Bombardier credit market completely out of the woods now

Bombardier’s bonds have traded considerably higher since their latest 8.75% bond issue (maturing December 2021) which is now trading at a premium to par.

They have to be looking at this and thinking about securing further long-term funding. It also gives them a lot more negotiating power with the Canadian government, who wants to inject some more money into the corporation (whether they need it or not) for political reasons.

Floating rate preferred shares are yielding 8%, while the fixed rate is yielding 9% (quite the premium to pay for a floating rate). Given the difference between the bond market and the preferred share market, I still believe the preferred shares are trading slightly cheap to what they actually should be.

The equity is also receiving quite a bid as of late, despite the massive warrants overhang in their earlier year government fundings. If they receive another large order for C-Series aircraft (something slightly larger than Air Tanzania), it is quite likely the stock will rise even further.

Bombardier will get their money from the federal government

It is quite obvious that Bombardier will eventually get some equity infusion from the federal government, which will be the final signal to all market participants that Canada will not let the corporation fail, even if the C-Series turns out to be an economic disaster (it does not appear to be at the moment – the risk at this point is on execution).

The question is what type of concessions Bombardier will have to make, and I suspect the “win-win” agreement will be only dismantling the dual-class structure of stock if the company keeps less than X jobs outside of Canada (mainly in the Province of Quebec).

The Government of Quebec (and the Quebec Pension Plan) invested previously into Bombardier and received common shares and warrants for a half-stake in the C-Series jet and also a chunk of the Bombardier transportation division.

My whole line of thinking was that preferred shareholders and bondholders would be the primary beneficiary of all of this capital infusion. Currently, the Series 4 preferred shares (TSX: BBD.PR.C) is trading at a 9.4% yield, while the Series 2/3 (floating/fixed) shares are at 8.2% and 9.1%, respectively. The next rate reset will be in August of 2017.


The yield curve for debt is quite healthy for Bombardier and they’ll be in a good position to refinance maturities, especially when they receive another equity injection. Yields should continue to compress in this scenario.

Bombardier debt trading like it is investment grade again

What a difference a year makes for Bombardier’s (TSX: BBD.A, BBD.B) credit profile:


Their credit profile over the last year has improved considerably – they can now tap debt capital from the market at reasonable rates. Right now the closest comparable is the 8.5 year maturity for 8.5% yield.

The market is clearly believing that their solvency concerns are over. This would likely get cemented (and yields will compress even further) on successful deliveries of CS100/CS300 jets to their customers, of which two are already delivered and 356 are currently in the pipeline.

The more junior preferred share (TSX: BBD.PR.C) with a 6.25% coupon is trading at a current yield of 9% (eligible dividends), which should continue to go lower as confidence increases in the firm’s ability to be financially sustainable with the C-series. The rumours of the pending Learjet sale would also be an injection of capital if it did occur, but it does not appear that this is necessary, nor is the rumoured injection of capital by the Government of Canada (although this might occur to give future customers the impression that the government will not let the company fail).

The common equity remains pinned around CAD$2/share, and there is considerable overhang from the warrants issued from the two Quebec financings. I doubt that there will be cash dividends on the common shares until the turn of the next decade.

Bombardier Bond Yield Curve Update


Investors increasingly are finding the 2018 and 2019 debt maturities to be “easy money”, while the middle and long-range part of the debt curve are relatively untouched from a month and a half ago.

Preferred share yields today for floating rate preferreds (TSX: BBD.PR.B) is roughly 8%, while on the fixed-rate (TSX: BBD.PR.C and BBD.PR.D) they are roughly 9%. Yields have compressed over the last month and in the humblest of my opinions, have room to compress further.

Small re-inspection of Bombardier

The on-again, off-again rumours regarding a billion-dollar injection with the Canadian government is purely negotiation strategies on both parts. The government wants to invest, but they also want to do it in a manner that allows them to save face. Conversely, the controlling shareholders of Bombardier want the money (it will indirectly end up in their pockets), but they also do not want to lose control over the gravy machine.

