TSX Bargain Hunting – Stock Screen Results

I’ve been doing some shotgun approaches to seeing what’s been trashed in the Canadian equity markets. Here is a sample screen:

1. Down between 99% to 50% in the past year;
2. Market cap of at least $50 million (want to exclude the true trash of the trash with this screen)
3. Minimum revenues of $10 million (this will exclude most biotech blowups that discover their only Phase 3 clinical candidate is the world’s most expensive placebo)

We don’t get a lot. Here’s the list:

September 1, 2017 TSX - Underperformers

1-Year performance -99% to -50%
Minimum Market Cap $50M
Minimum Revenues $10M
#CompanySymbolYTD (%)1 Year (%)3 Year (%)5 Year (%)
1Aimia Inc.AIM-T-74.89-72.74-86.9-84.6
2Aralez Pharmaceuticals Inc.ARZ-T-73.77-76.19-56.6
3Asanko Gold Inc.AKG-T-62.86-71.4-38.8-58.1
4Black Diamond GroupBDI-T-58.41-56.78-93.7-91.4
5Cardinal Energy Ltd.CJ-T-60.91-51.8-79.7
6Concordia InternationalCXR-T-42.81-85.24-95.6-69.2
7Crescent Point EnergyCPG-T-53.04-56.72-80.8-79.1
8Dundee Corp.DC.A-T-51.6-51.76-84.7-87.4
9Electrovaya Inc.EFL-T-42.72-61.8822201.2
10Home Capital GroupHCG-T-55.42-52.16-74.3-45.2
11Jaguar MiningJAG-T-54.31-62.14-55.8-99.7
12Mandalay Resources CorpMND-T-53.75-66.36-65.7-52.6
13Newalta CorpNAL-T-56.9-59.68-95.5-92.7
14Painted Pony EnergyPONY-T-64.97-60.94-77.4-65.9
15Pengrowth EnergyPGF-T-60.62-59.57-88.9-88.6
16Redknee SolutionsRKN-T-51.92-64.95-78.2-41.4
17Tahoe ResourcesTHO-T-53.04-66.27-78.2-66.9
18Valeant Pharmaceuticals Intl.VRX-T-15.25-56.68-87.4-67.3
19Western Energy ServicesWRG-T-61.61-55.09-88.6-82.7

Now we try to find some explanations why this group of companies are so badly underperforming – is the price action warranted?

1, 8, 10 and 18 are companies with well-known issues that have either been explored on this site or obvious elsewhere (e.g. Valeant).

2 is interesting – they clearly are bleeding cash selling drugs, they have a serious amount of long-term debt, but they have received a favorable ruling in a patent lawsuit against (a much deeper-pocketed) Mylan. There could be value here, and will dump this into the more detailed research bin.

3, 11, 12 and 17 Are avoids for reasons I won’t get into here that relate to the typical issues that concern most Canadian-incorporated companies operating foreign gold mines, although 12 appears to be better than 3 and 11. 17 has had huge issues with the foreign government not allowing them to operate their primary silver mine.

4, 13 and 19 are fossil fuel service companies.

5, 7, 14 and 15 are established fossil fuel extraction companies with their own unique issues in terms of financing, profitability and solvency – if you ever predicted a rise in crude oil pricing, a rising tide will lift all boats, but they will lift some more than others (specifically those that are on the brink will rise more than those that are not). 14 is different than the other three in that it is mostly natural gas revenue-based (northeast BC) which makes it slightly different than the other three which warrants attention.

6 If you could take a company that clearly makes a lot of money, and drown it in long-term debt, this would be your most prime example. It just so happens they sell pharmaceuticals. Sadly their debt isn’t publicly traded but if it was, I’d be interested in seeing quotations.

9 A cash-starved company selling a novel lithium-ceramic battery at negative gross margins would explain the price drop. Looks like dilution forever!

16 Lots of financial drama here in this technology company. They went through a debt recapitalization where a prior takeover was interrupted by a superior bid. Control was virtually given at this point and the new acquirer is using the company for strategic purposes that do not seem to be in line with minority shareholder interests. A rights offering has been recently conducted that will bring some cash back into the balance sheet, but the underlying issue is that the financials suggest that they aren’t making money, which would be desirable for all involved.

Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Amended Exchange Offer

You can read my previous analysis piece on the original exchange offer here.

Dundee Corporation has announced a revision to the exchange offer. This offer would have never been made if there were sufficient votes to accept the original exchange offer (2/3rds of votes required).

The management information circular has not been posted yet, but James Hymas beat me to the punch to providing some of his always excellent analysis on anything relating to preferred shares.

My own quick summary is: the deal stinks less compared to the original offer, but it still stinks.

