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).

Pinetree Capital will undergo a change of control

A company that I used to write about in the past, Pinetree Capital (TSX: PNP), will finally be undergoing a change of control.

I own a small portion of their senior secured debentures (TSX: PNP.DB). This holding was much larger earlier in 2015, but they were mostly liquidated through redemptions throughout 2015. By virtue of the last redemption (which was partially paid out in equity) I also own a small amount of equity in Pinetree Capital that I have not bothered to selling yet as they were trading below my opinion of fair value.

I anticipated that the final liquidation of the public entity would be in the form of a constructive sale of its sizable ($500 million+) capital losses. Instead, it comes in the form of a rights offering. I’m not sure what the formal terminology of this is, but I would call it a passive takeover.

Pinetree will issue rights that are exercisable at 2.5 cents per share (which is about a penny, or nearly 1/3rd, below their existing market price). If no more than 40% of these rights are exercised, then a numbered corporation entity controlled by Peter Tolnai will exercise the remaining unexercised rights and take control of approximately 30-49.9% of the company. Tolnai also receives $250,000 for his efforts (probably paying for a lot of legal and advisory fees to structure the rights offering) (Update: Only $250k received if there was a superior offer, see the comments below).

Considering only 22 million shares (of approximately-then 200 million shares outstanding) were voted in their last annual general meeting, it would be a reasonable bet that investor appetite to purchase further shares in Pinetree will be most certainly less than 40% of the existing shareholders. A 30% stake in the company is akin to effective control. I have some fairly good guesses why Tolnai would not want more than 50% ownership of the company.

The rights will be traded on the TSX, but my analysis would determine the price would trade at bid/ask $0.005/$0.01 assuming the common shares are trading at bid/ask $0.03/$0.035. As a result, the rights would not be easy to liquidate after transaction charges and would probably remain relatively illiquid.

Peter Tolnai, judging by his website, feels like somebody I could relate to personally. My guess is that he is taking a strong minority stake in the company for the purposes of obtaining a functional, inexpensive, and public entity to raise capital and utilizing the rich reserves of capital losses to grow capital tax-free. I would deeply suspect he has a team in mind and will be raising capital after the April 22, 2016 special meeting that will authorize a (much needed) 100:1 reverse split.

The net proceeds of the rights offering is to pay off the senior secured debentures, which mature on May 31, 2016. The amount outstanding on the debentures is not huge – $6.7 million principal plus six months’ interest (another $335,000). However, Pinetree has disclosed in its filings that if it is unable to raise money with these rights, they would have to liquidate its remaining privately held investments, implying it does not have anything liquid anymore.

Considering Pinetree Capital has not released any financial information since the end of their September 30, 2015 quarter, it remains to be seen what their current balance sheet situation looks like on the asset column. I’m guessing they sold off all of their liquid publicly traded securities in 2015 (the largest of which was PTK Technologies). Pinetree must release their audited financial statements for the year ended December 31, 2015 by the end of March.

Shareholders as of March 23, 2016 will receive the rights to buy at 2.5 cents per share (which means March 18, 2016 is the last day to purchase common shares if you wish to receive rights), but somehow I don’t think the market will be bidding up Pinetree common shares.

This leaves the last question of the valuation of the final entity, assuming the rights are exercised in full. With the senior secured debentures paid off, there is likely a non-zero value in the company, but a better snapshot can be obtained after the release of the year-end 2015 statements. Another question will be how Peter Tolnai’s team will plan on making capital gains and utilizing the huge tax assets left in Pinetree, but considering he will likely have a 30-49.9% stake in the company, his incentives are well geared towards the passive shareholder base.

Utilizing Pinetree’s capital losses is actually a problem that I would like to help him solve, to quote a line from his “Giving Back” section on his biography, if I was so privileged!

Pinetree Capital – another debenture redemption

Previous articles on Pinetree Capital can be found with this link.

