Yellow Pages Q1-2020 – somewhat surprising

Yellow Pages (TSX: Y) posted Q1-2020 today and the results were somewhat surprising (the form of the surprise is “Wow, this is less worse than I was expecting”) – while it is generally well known that the revenues (and subsequently cash flows) are eroding, the rate of decline has generally been lower than my expectations. Management tries to spin it as the “decrease in decline”, and ultimately they will have to figure out how to stabilize the business in order to keep the entity viable, but the management of the decline so far has been superb.

The key metric in my book is customer count, which is down to 147,700 (31,100 less than the previous year’s quarter, a still fairly miserable decline), at an average spend of $2,571 per customer.

Employee count is down from 768 in Q4-2019 to 722 in Q1-2020.

Cash generation remains remarkably good, going from $44.4 million in December 31, 2019 to $70.9 million in March 31, 2020. The material debt on the books is the (TSX: YPG.DB) $107 million debenture which management has re-iterated will call at par on May 31, 2021 (before this date they would have to pay 110 on the dollar, which would be financially a net negative).

With the impact of Covid-19, on the conference call the following remarks were given by the CEO in response to the sole question:

Our — I mentioned that, yes, our bookings have taken somewhat of a hit that will be reflected somewhat in future quarters. We don’t have a quantification for you on that. But it’s in the scheme of things, I would characterize it as modest.

…

And on the biggest surprise to me, frankly, is on our cash collections. Our cash collections have continued virtually extremely significant sign of the strength of the continued virtually sector and the market that we serve and the anticipated health of that sector. Again, there’s no guarantees. We don’t make a guarantee, but I expected there to be large and noticeable declines in our receipts of revenue — receipts of cash from our customers. And if there is any effect, it’s imperceptible, actually.

Interesting colour commentary. The CFO accrued an extra $1.5 million for projected bad debt expense, but relatively speaking that isn’t a lot in relation to the overall business. The market very obviously anticipated some sort of COVID-19 impact, but they probably over-reacted (although Yellow’s customer base is concentrated almost directly in the COVID-19 crosshairs, short of airlines and cruise ships).

Finally, on plan, the company will be issuing an 11 cent per share dividend (about $3.1 million a quarter) – the first dividend in nearly a decade. I don’t think anybody a few years ago would have seen this coming. An interesting quirk – 4 cents will be eligible and 7 cents non-eligible. Accounting-wise, the ability to declare eligible dividends comes from the GRIP pool and this is generated through income taxed at the large corporation rate.

On the pension plan liability, the CEO said during the AGM that the plan has a surplus on a going concern basis:

This is David Eckert, the President and Chief Executive Officer of the corporation. And let me say, I thank you and appreciate that question. We take our obligations to our retirees’ and our pensioners’ defined benefit pension plan very seriously. We pay a lot of attention to that, and we have been working very hard for every dollar that almost every pensioner will ultimately and on a timely basis, be paid. Let me point out that at the time of the most recent valuation of that plan, the plan was actually showing a surplus on a going concern basis. And that assumes that the company is a going concern and is able to continue making payments into the plan. And we have been working very hard, as I think most all shareholders know for years now, to make sure that the company does well and is in a position to make payments on all of its obligations, including the defined benefit pension plan. I will point out that in just the last — we announced this morning that in just the last 9 quarters, as evidence of that, we have reduced our, what we call, our net debt in just 9 quarters from over $350 million to only $28 million. And that’s beneficial to everyone. With respect to your specific question, the voluntary additional contribution that we announced our intention to make this morning, beginning in June of this year, each month through the end of next year, would double our regular required monthly contributions. And those would go from approximately $150,000 a month to approximately $300,000 a month. But let me just reemphasize that at the point of the last valuation of the plan, the plan was actually in a surplus position, ongoing concern basis, and we have every intention, and I think the results of the last few years underscore this. Every intention of having this company continue to thrive as it has in recent times. And thank you for your question.

Looking at the financial statements, the plan is still in the liability column for $86 million, but this is a lot better than it was before (it was greatly helped by an increase in the discount rate from 3.1% to 3.8%). The details come out every annual filing, and at the end of 2019, the fair value of the plan assets were $484 million, while the benefit obligation was $573 million ($89 million liability).

I’ve had to downscale my own financial projection for Yellow due to COVID-19 and the general economic damage that the shutdown is going to cause. Yellow Pages will easily generate enough cash to pay the debentures, but the real question will be what happens to the remaining business. Going forward to 2022 and beyond, there is a very viable case for roughly $40 million/year or so in annual cash generation. Without debt, it makes the valuation easier – a multiple of cash. Again, this depends on the trajectory of the revenue curve and how viable management can make their business.

Now my pondering is whether the company will get on the radar of dividend ETFs. During COVID-19 I did some serious portfolio adjustments so Yellow is no longer my largest holding (it was painful getting proper liquidity) but I still hold some and do not see a reason to blow it out. I think almost everybody else has, so I wouldn’t anticipate supply pressure being extreme – others have likely dumped!

The Bombardier bailout

This is going to be good.

Our illustrious government has figured out a headline-free way to bail out Quebec firms, such as Bombardier, and do it in a ‘governmentally distant’ manner, shielded by a crown corporation business development corporation.

The name of this will be through the Large Employer Emergency Financing Facility (LEEFF).