The revised terms of the amended offer compared to the original exchange offer include:

– The removal of the $0.223/share consent payment for shareholders voting yes to the proposal before a specified date.
– The ability to redeem 15% of the issue on June 30, 2016 and a further 17% of the then-issue (i.e. another 14.45% of original issue size) on June 30, 2018January 31, 2018;
– An increase of the dividend rate from 6% to 7.5%;
– Granting of 0.25 warrants to buy DC.A stock with a strike price of CAD$6.00 with an exercise price of June 30, 2019 (which will be listed on the TSX).

Closing Market Prices for Reference

DC.A: $5.95/share (no dividend)
DC.PR.B: $12.00/share (11.9% yield)
DC.PR.C: $14.43/share (6.2% yield)
DC.PR.D: $9.50/share (11.8% yield)

Analysis

The meeting date has been postponed to January 28, 2016, but shareholders of record on December 3, 2015 (per the original exchange offer) will have a vote on the matter. They chose to keep the original record date – a revised record date would include shareholders that were more willing to buy into the terms of a sweetened exchange offer.

By far and away the most important provision is the removal of the $0.223/share consent payment. This consent payment introduced the concept of a prisoner’s dilemma where if you believe the deal was going to pass, you would be incentivized to vote in favour of the deal despite how bad it was.

Without a prisoner’s dilemma, there is no incentive to voting yes for a marginal or mildly adverse offering (which was the only way the previous offering had any chance of passing).

This deal still stinks, but the removal of the $0.223/share carrot will remove votes in favour because (and this is my personal speculation) most of the shareholders are angling for the June 30, 2016 redemption.

So now, shareholders can vote against the proposal and face no “punishment” of having missed out on a consent payment.

Notably the consent payment for the intermediaries is still in effect – brokers will receive $0.1784/share for each vote in favour received by January 21, 2016 and $0.0892 by January 26; so if you are indeed in favour of this bad deal, it would be in your best interest to vote your shares at the actual meeting so the company doesn’t have to pay out consent payments to third parties!

The ability to redeem 15% of the shares on the original June 30, 2016 redemption date is “nice”, but not of material economic consequence. The subsequent tranche (14.45% of the original offering size) on June 30, 2018January 31, 2018 is long-dated enough that credit risk considerations come into play (for instance, the company’s credit facility would have to be renegotiated at this point and you would expect their subsidiaries would actually start making money at this point).

The increase of the dividend rate to 7.5% reflects the very weak trading performances of the other two preferred share issues (yielding nearly 12% at current prices). James Hymas has done a much better job than I could explaining the quantitative details of this component. Credit risk, especially by redemption time, becomes a huge factor in properly determining the course of action for this exchange offer. Dundee is good for a June 30, 2016 redemption through the unused portion of their credit facility. After this, who knows?

I will attempt to ballpark a valuation of the warrants. The company stated the warrants would be listed on the TSX if the exchange offer is accepted and this would give preferred shareholders a venue to liquidate for immediate cash proceeds. While the historical volatility of Dundee common shares as of the past 30 days has been around 80%, their at-the-money options currently trade at an implied volatility of 42%. Using Black-Scholes valuation (which is not the best way to value long-dated options, but is good enough for paper napkin purposes such as this post) we get an option value of $1.84/share, or about 46 cents per preferred share (as each share would receive a quarter warrant).

Using some more formal methods involves different results – if you are that bullish on Dundee’s common stock, why bother playing around with the preferred shares when you can simply buy the common shares or even the other preferred shares?

Doing some simple sensitivity analysis, if Dundee traded to $8 (25% higher) between now and the January 28, 2016 special meeting, the implied value of the warrants per preferred share would be approximately 83 cents (50 cents intrinsic value and 33 cents time value), assuming implied volatility doesn’t drop (in reality – it would slightly). 83 cents does not come close to mitigating the capital losses that have occurred between the initial offering (when shares were trading at CAD$17) and when the exchange offer was proposed. Right now preferred shareholders are sitting on a $2.60 drop in market value and this exchange offer will come nowhere close to compensating them even with the increased coupon and partial early redemption rights.

I also find this statement to be amusing:

The determination of the Board of Directors is based on various factors, including a fairness opinion prepared by GMP.

Apparently the original exchange offer was fair, but the amended one is as well! Is there any offer that wouldn’t be considered fair by GMP?

Conclusion

Preferred shareholders have an even easier decision this time around – vote against the offer. It is still terrible compared to the existing Series 4 preferred shares.

As I have disclosed in my prior post, I sold out my DC.PR.C position between $17.20-$17.44/share in late November/early December. I’m a spectator at this point.

