “Company”) today announced that its Executive Vice President and Chief Financial Officer, Bharat Mahajan, has notified the Company of his decision to resign and that he has accepted a different position.

The Company also announced the appointment of Dean R. Beacon as Executive Vice President and Chief Financial Officer. Mr. Beacon previously held the position on an interim basis from September 9, 2019 to January 8, 2020.

The obvious question is – what the heck happened? Two weeks into the job and he’s leaving?

When a long-time CFO exits the company, it could be for a myriad of reasons, including the fact that he/she just has done their job for king and country and wants a graceful exit – nothing to do with the underlying performance of the company. However, when a new CFO is hired and they leave 12 business days after the fact, it leads one to speculate.

A few possibilities:

a) He came in, saw some huge ethical issues, and got out;
b) He came in, the CEO did not like his personality and/or work performance (isn’t an interview process supposed to pick up on this?) and effectively told him to leave;
c) He came in, realized he was over his head, and got out?

I can’t identify a scenario where this sequence of events portends a good outcome for a publicly traded company. They have to release their audited year-end financial results by the end of March.

Unfortunately, I can’t get a borrow on the stock.

The opposite of panic

Pretty much everybody wrote off this dinosaur of a company ages ago (especially during 2018 when new management tried to figure out how bad everything was before they started administering the foul-tasting medicine of structural changes and cost controls), and as a result, there is hardly anybody left that wants to send their supply into the market.

The risk of insolvency has been abated with a very aggressive debt paydown. It’s all about cash generation at this point – revenues are declining, but there will be a point where things will stabilize. When that will be is anybody’s guess, but it seems at present to be more likely than not at a cash generating level. Inevitably, you will have the computer traders and other passive vehicles jumping on board, and then it’s off to the races again. There will be some backing-and-filling of the stock price as you will have people waking up and hitting the sell button, but something to keep in mind is the extremely small float of 7.3 million shares outstanding will likely mean that the volatility will be upwards (demand-driven) rather than down. Today, for instance, somebody at around 10:30 (pacific) really wanted 2,000 shares of stock and it was enough to take it from 10.15 to 10.45 in a hurry.

What a chart of panic looks like

Company should be able to generate about $100 million in cash through operations in Q4, the thermal coal part of their market segment is steady, and coking coal markets look to be in-line.

CapEx will be elevated due to Leer South construction and thus share buybacks will be slowed down (to roughly $40-50 million/quarter, my estimate, compared to the $75 million they’ve been doing), but at that rate they still retire ~5% of the stock outstanding quarterly since each share they’re buying back at US$60 will result in roughly a 20-25% ROI given the estimated future cash returns they will earn.

The panic is generated through two sources: ESG-forced policy investors forced to dump stock in coal companies; and fears that low natural gas pricing will displace coal power generation. The first is a social construct that simply serve to fuel incumbency protection. The second is more relevant, but power generation is a very slow-moving industry where long lead times and up-front capital costs means that existing coal plants will continue to be economically productive for years to come. This does not factor in coking coal, which is half of the company’s revenues, and has nothing to do with the war on thermal coal currently being waged.

In the meantime, the underlying company continues to generate cash. The company itself is in a net cash position.

As long as the cash is being generated, one of two outcomes will occur. If the stock price is at panic levels like it is currently, share repurchases will be massively accretive to EPS and will elevate the stock price when the supply dump is finished. The other option is the company can stockpile cash and issue a special dividend – with a lower share count, this leads to a significant cash outlay per share.

I have no idea how long this supply dump will be, but it isn’t often when you see companies trading at 3x historical PEs being mass dumped – of course, companies are valued on the basis of future earnings, but there’s quite a large margin of error to work with given that ARCH is far, far, far away from being insolvent!