Reassuringly, money to be loaned will be conditioned upon:

Companies seeking support must demonstrate how they intend to preserve employment and maintain investment activities. Recipients will need to commit to respect collective bargaining agreements and protect workers’ pensions. The LEEFF program will require strict limits to dividends, share buy-backs, and executive pay. In considering a company’s eligibility to assistance under the LEEFF program, an assessment may be made of its employment, tax, and economic activity in Canada, as well as its international organizational structure and financing arrangements. The program will not be available to companies that have been convicted of tax evasion. In addition, recipient companies would be required to commit to publish annual climate-related disclosure reports consistent with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, including how their future operations will support environmental sustainability and national climate goals.

Let the gravy train flow! Bombardier gets another low-interest rate loan of a billion dollars.

Gran Colombia Notes indenture amendment

Gran Colombia Gold (TSX: GCM.NT.U) posted an update to their note indenture regarding the proportional change of the amortization in the event of a redemption or repurchase.

(Attached amendment)

Amendments. Article 4 of the Indenture is hereby amended by adding the following as Section 4.11:

In the case of any partial redemption or repurchase of Notes (for greater certainty, other than pursuant to an Amortizing Payment), the principal amount of Notes redeemed or repurchased shall be proportionately allocated among all remaining scheduled Amortizing Payments set out in Appendix C and shall be allocated to the pro rata reduction of each remaining Amortizing Payment. Within five Business Days of the completion of a partial redemption or repurchase, the Issuer shall deliver to the Trustee an updated Appendix C and Appendix D reflecting the effect of such redemption or repurchase; provided, however, that in respect of the Partial Redemption, the updated Appendix C and Appendix D shall be delivered on the date hereof.

It was not at all clear from the text of the original indenture (indeed, it wasn’t there at all) that the amount of gold held in trust is reduced in the event of a redemption or repurchase.

If you assume that there isn’t a reduction (indeed, there is nothing in the language to suggest that there is a reduction), it dramatically increases the economic value of the notes in periods subsequent to the redemption.

Indeed, on March 26, 2020 you can see my strike-through comments with the said interpretation.

I do not have enough in these notes anymore where it is economically feasible to mount a legal case that this indenture amendment is illegal and that noteholders should receive the full entitlement of gold, unreduced by the redemption.

Indeed, it is going to be somewhat of a moot point, as I would deem it likely the company will redeem for 104.13 on or after April 30, 2021. Even with the reduced amortization, at a US$1,700/Oz gold price, the company will be paying an extra 11.3% on the notes in the upcoming four quarters.

However, if somebody out there owns a few million of these notes, there would be a pretty powerful claim to be made. I suspect that despite receiving an “Opinion of Counsel” from the Trustee that this “defect and inconsistency” wouldn’t be seen as such in the eyes of the court – it instead looks like retrospective contract re-writing, of course in the favour of the issuer.

There is one obvious insider that had to disclose on SEDI that he owns a large volume of notes, but he is unlikely to sue his own company and is likely to claim economic rent through other methods. Any other large holders would probably make due by just settling with the company, away from the public spotlight. The differential amount would not be considered material and likely would not be too visible on the financial statements short of a few extra bucks of legal expenses.

If anybody was wondering, the difference is (at US$1,700/Oz) a total 20.7% payment over the next 5 quarters (April 30, 2020 to April 30, 2021) vs. 13.3% under the revised scheme. This 7.4% difference over the $44.7 million outstanding post-redemption is around a $3 million payment difference (this accounts for the reducing principal amount of the notes over the quarters), not a trivial chunk of change.

Even with all of the regulatory protections of public markets, I’m not surprised to see this happening. I’m happy to have my position reduced and eliminated with the inevitable call-out of notes.

If I were Shopify

Shopify (TSX: SHOP) is the new technological wunderkid of the TSX, following in the footsteps of Nortel, RIM, Valeant Pharmaceuticals and now SHOP. Good for them for achieving a market capitalization of $100 billion – a proud accomplishment to say the least. They deserve it.

The question is whether SHOP will retain its competitive advantage in the future. For now, things are great, but just like what happened to Nortel and Blackberry, you can lose your competitive advantages in technology more quickly than one anticipates, especially if you’re Canadian!

But what got my attention was their secondary offering where they raised US$1.3 billion (selling shares at US$700).

I should charge them for this advice, but I will offer it freely: If you can, raise more equity capital at this price. Like, try to raise $10 billion.

You’ll thank me in five years.

USA negative fed funds rates

I forgot to check my quotations but I see now the markets are predicting a negative short-term interest rate from the US Federal Reserve (a projected -0.06% fed funds rate for 2021):

I note that Interactive Brokers charges you -0.808% to hold CASH Euro balances over 100,000 Euro. Conversely they charge you 1.5% to borrow up to 100,000 Euro (and 1% for the next 900,000 Euro, and 0.5% for the next 149 million).

Notably, at this point, the Bank of Canada is still projected to be steady for the next two years.

However, as economic conditions deteriorate and monetary policy continues on quantitative easing forever, this might not be sustainable.

As we already have some history on European institutions (in addition to Japanese ones) in negative rate environments, there are some general guidelines as far as investment is concerned.

Although the government risk-free rate is going to be suppressed by central bank actions, the ripple effect in the non-government markets will be huge. This is playing out in asset prices right now. It’s not going to end up well for most other than the most financially nimble participants. I’d suggest throwing out the conventional playbook. While COVID-19 is not the cause of this, it definitely accelerated matters.