Update January 9, 2016: The initial part of this post had the second redemption date as June 30, 2018 when it should be January 31, 2018. The above has been corrected and the 5 month difference does not materially change the above analysis.

Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Exchange Proposal – Analysis

Dundee Corporation (TSX: DC.A) has a preferred share series, Series 4, which trades as TSX: DC.PR.C. The salient features of the preferred share is a par value of $17.84, a 5% coupon, and a shareholder retraction feature which enables the shareholder to put the shares back to the company at par on or after June 30, 2016. The company has the right to redeem the preferred shares at $17.84 in cash or 95% of the market value of DC.A stock, or $2/share, whichever is higher.

I was going to wait for the management information circular to be released before definitively writing about this proposal, but my impatience got the better of me (in addition to me no longer being a preferred shareholder, which tells you what I think of the arrangement). James Hymas has written twice about this one (Link 1, Link 2) and his conclusion the was the same as mine when I read the arrangement: we both don’t like it.

Dundee announced they wish to change the terms of the preferred shares per the attached proposal as they do not wish to allocate what would functionally be a CAD$107.4 million cash outlay, puttable at any time by the preferred shareholders. The special meeting will be held on January 7, 2016 with the record date at December 3, 2015 (so shares purchased until November 30, 2015 are able to conduct business at the meeting with the typical 3 day settlement period).

Details of proposal

(ranked in my order from most important to least important)

1. Shareholder “put option” can only be exercised on June 30, 2019 (from the present date of June 30, 2016);
2. A consent payment for an early “yes” vote of $0.223 (one quarterly dividend coupon payment) and $0.1784 for the broker holding the shares!
3. Coupon goes from 5% to 6%;
4. Company will have redemption features above par (and at par at June 30, 2019) that realistically will not be triggered;
5. A “reverse split” at a ratio of 17.84/25 to adjust the par value of the preferred shares to $25/share making the math a little simpler;

The required vote is 2/3rds of the voting shareholders.

Analysis

Dundee Corporation is controlled by the Goodman family in a typical dual-class share structure. The corporation is a quasi-holding structure, with entities that are consolidated on the financial statements and some that are accounted for with the equity method. Thus, reading the income statement of the consolidated entity is not a terribly fruitful activity until one looks at the components. Most of the significant components are losing money. Considering that there are some heavy investments in oil and gas, and mining, this is to be expected. The best income-producing asset is the spun-off Dream Unlimited (TSX: DRM) which is a real estate development company. The take-home message is that the corporation as a whole is bleeding cash – about $25 million a quarter in 2015 to date.

Their balance sheet is not in terrible condition, but it is deteriorating – At Q3-2015 they reported $274 million in consolidated cash in addition to having a $250 million credit facility (with $93 million drawn) that expires in November 2016. However, most of the other assets are related to their heavy investments in the resource industry, which already received an impairment charge in Q3-2015, and likely to be impaired further.

So while it is very evident that Dundee will be able to pay their CAD$107 million preferred share liability when it is available to be redeemed on June 30, 2016 and beyond, the clause to extend the redemption date from June 30, 2016 to June 30, 2019 involves a pricing of significant credit risk over the incremental three year period, hence this deal being very unattractive for preferred shareholders – it is not entirely clear that the company will have any cash left to redeem the shares! The company does have the option to redeem the preferred shares in common shares of Dundee, but at this point the common shares might be worth under the CAD$2 threshold which is the minimum conversion rate.

Finally, the market does have valuation information on the other preferred share series trading – DC.PR.B and DC.PR.D – currently giving a 9% yield with no redemption possibilities – and this would suggest that the proposal of DC.PR.C, assuming a moderate “redemption” premium (i.e. with the shareholders receiving their money back in 3.6 years), would result in such shares trading at a minimum of 92 cents on the dollar, or roughly CAD$16.41 equivalent on today’s preferred share price (roughly a 4% price reduction on today’s CAD$17.00 trading price!). This assumes that there is equal “credit risk” with non-payment of dividends between now and the redemption date and no risk of receiving a lessened payment in 3.6 years – hence, 92 cents on the dollar would be a maximum valuation at present given market conditions.

Thus, the consent payment would need to be significantly higher than $0.223/share for preferred shareholders to be compensated for the extra three years of “holding risk” they are taking – my minimum estimate would be about $1.43/share for this to even be considered on par value, or $0.60/share when considering the existing market price of CAD$17. Taking the mid-point of this would be a $1/share consent payment. I would suggest that $0.60/share cash plus another $0.40/share in common stock be given for such a deal to be accepted. I’d love to see how the “fairness opinion” rationalizes this original deal being fair for shareholders – maybe fair for the company paying for the report!