There will be a happy equilibrium where the taxpayers of Canada will transfer wealth to the owners of Bombardier, but the structure of the arrangement is up for debate. My suspicion is that some sort of arrangement will be made as long as they keep a certain number of jobs in Quebec, the Class A share owners will not be compelled to convert into Class B shares.

The credit market has been much more kinder to Bombardier, to the point where they can raise capital at a very reasonable rate:

The Class B equity has been hovering at $2/share, with the control premium (Class A shares) being around 10% of late.

Floating rate preferred shares (TSX: BBD.PR.B) has been hovering around 8.4% yield, while fixed-rate with conversion risk (TSX: BBD.PR.C) has been hovering around 9.9% of late.

As I alluded to earlier, investors must make a distinction between revenues and profit, and Bombardier is focussed on revenues at the moment. They will continue to service their debt and preferred shareholders, but I do not believe equity holders will be receiving dividends anytime soon. There is also a significant overhang with the two Quebec deals, with a significant number of warrants outstanding at US$1.66 level – although these warrants are held by institutional owners (Quebec), this will be a valuation overhang which will serve to depress the maximum upside of the common shares. If it ever gets to the point where these warrants are exercised, it would buffer the serviceability of debt and preferred share dividends.

I am of the general belief that if Bombardier plods along and returns to a profitability at a level that is somewhat less than what they have touted in their 2020 vision, and that their C-series jet clearly has a “runway” of perpetual orders keeping the assembly lines busy, that BBD.PR.C would trade around the 8% level (or roughly $19.50/share). The credit markets are indeed pointing toward this direction.

Now the corporation just has to make money.

I am still long their preferred shares, but under the belief that a good quantity of upside has been realized by investors in relation to previous trading prices. I went long on preferred shares less than a year ago when there was a lot more gloom and doom, and having been called a “brave soul” by national media for doing so.

Bombardier update

It is virtually a given now that Bombardier will announce that Delta Airlines has ordered a bunch of C-series jets. The announcement will probably be Thursday as there is no reason for them to move back the earnings announcement unless if they want to have a huge feel-good party for their annual general meeting on April 29th.

However, in terms of pricing of securities, “buy the rumour, sell the news” is the cliche to follow here. Most (if not all, or even an over-reach) of this news has been baked into current market pricing, which means that investors will now have to focus on the finer details, such as: how much of a price concession did Bombardier make in order to ink the sale on the contract?

These price concessions inevitably will affect profitability of the overall entity, and while it is nice to sell jets at a near break-even profit margin, the corporation needs to eventually make money.

However, Bombardier has solved one of their massive problems which was a chicken-and-egg type matter: they now have an American purchaser of their jets, which is a lot better than how things were portrayed for them half a year ago. More importantly, they are current in a position to raise capital again from the public marketplace.

I will point out in a reduced profit scenario that the security of income from the preferred shares (or even the bonds) looks more favourable from a risk-reward perspective than the common shares. Back in February, investments were selling preferred shares (the 6.25% Series 4) at 18% yields, but today it is at a much more respectable 10%. I’d expect this to get around 7-8% before this is done.

My investment scenario is pretty much resolving to my initial projections – just have to continue to be patient and then the decision is going to be whether I sell and crystallize the gain, or just be content to collect coupons and sit on a large unrealized capital gain.

(Update, April 28, 2016): As expected, Bombardier has announced that Delta has purchased 75 C-Series jets with an option to pick up another 50. This is a huge win for the corporation, but again, the question remains: how much money will they actually be able to make when they produce these things? Let’s hope they’re able to actually get the production lines going and crank them out without issues, unlike their Toronto street cars…

I’ve glossed over their Q1-2016 financial statements, and as expected, they still show an entity that is bleeding cash, albeit they have a lot of liquidity available – US$4.4 billion in cash and equivalents when you include Quebec’s $1 billion investment. They’ve got US$1.4 billion due in 2018 on their March 2018 debt (coupon 7.5%) but this is trading at around a 6.5% YTM at the moment so they can refinance it.

