Going from public to private

A few of these have hit the headlines recently in a relatively short time period:

Genworth MI (TSX: MIC) having their 43% minority interest held by the public acquired by the majority holder Brookfield; this can generally be attributed to a relatively inexpensive valuation if it passes.

Dorel (TSX: DII.A/DII.B) is going private, lead by the managing family. An investor in the COVID-19 bottom would have made an astounding 10x their investment, although at that time it should also be pointed out that their financial position was already quite leveraged (principle: the more dangerous they look, the cheaper they are).

Rocky Mountain Dealerships (TSX: RME) in a management-sponsored takeover of the company with a capital management firm. In general, I’d consider the $7/share offered in relation to the rest of the firm to be a fairly cheap acquisition.

Clearwater Seafoods (TSX: CLR), while not strictly going private, will effectively operate as such under Premium Brands (TSX: PBH) holding half the ownership while the Mi’kMaq First Nations will control the other half of the company. My assumption is the (relatively high) valuation paid has strategic value in light of the First Nations’ fishing rights – squeeze out the competition.

The last three are companies that are generally off the radar of most institutional investors. Makes you wonder if others are brewing – if your obscure company doesn’t get much love from the financial marketplace, why bother staying listed?

Clearwater Seafoods debenture refinancing

This is slightly old news, but on October 7, 2010 the management of Clearwater Seafoods Income Fund are trying to get $45 million in debentures, due at the end of the year, out of the way without excessive cost.

The terms they offered are the following:

– Higher Interest rate: The proposed amendments provide Debentureholders with an interest rate that will be increased by 3.5% from 7.0% to 10.5%.
– Lower Conversion Price: The conversion price will be reduced from $12.25 per Fund unit (“Fund Unit”) to $3.25 per Fund Unit.
– Extended Term: The maturity date will be extended from December 31, 2010 to December 31, 2013, and the amended debentures will not be redeemable prior to June 30, 2011. As such, Debentureholders will have a longer period of time to receive a higher interest rate and potential to exchange their debenture for equity in an entity that is poised to create significant value for unitholders.

The higher interest rate is the only appealing sweetener for the holders – the conversion price decrease is insignificant when compared to the present unit price of 86 cents per unit; the extension of the maturity is also not beneficial when considering that it puts them behind in order with a series of term loans and a bond maturing on August 2013.

If I was holding the debentures (which I am not), I would walk away this deal.

If they dropped the conversion price to $1.00/unit, I would consider it. $3.25/unit, however, is a ridiculously high conversion rate.

Even if the debenture holders were stupid enough to approve this deal, they will not be collecting their coupons for too long since the company actually has to generate cash to pay out. It will not be long before this whole company has to give out a lot of equity to get rid of the high debt on their books. It would be one thing if the company were operationally running well but was financially leveraged too highly, but it just appears that this company is not particularly profitable, but management talks like it is.

When management has to use language like “potential to exchange their debenture for equity in an entity that is poised to create significant value for unitholders” in a pitch to debt holders, I have my doubts the right people are running the company as they are taking their owners and creditors like idiots.

The public will find out on November 12, 2010 whether this proposal goes through or not.

As I have previously disclosed, I have no holdings in Clearwater Seafoods equity or debt.

Clearwater Seafoods buys 3 months of time

I wrote earlier about Clearwater Seafoods Income Fund and their solvency issues. They had two maturities due – a small one in late September, and a much larger one on December 2010.

I have been an interested spectator to see how this resolves. I am not interested in purchasing either their equity or debt.

The first announcement in this refinancing game was on September 28, 2010, when Clearwater came to an arrangement with the September debt holders.

Of the CAD$11.9M debt that was due, three of the debtholders consisting of a majority ($8.8M or 74%) of the amount agreed to extend the debt to December 15, 2010, with the penalty of raising the coupon from 6.7% to 10.5% and the accumulated interest to date.

The rest of the minority holders (26% or $3.1 million) will be paid off the interest and debt principal.

So the company managed to pay off $3.1 million of debt, and deferred $8.8 million for less than three months.

The big maturity coming up (December 31, 2010) is a $45 million issue, which trades as CLR.DB on the TSX, with the last quoted value of 88 cents on the dollar. The relatively large price suggests the market anticipates that there will be a refinancing at relatively attractive terms for the underlying company. If Clearwater manages to get around this debt hurdle, there are successive hurdles to be cleared in 2012, 2013 and 2014.

Clearwater Seafoods facing debt crunch

Clearwater Seafoods Income Fund (TSX: CLR-UN.TO) is a financially distressed entity. The fund has an equity interest in a limited partnership. The limited partnership is the operating business that sells seafood. The units are trading at around 80 cents, with a market capitalization of about $23 million. The trust has stopped paying distributions since 2007 and is not likely to pay distributions for a long, long time.

Whenever investing in an income trust, they typically have more complicated ownership structures than corporations. You can usually get a summary of the structure in the first few pages of the annual information form. I have extracted a diagram which illustrates the relationship between the fund and the operating entity:

Whenever I see something like this, I think negatively since usually such structures exist to give certain (usually founding) entities control over the operating assets, but to distribute the economic interests to other parties that is not in proportion to voting interests. In this case, the unitholders of Clearwater Seafoods Income Fund are simply there for the ride by virtue of having a 54% voting interest in a very indirect say as to what goes on at the operating level. As a result, an investor would need extra compensation (i.e. higher reward) for the extra risk that they are taking (the risk that their interests are not going to be in alignment with the people holding the puppet strings).

Clearwater also has a debt problem – as of June 30, 2010 the operating entity has about $218 million in debt outstanding, and of this debt, the trust has lent the operating entity $45 million in exchange for partnership units (they have also done this in other instances with different terms and maturity dates). This loan matures in December 31, 2010. The operating entity also does not generate enough cash, nor are there other assets readily available to pay off the debt. As a result, the company will have to find external financing or find some method to recapitalize the debt.

There is also another $11.3 million loan that is due in September 2010.

In the management discussion and analysis, we have the following paragraph:

In December 2010 Clearwater Seafoods Income Fund has $45 million of convertible debentures that come due. These funds were invested by the Fund in Class C Units issued by Clearwater with similar terms and conditions, including maturity in December 2010. Clearwater also has approximately 1.3 billion in ISK denominated bonds, including CPI and accrued interest that come due in September 2010 (approximately Canadian $11.3 million at July 3, 2010). Clearwater is currently investigating refinancing alternatives and plans to refinance both before the respective maturity dates.

When we look at the market for the $45 million debenture, we see it is trading at 88.5 cents on the dollar. So the market is heavily betting that the debt will be refinanced at relatively favourable terms to debt investors. Recapitalization, however, appears to be out of the question since it would require relinquishing control to the debtholders and the current market value of the units is far too low to make a direct conversion worthwhile. Going into bankruptcy protection might occur if the debtholders and trustees cannot come to a mutually equitable arrangement.

Given the lackluster cash flow from operations, the complexity of the trust and underlying operating entities, and obvious credit risk, I will be watching this one purely from the sidelines to see how this mess gets resolved. My cursory look at the situation would suggest that the debt and equity are both overvalued.