Aimia – not at this time

It’s been quite some time (four years) since I’ve written about Aimia (TSX: AIM).

The corporation is much ‘cleaner’ than it was when they were operating Aeroplan and especially now that they’ve sold their last loyalty program (PLM) they are sitting on a bunch of cash and assets. The PLM sale netted about $537 million, and by virtue of significant operating and capital losses in the past, the tax hit on this transaction will be relatively low. They still have a tax shield going forward and one of their stated intentions is to use their newly found half-billion dollars for investments to chip away at their tax shield.

From the June 30, 2022 balance sheet, they have a bunch of investments in income-losing entities. It does not inspire much confidence about future speculations.

Writing off the entirety of their investment portfolio, this leaves them with about $550 million to play with on 92 million shares outstanding, or about $6/share. There is no material liabilities or debt on the sheets. However, they do have $236 million in perpetual preferred shares outstanding which sucks out nearly $13 million/year out of the company, plus an even nastier Part VI.1 tax for another $5.1 million (hint to Aimia management – you perhaps might wish to NCIB the preferred shares). The rate resets are due in March 2024 and 2025, which would be at rates significantly higher than what they are paying now.

We know through public filings that they bought back 7.13 million common shares for $31.45 million in July and August. In a few days we will know about their September buybacks. The ending balance for August would be 85 million shares outstanding and approximately $510 million cash on the balance sheet, minus whatever else they threw money at in the interim.

Practically speaking, Aimia is trading at a price that is close to its cash balance, and assuming the remainder of its investment portfolio is worthless.

You would think that they should be able to convert half a billion dollars into something that earns a positive return. The Divestor Oil and Gas Index would be one avenue.

I tend to shy away from these “sum of the parts” entities because the incentives are generally misaligned for minority shareholders to make a proper return. Aberdeen International (TSX: AAB) was a poster child for this.

Aimia is controlled by Mittleman Investment Management, although they do not own a dominating stake in the company (approximately 10 million shares held between the company and the two brothers). Since Aimia does not have a common stock dividend, returns would be through capital appreciation. This typically would be driven by a share buyback, but as clearly evidenced by July and August’s trading action, the market has been more than happy to part ways with its shares at an average of $4.41.

The preferred shares are also not trading at a level that I would consider sufficient compensation (roughly 7% current yields and illiquid) given the overall situation.

Given the stress we are seeing in the market, even if there was a dump of liquidity on Aimia, I would find it probable that there would be some other part of the market that has a viable operating entity to be trading at equally or better levels at such a time. The fixed income component of it, however, I will continue keeping on eye on.

Making investment comparisons

This post is a little more abstract, but the thinking should be fairly easy to understand. The revolves around the concept of hurdle rates, and making comparisons to baseline investments.

I’ve been reviewing a bunch of companies that have balance sheets that have tangible (or nearly tangible) financial assets that when netted against their liabilities are trading below liquidation value. An example of this would be Input Capital (TSXV: INP) which Tyler has tweeted about, in addition to SM keeping me informed by email.

In the case of Input, taking their December 31, 2019 balance sheet as-is without mental adjustments, gives them a $1.24 book value. At a current market rate of 71 cents, that’s trading at a 43% below book discount. Assuming the asset side of the balance sheet doesn’t have more write-down surprises, the company on the income side still makes a modest amount of cash on their canola/mortgage streaming business, albeit at a rather high cost on administration (as a percentage of assets). If they decide to wind down, shareholders should be able to get out with a mild positive. Their mortgage portfolio will amortize and the board of directors can command management to fire themselves and call it a day.

So lets assume I have a chunk of cash, and I’m evaluating this option for the portfolio. To be clear, I’m not interested, and INP has very poor liquidity – typical trading volumes in a day is less than CAD$10,000. Piling onto our list of assumptions, let’s say liquidity is no concern.

The question is: What do I compare this to?