The company expects the C-series program will consume $2 billion further cash for the next five years, of which the province of Quebec has generously chipped in a billion. After that they expect things to be cash flow positive. Who knows if this will happen!

(Update, April 29, 2016) The market has “sold the news” as I expected. I generally believe the common shares will have a significant drag compared to the historical charts due to dilution, but the preferred shares and debt should normalize to “reasonable” yield levels simply due to their standing being in front of line on the pecking order. This is assisted with the Beaudoin family’s very rational self-interest in maintaining their control stake with the Class A common shares which will translate into outwards cash flows being paid as scheduled. If the Government of Canada decides to chip in a billion dollars, it is icing on the cake, but it is not required as Bombardier will be busy for at least the next four years producing C-series jets. Assuming they can actually execute on the production and the jets live up to their reported (superior to competition) specifications, they should be good to at least pay off debts and preferred share dividends.

Each additional order of C-Series jets will be making profitable margin contributions and as these orders continue to come in, the common shares, preferred shares and debt will ratchet up, accordingly. I still believe they are under-valued but not nearly as much as they were late last year when everybody was in doom and gloom mode! The preferred shares are the sweet spot in terms of risk-reward.

Bombardier bond yield curve

Bombardier’s bond yield curve has gone much more favourable over the past couple months. Their March 2018 bond issue (the nearest maturity) is trading at par (coupon is 7.5%), while going out to January 2023 the yield to maturity is trading just north of 10%.

(Update on April 18, 2016: After rumours of Delta Airlines close to purchasing C-Series jets and the rejection of the Canadian government’s bailout offer, the yield curve has compressed even further – the January 2023 yield to maturity is now at a bid of 9.5% – the rejection of the bailout offer has to be a positive signal for the company, i.e. they have the financial wherewithal to go on their own without further equity injections).

So while the company isn’t completely out of the woods yet, the market is giving them an opportunity to refinance debt if they choose to do so – However, it is unlikely a bond offering will be made until 2017.

On the preferred share component of their capital structure, their BBD.PR.B series (floating rate) is trading a shade under 10% eligible dividend yield, while the BBD.PR.C series is at 12.7% – somewhat reflecting an increased relative risk of dividend suspension, coupled with a conversion risk (as the company has the right to redeem for equity at the greater of $2/share or 95% of VWAP).

Also muddling the market news is the proposed federal government investment in Bombardier which would likely cement its ability to maintain its credit rating and dividend-paying ability of its preferred shares.

I continue to remain long on the preferred shares.

Revisit of Bombardier

There was an article on the Globe and Mail regarding my declaration that I had invested in Bombardier preferred shares (TSX: BBD.PR.B / BBD.PR.C).

I’m going to look very smart or very stupid at the end of this ordeal.

I will emphasize this is a high risk, very high reward-type opportunity. With high risk goes the chance for permanent capital loss, so the position size is appropriately small.

At current market prices, BBD.PR.B trades at a 12.6% yield, while BBD.PR.C trades at a 16.5% yield.

Other than the obvious business execution risk entailed within their aircraft division (specifically the execution of the C-Series project), there is another huge risk for investors: they will suspend preferred share dividends.

If this happens, BBD.PR.C will trade significantly lower (percentage-wise) than BBD.PR.B. The conversion risk is another component of the yield differential.

The comment about bond yields was accurate as of the middle of November, where after the government equity injections the short-term maturity bonds traded at reasonable yields. Today, however, yields have significantly widened, which also accounts for why the preferred shares are trading at such blowout yields.

Below is a graph of various yield to maturity curves of Bombardier debt (note these are NOT “yield to maturity” curves, I use a current yield + capital gain calculation which is non-standard but a more intuitive measurement for high yield debt I prefer using):


The near-term maturities have risen to the 10% yield levels, which puts the corporate entity in the refinancing danger zone.

Considering how much equity was injected into the company (US$2.5 billion) over the past few months, this is not exactly an enthusiastic market for debt, especially their March 2018 issue which matures in just 2.25 short years from now (albeit this specific issue’s last trade was 98 cents on the dollar – but go back another 6 months and that one traded at 90 cents!).