Today, they announced a redemption of $3 million in their senior secured debentures out of a total of $9.716 million outstanding. Interest accrued will be another 1.07% on principal. The redemption will be effective January 8, 2016.

The only wrinkle in this announcement is that $1 million of the $3 million principal will be redeemed in equity of Pintree Capital (TSX: PNP) and based on 95% of the weighted average price of trading from December 2 to December 31. So debentureholders will have 10.3% of their debt redeemed in equity of Pinetree Capital.

Based on Pinetree Capital’s equity, they have 201.9 million shares outstanding and are currently trading at 5 cents per share. If trading is around the 5 cent level, Pinetree will be issuing 21.05 million shares, representing a dilution of approximately 9.4% to existing shareholders. If the common shares start trading lower as a result of this announcement, each incremental decrease in trading will result in more dilution to shareholders – a mildly toxic convertible situation. For example, if the weighted average price is 4 cents a share, Pinetree will issue 26.3 million shares with 11.5% dilution. At 3 cents, the issuance is 35.1 million shares (14.8% dilution).

My guess at present is that the common shares will trade around 4 cents as a result of this announcement, but after the issuance of shares there will likely be a supply dump.

What was peculiar is the following quote in the news release:

The issuance of common shares in partial payment of the redemption amount is subject to the satisfaction of certain conditions contained in the indenture governing the Debentures, including the approval of the Toronto Stock Exchange, failing which the total redemption amount will be paid in cash.

I have guessed the motive of the company to do this redemption was to reduce interest expenses, but if they are opting to not deploy cash in exchange for (nearly worthless at this point) equity, then it is constructively like doing a secondary offering in the marketplace at a very low share price.

The other motive for this partial redemption might be management bracing for impact when they take an impairment expense on their Level 3 assets when they do the year-end audit. The deadline for the year-end annual report is the end of March 2016. They still have to abide by a debt-to-assets covenant of 33%. They are at 28% as of the Q3-2015 report. If there is a mild asset impairment then they will breach their covenant. There might be a temporary breach of the covenant (between the December 31, 2015 reporting period to January 8, 2016) which will be cured by this redemption, but investors will not know about this breach until the issuance of the annual report itself as they no longer report monthly NAV.

Pinetree also received a serious setback when Aptose Biosciences (TSX: APS) suspended a clinical trial, taking its stock price down 50% on November 20, 2015. This probably destroyed another $2.5 million in Level 1 assets (of which $14 million was remaining on September 30, 2015!).

In terms of estimating the shareholder value, the primary variable at this point is whether the board of directors has any plans on executing on a recapitalization-takeover of the company, utilizing its massive capital losses for an acquiring entity. I’m guessing this would be worth about 8-10 cents a share, but first they need to get rid of their remaining debt.

The endgame for Pinetree Capital

Long-time readers will know of my investment in Pinetree Capital Debentures (TSX: PNP.DB) and the various amounts of volumes written on this company in the past, probably more than anywhere else on the internet and if I may modestly say so, in higher quality.

The debentures caught my eyes when the underlying company blew their debt-to-assets covenants and while having questionable asset quality, they still had enough blood that could be squeezed from the stone which would flow through to the bondholders.

So far this has been the case – purchasing my 70 cent stones has yielded one dollar blood droplets, plus a generous annual coupon of 10%. In addition, security is granted on all assets of the company, so even if things went wrong, there was a first-in-line claim to picking what was left of the carcass.

By virtue of going from $54 million in debt to about $10 million presently, I’ve had over 80% of my initial position redeemed in cold, hard cash. There’s a bit of residual that I continue to hold. I had an order set to liquidate the position above par, but I am content on riding it until maturity (or CCAA proceedings, whatever the case may be!).

This brings me to my latest post on the company, which is subsequent to their third quarter release. The information contained in the news release is relatively useless for analysis purposes, but their financial statements on SEDAR are much more relevant and I will quote some of the material.