If I compare this to the simple risk-free cash amount (e.g. the brain-dead option is (TSX: PSA) which yields a net 2%), then yes, Input Capital looks fairly good by comparison. If INP materially winds up in 3 years and captures 90% of its present book value (conservatively assuming they lose a bit in the process of wind-down), that’s a 16% CAGR gainer. You’re effectively getting 14% net on the risk-free option – the risk of this not happening is what you’re getting this 14% spread for (such as the critical assumption on whether they choose to liquidate or not!).

However, things are not so easy in our multiverse of investment options.

For instance, you have other choices. Coming up with baseline options is vital for making comparisons. Other than the risk-free option (government bonds or for smaller scale amounts of money, PSA), there are surprisingly a lot of companies out there trading under book value that appear to be making money.

Perhaps the least glamorous, most boring, but relatively safe option is E-L Financial (TSX: ELF) which owns nearly all (99%+) of Empire Life, 37% of Algoma (TSX: ALC), and 24% of Economic Investment Trust (TSX: EVT). At the end of Q3, its book value (stripping the $300 million of preferred shares outstanding) was $1,421/share while its market value today on the TSX is $814, which is a 43% discount below book value, identical to INP’s discount today. ELF also from 2009 to 2018 compounded its book value by 9.7% annually, and clearly is a profitable entity.

So we compare two opposing options: INP and ELF – why in the world would you choose INP? The only reason would appear to be a chance of a quick and clean liquidation over the next few years, and that is measured against ELF earning 10% of book value over those three same years, and staying at a 43% below-book valuation. The only thing you don’t get with ELF is an interesting conversation at a cocktail party.

The baseline comparison of ELF compounding book value at 10% a year creates quite a hurdle for other below book value investments – the underlying mis-valuations must be very severe in order to warrant an investment in other vehicles. When scanning my portfolio, all of the common share investments have clear rationales for expected returns higher than this hurdle rate.

When you compare to real bottom of the trash barrel options like Aberdeen International (TSX: AAB) which are trading 85% below book value, why would you want to put investment capital into a sub-$100 million market capitalization entity when there is a perfectly viable option that is clearly a legitimate firm, and has a very good track record of building its balance sheet? (For those financial historians out there, many years ago Aberdeen was subject to a bruising proxy fight where an activist tried to take over the board for the purpose of realizing book value, but the management was successful at fighting it and then proceeded to fritter away the company into what it is today – a 3.5 cent per share stock – shareholders got what they deserved!).

As a final note, the presence of fixed income options that appear to give off very high low-risk returns tends to make such comparative decisions really difficult. For example, Gran Colombia Gold’s notes (TSX: GCM.NT.U) are linked to the price of gold and give out more yield when above US$1,250/Oz. Given the seniority of the notes (they were secured by the company’s primary mining operation), even at the baseline gold price, the notes represented a very low-risk 8.25% coupon. At current gold prices, the coupon effectively rises to around 15%. It is difficult to compete against such investments, except in this specific instance they must be capped as a reasonable fraction of the portfolio (if the mine had an implosion, explosion, earthquake, etc., then there would be trouble). The opportunity is now gone since the notes are now in a redemption process and the remaining principal value will be whittled away with quarterly redemptions at par values below market trading prices, and the rest of it will likely get called off after April 30, 2021 (at 104.13 of par).

I won’t even get into comparisons with the preferred share market, where there are plenty of viable options with little risk that will yield eligible dividend yields roughly in the 6% range that would require an economic catastrophe of huge magnitude before they stopped paying out. The ebbs and gyrations of the underlying business itself is almost irrelevant to most of these preferred share issuers (e.g. Brookfield preferreds will likely pay dividends in your lifetime and mine). People, however, do get confused on the “stopped paying out” part of preferred shares vs. them losing market value – the preferred share trading today at 6% might look good to leverage up money at 2.2%, but if those preferred shares start trading at 7% or 8%, you might be the unwilling recipient of a margin call or the margin calls of others.

To conclude, just because an investment looks good on an absolute basis doesn’t mean the research stops there before hitting the buy button – making comparative measurements is just as important. Nothing precludes one from buying into both options; after all, if there is no correlation between the two investments and your success rate is 70%, you’ll hit your target on at least one investment half of the time.