Part of this is likely because of year-end dumping for tax reasons, and the embarrassment factor of any fund managers that are holding onto this – they don’t want those shares to appear on their year-end financial statements to clients!

However, there is also a very deeply political component to my investment thesis. The Quebec investments are part 1 of the story. I’m waiting for part 2 to resolve itself (and this does not involve a federal government investment – if it happens, it will be icing on the cake).

Bombardier paper napkin valuation

Based on the slides on their investor day, looking at their 2020 financial roadmap, if the corporation is seriously able to reach $25 billion in revenues and 7-8% in EBIT, the quick calculation is the following:

$25 billion revenues
* 0.075 EBIT margin
= $1.875 billion EBIT
Less: $750 million interest expense (Assume $10 billion debt at 7.5%);
= $1.125 billion EBT
Less: $298 million (15% Federal + 11.5% QC = 26.5% taxes)
= $827 million net income

At this point they would likely have around 2.3 billion shares outstanding, so this would equate to about 36 cents a share. Just picking a P/E out of the cloud (15) and multiplying gives a $5.40 share estimate, or about 4.2x above existing market value, or about 33% CAGR if we use the full five years starting today.

Of course, for this to happen, a lot of execution risk (technical, marketing) has to be resolved, but management did a fairly good job solving the immediate financing risk – investors and customers no longer have to care whether the company is going belly-up or not (they are not).

I stress this is a total paper napkin exercise. Actual valuations under a more rigorous process can vary by a factor of 10!

Bombardier Bailout, part 2

Today’s big news is that Bombardier is selling 30% of its transportation division to the Quebec Pension Plan (CDPQ) for $1.5 billion.

The quick analysis is the following:

1. BBD will have received a cash injection of US$2.5 billion as a result of selling 49% of its C-Series aircraft interest and 30% of its transportation division; this will alleviate any short-term solvency concerns (from the September 30, 2015 balance sheet, they will have over CAD$5 billion liquidity to deal with). This capital is obtained with zero interest cost and some potential dilution of shareholders if the common share price ever gets above the US$1.66 exercise point (which one would hope it does in the recovery scenario!). Near-term bond yields (2018 maturities) are trading at 6.8%, while mid-range debt (2022 maturity range) is between 10-11%. The market is still skeptical of the financial recovery of the corporation.
2. BBD issues another 106 million warrants at an exercise price of US$1.66 on their subordinate voting shares. This is in addition to the 200 million they issued with the previously announce US$1 billion investment from the Quebec government.
3. BBD is required to maintain a cash balance of US$1.25 billion otherwise control on the board will start to erode.
4. This will save BBD from the hassle of doing an IPO (i.e. going through a regulatory quiet period, doing an institutional investor road-show, etc.), but noting that the CDPQ will have rights to trigger an IPO after 5 years of investment. CDPQ will also have significant minority shareholder rights.
5. If the Government of Canada wishes to tag along with some sort of contingent financing offer or backstop, BBD is in a considerably better position to negotiate as they will have sufficient financial reserves to do so.

I view this generally as a positive for the corporation, although they will still need to execute on getting the C-Series jet out the door and be able to generate sales. However, they seemed to have tackled the immediate perception issue of financial trouble, and have shown the financial world that the Quebec government will do whatever it takes to ensure Bombardier’s survival. If the Government of Canada chips in some cash, it will be icing on the cake.

My assessment of the preferred shares is still the same – they will likely pay dividends for the foreseeable future. At CAD$6/share, BBD.PR.B gives off a 11.25% yield, while BBD.PR.C is sitting at around 16%, with the risk that they’ll be force-converted to 12.5 shares of BBD.B – something I doubt management will do, but financially speaking it would make sense to issue 118 million shares to save CAD$14.7 million/year cash flow – with the way they are treating their equity holders, they might as well eliminate this headache off the books. This is the most likely reason why there is such a yield spread between the preferred share series.