Ethics

What is unusual about this proposal is that the intermediary (i.e. in most people’s cases, the broker that holds the shares) receives $0.1784/share that is tendered in favour of the deal. This clearly will create a conflict of interest between brokers and their clients. Ironically if that extra $0.1784 were applied to the beneficial shareholder, the proposal might have stood a higher chance of passing.

These tactics are clearly anti-shareholder and a huge red flag against management that would propose such a scheme.

Conclusion

My recommendation is that DC.PR.C preferred shareholders reject the proposal. It needs to be sweetened further.

I did sell all my shares between CAD$17.20 to CAD$17.44 on the open market last week and am happy to be rid of this headache.

Search for yield – Dundee Corp

Dundee (TSX: DC.A) is an investment corporation. They are family-controlled (by the Goodman family) who control approximately 87% of the voting interest and 18% of the economic interest of the firm through a typical dual class share structure.

By virtue of owning Dundee Financial and other majority and minority-held investments, their consolidated financial statements are a mess to read. When pulling apart the components, they are diversified among real estate, energy, financial, mining and agriculture, in that order.

At the end of the day their stated book value is about $1.45 billion dollars, trading at a market capitalization of about $540 million. There are good reasons to believe the book value will be impaired simply due to their slowness in writing down some investments that clearly will not perform, but even assuming a 50% write-down (which seems appropriate) this brings the entity down to a liquidation value that is still well above its market capitalization.

On the liability side, the holding company has $92 million in term facility debt and subsidiaries make up approximately $100 million more in non-recourse debt. The leverage is not huge. The term facility is good for $250 million total and expires in November 2016 which is salient to the discussion below.

I generally have an aversion to controlled corporate structures as a minority holder unless if there are significant reasons why one would believe there is an alignment of interests. There also needs to be some reasonable assurances there isn’t a cesspool of conflict of interests in the other subsidiaries / operating companies that would cause shareholders to believe they are being taken to the cleaners with. I don’t get this element of confidence with Dundee, so I would steer away from the common shares. This is also found in companies with similar capital holding companies, including firms that have been on and off my radar (let’s be specific: Pinetree Capital is one of them – trading at around 50% of reported net asset value!).

On a more humorous note, Dundee’s logo also looks like the Blackberry logo, which is kind of disturbing considering how Blackberry has fared:

At least their logo is pointing upwards instead of flat.

I am writing not about the common shares, but rather the preferred share securities of Dundee. They have a series of preferred shares (Series 4) which has a par value of $17.84/share. The reason for the unusual par value was because Dundee split off DREAM Unlimited (TSX: DRM) which partitioned the original preferred share series issue (into DC.PR.C and DRM.PR.A). The shares have a coupon of 5%, paid out quarterly.

The preferred share series has an interesting feature: they are redeemable by the holder for $17.84/share after June 30, 2016. They are also retractable by the company indefinitely (at $17.84/share cash) and convertible into common shares at 95% of TSX market pricing or $2/share, whichever is more until June 30, 2016. The aggregate value of the preferred shares at par is $107 million.

This creates a rather interesting situation where an investor can purchase shares today (trading at roughly 97 cents on the dollar) and force a redemption in about 10.5 months’ time, skimming a 5.15% preferred yield and a 3% capital gain. One clear risk is whether the common shares will be trading above $2/share by June 30, 2016, which would seem to be a likely bet even if the underlying asset value of Dundee’s oil and gas companies are seriously impaired. It also does not help that most of their operating entities and equity-accounted entities are losing money, but the question is how much money will they actually end up losing between now and June 30?

There is also sufficient management interest in ensuring that their (not trivial) 18% economic stake in the firm is not diluted with a share conversion, coupled the with the fact that their operating credit line appears sufficient to pick up the bill (in addition to the $87 million cash they already have on hand in the holding corporation).

The preferred shares are extremely illiquid and trade in a narrow range that is presumably due to the redemption/retraction feature.

It is an interesting gamble that seems like it is reaching out for yield, but with an element of security given the pre-existing credit facility and 80% distance between the existing common share price and the $2 floor for preferred conversion.

In relation to the tax-preferred status of an eligible dividend coupled with a (presumed) capital gain at the end, one is looking at a functional tax-preferred 8% with a reasonable amount of asset security (although the security is implied by redeem-ability, definitely not direct security!), contrasted with a fully-taxable 1-year GIC at 1.2% (without liquidity) or 0.85% with liquidity. The spread seems to be a reasonable compensation for risk.

I would like to thank a comment poster by the name of Safety, who on May 25, 2015 posted about this in one of my prior rantings. I was indeed quite surprised at the quality of this person’s comments and hope he can chime in here again.

Anyhow, I finally picked up a few shares.