Investment companies, agency, and Difference Capital / MOGO Merger

Most corporations that specialize in maintaining equity portfolios typically trade less than their component parts, simply due to the control issue. Shareholders generally have little control or say on when the company can reach their purported net asset values. Management usually has an incentive to not sell off their companies so they can collect salaries and/or benefits and/or power that comes with control.

As a result, it is a very relevant consideration before investing in such vehicles that the incentives of management are in line with your incentives (presumably as a minority shareholder). Some managements do care about their overall shareholder base (Berkshire presently I would judge to be part of this category, although they are much more of an operating company than most think), while most generally regard minority holders as an annoyance to be mitigated. It is rare where minority shareholder groups will organize to a point where a credible proxy fight can be contested, but such contests are expensive and usually the bias is toward incumbent management. A good example of a failed proxy fight was the contest for Aberdeen International (TSX: AAB) in early 2015 (a very brief legal summary is here).

Aberdeen was a notable case where it was trading far below its net asset value and the share structure did not have super-voting shares. The dissident group failed to accumulate enough support and shares to overthrow the board. Aberdeen at that time was trading at 15 cents a share and the book value was roughly 40 cents. Today they are down to a market value of 5 cents per share.

There are plenty of other cases to examine with these types of companies. Dundee Corporation (TSX: DC.A) is a conglomerate with consolidated and non-consolidated investments and has been trading below book value for a considerable period of time. In their last annual report, I highlight the salient page which shows that their operating entities are not doing too well:

Dundee is a dual class structure, with the founding family controlling the entity via super-voting shares. In order to resolve a situation with a redeemable preferred share issuance (which I have written about in the past) they also notably diluted their shareholders – issuing about 42 million shares to go from 61 million to approximately 103 million shares outstanding effectively – at a conversion price of $2/share. After this conversion, the parent company will hold no material debts and management will have a lot more time to be able to figure out how to transform the operating businesses into profitable entities. Presumably until this happens, Dundee will be trading under book value.

The last entity I will point out is Difference Capital (TSX: DCF). They were notable with having “Dragon’s Den” titan Michael Wekerle being their original CEO and lead investor and they invested in a whole smattering of private placements and various business ventures.

This didn’t quite work out for them for the majority of their history. In 2018, they able to focus on monetization of their portfolio in order to mostly pay off a convertible debenture. The remaining part was financed with a 12% secured loan which was partly paid for by insider money. In their year-end of 2018, they held a net asset value of $7.20/share on their financial statements and this was contrasted with a $3 share price (indeed, shortly after the new year, they executed on an asset disposal that spiked their share price up to $4) – hardly a risk for insiders to take when they were first in line on security and taking a nearly guaranteed 12% return – the shareholders are the ones effectively paying for this.

The final monetization of their company was announced on April 15th – however, it was to another company called MOGO Finance Technology (TSX: MOGO) which is chaired by Wekerle and 22.4% of MOGO is already owned by DCF.

DCF is nearly majority controlled by Wekerle (47% via a holding company that he wholly owns). Thus, a DCF shareholder has to ask whether their interests are aligned with his.

The agency issue is whether DCF minority shareholders benefited from the MOGO transaction. The obvious answer, when looking at the financial situation, is no. It reminds me of what Elon Musk did when he merged SolarCity and Telsa together – SolarCity was about to financially fail, but Musk wanted to fold it into Tesla to avoid the negative attention that such a failure would cause, with Telsa shareholders picking up the bill to deal with the entrails of that transaction.

Instead, this transaction was likely to give MOGO some financial breathing space as they were effectively buying the residential value of DCF’s private equity portfolio and more importantly, cash.

