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).
Difference Capital (TSX: DCF) was the venture capital corporation created by Michael Wekerle in 2012 (done via reverse merger of an existing corporate entity). It invested in a whole bunch of private entities in the hopes of making superior returns. While the going was initially good, it has steadily eroded in value as demonstrated by the five year chart.
In its modern incarnation, it has about $79 million invested (mostly in equity, and the rest of it in debentures and real estate) along a smattering of mostly private entities. They did employ some leverage in the form of a convertible debt offering and they did get in a bit of financing trouble as a result of the debt issuance, but for the most part they cleaned this up in 2015-2016 through buying back the debt at a discount, from $47 million outstanding at the beginning of 2015 to $32 million on June 30, 2016. The debt has an 8% coupon.
They also have $16 million in cash, and an extra $3 million in receivables if some of their prior asset sales do not incur claims by the end of 2017.
The math is simple – can they cover the $32 million in debt over the next couple years? Assuming there are no material claims, they have $37 million to pay off in interest and principal (interest expense assuming no buybacks), which leaves them about $18 million short if you completely dedicate their existing cash and receivables against their debt. Their burn rate is also about $3 million a year, excluding interest, offset by about $1 million in investment income.
The equation then becomes a matter of raising $22 million over the next couple years to service their debt, or to obtain an extension of their debentures (with some sort of sweetener). I view the latter to be the more likely scenario, but it is quite conceivable that they could cash out an investment or two and partially chip away at the $22 million figure. The other option is to equitize the debt at maturity, but this would be done at a significant discount to their proclaimed NAV.
The debt is trading at 97 cents on the dollar and given everything I have seen, I would view it as over-valued at present. The market is weighing the probability of a clean maturity to be too high.