MOGO is bleeding significantly serious amounts of money:

The cash shortfall is significant. Operationally, MOGO is not in terrible shape – they reported an operating income loss of $4 million in 2018. The real deficit in MOGO is the cost of their capital. They have $75 million outstanding on a credit facility, $42 million in non-public debentures (ranging from 10% to 18% interest), and $15 million in 10% convertible debentures (TSX: MOGO.DB). When reading the fine print on the credit facility, the following is the key paragraph (note the underlined):

On September 25, 2017, the Company finalized a new senior secured credit facility of up to $40 million (“Credit Facility – Other” and, together with the Credit Facility – Liquid), which was used to repay and replace Mogo’s previous $30 million entered into on February 24, 2014 (“Credit Facility – ST”). This transaction resulted in the extinguishment of the Credit Facility – ST. On December 18, 2018, the Company increased the borrowing limit on the Credit Facility – Other from $40 million to $50 million. The facility bears interest at a variable rate of LIBOR plus 12.50% (with a LIBOR floor of 2.00%) up to the first $40 million of borrowing, a decrease from the variable rate of LIBOR plus 13.00% (with a LIBOR floor of 2.00%) under the Credit Facility – ST. The incremental portion of facility borrowings above $40 million bears interest at a variable rate of LIBOR plus 11.00% (with a LIBOR floor of 2.00%). Consistent with the previous facility, there is a 0.33% fee on the available but undrawn portion of the $50 million facility. The Credit Facility – Other matures on July 2, 2020, compared to the maturity date of July 2, 2018 under the previous facility. The amount drawn on the new facility as at December 31, 2018 was $44.3 million (December 31, 2017 – $28.8 million) with unamortized deferred financing costs of $0.2 million (December 31, 2017 – $0.2 million) netted against the amount owing.

You’re not going to get rich borrowing money at LIBOR plus 12.5%! Indeed, as a percentage of revenues, interest expenses are 28% – they will never show a profit at that level of interest bite.

Hence the presumed justification for the merger with DCF – Michael Wekerle has invested significant resources into MOGO. MOGO is borrowing money at exorbitant rates and DCF will add some assets to MOGO’s balance sheet, which can eventually be liquidated for desperately needed cash.

Does this in any way benefit non-controlling shareholders of DCF? Not at all. This explains why DCF traded down after the transaction and MOGO traded up.

Currently, MOGO has a market capitalization of $80 million (this is after it received a good 15% rise after the DCF announcement). Will they be able to find cheaper financing? Most of their debt matures in 2020.

But either way – this is yet another example of making sure to check the motivations of controlling shareholders before you jump on board – you might find they will make decisions that will have little to do with adding value to the stock and instead use the entity for other strategic purposes.

Difference Capital – Year-End 2016 Report

I wrote about Difference Capital (TSX: DCF) in an earlier post. They reported their 4th quarter results a couple days ago and their financial calculus does not change too much. They have CAD$29.6 million in debentures outstanding, maturing on July 31, 2018. Management and directors own slightly under half the equity, and thus they want to find a dilution-free way to get rid of the debt.

At the end of 2016 they have about CAD$14.4 million in the bank, plus $60.8 million (fair value estimate of management) in investments. One would think that in 2017 and the first half of 2018 some of these investments could be liquidated to cover the debentures. The situation is similar to the previous quarter, except for the fact that they’ve retired about 10% of their debt in the quarter, which is a positive sign.

Due to their investment portfolio not making any money (they have been quite terrible in this respect), they have a considerable tax shield: $186.3 million in realized capital losses, plus $41.9 million in non-capital losses which start to expire in 2026 and beyond. If you assume that they can realize both of these at half of the regular tax rates (I just quickly assumed 13% for the capital losses and 26% for the net operating losses), that’s $17.6 million.

Considering the market cap of the corporation is $26 million, there’s a lot of pessimism baked in. Mind you, there are a lot of corporations out there with less than stellar assets, a ton of tax losses, and tight control over the corporation (TSX: AAB, PNP quickly come to mind) so it is not like these entities are rare commodities. The question minority shareholders have to ask is whether the control group wants to bleed the company through salaries, bonuses and options or whether they are actually genuinely interested in profitably building the corporation (in all three cases, to date, has not been done).