First of all, they were in breach of their covenants and failed to cure them and were under forbearance with a committee of debtholders. This has now passed and the company’s debt-to-assets ratio is once again under 33% (it is approximately 28% as of the end of October). As a result, the debtholders no longer have any direct control of the company’s operations.

What will follow is a simple mathematical exercise in terms of the cash requirements of the company vs. their capacity to actually pay it.

The company still has about $9.8 million in secured debt to pay off, which matures on May 31, 2016. They have an approximate $0.5 million coupon to pay off on November 30 and assuming no further maturities, another $0.5 million in May 2016.

They are sub-leasing their offices and paid somebody $1.55 million so they could get rid of their lease. $1 million is to be paid in Q4-2015, and the remainder on February 1, 2016. They pay about $0.6 million/year for their lease so they gave somebody a 2.5 year inducement on a lease contract that expires on December 2023. They vacate their office effective February 1, 2016. It is not known where they will be moving to, but one can reasonably expect that Pinetree Capital can be run out of a lawyer’s office in the near future instead of a 9,928 square foot behemoth employing less than 10 people.

The company’s burn rate otherwise is $0.8 million/quarter, so operationally they will spend about another $2 million, plus likely professional fees if they are going to do anything financially sophisticated (like liquidating their tax losses!).

So their total cash requirements to May 2016 is likely to be around the $14 to $15 million range – $10.8 million for debenture principal and interest payments, and the rest of it the usual G&A and professional expenses that all publicly traded companies must incur.

In terms of their ability to pay, they had $2.3 million cash on the balance sheet at September 30, 2015. We know they redeemed $5 million in debentures (plus $0.2 million interest) in October, so this functionally put them at a negative $2.9 million balance.

Level 1 assets included $14.2 million in equities – likely consisting of PTK, APS and AAO equities. They do have a minor amount of PRK and LAT, but disposal of these equities will prove to be difficult given the lack of liquidity.

Let’s pretend they liquidated enough Level 1 assets to pay the $2.9 million residual (or they were actually successful in liquidating some of their Level 3 assets, which would be a minor accomplishment). This leaves them with $11.3 million in Level 1 assets remaining to bridge a $14-15 million expense requirement over the next 7 months.

In other words, even if they were to get perfect liquidity on their Level 1 assets the next half year, they still are going to be short on cash.

The remaining assets are Level 3 assets, which total $24 million. However, most of these assets are private investments and hints of what these are can be dredged through previous press releases. SViral was a $5 million investment that nothing could be heard of over the past year in terms of that company’s operations (indeed if any exist at all).

Keek was a slightly more transparent case as it is publicly traded. Pinetree had invested $3 million in their secured notes and they cut a deal to sell them for an undisclosed amount of money. Did Pinetree receive 100 cents on the dollar? Or did they take a slab of equity that they can’t possibly choke through the marketplace?

Due to management not disclosing any information at all about Pinetree’s investment portfolio, one can only guess what else is in there. However, as the year-end audit comes closer, the auditors will have to determine whether management performed a proper test for asset impairment (IAS 36 for those in the accounting world reading this – I am an accountant, after all!) – i.e. is the book value as stated on Pinetree’s books actually what the fair value of those assets are? I would find it very difficult to believe that a $5 million equity investment in SViral is still worth $5 million presently.

My gut instinct says the real value of this Level 3 portfolio is worth about 25% of what management says it is, but without any real disclosure of the components, who knows?

One thing I do know, however, is that management has a huge incentive to ensuring that reported value is kept as high as possible, because they don’t want their assets to fall to the point where the debt-to-assets covenant (33%) gets breached again! My calculations show if they had to impair $6 million of their $24 million in Level 3 assets (without any offsetting gains in their remaining Level 1 asset investment portfolio), they’d once again breach the debenture covenant and have to go through the charade of curing the default.

There are a couple other options for Pinetree and both of these have been discussed before.

One is that in their indenture agreement they are allowed to redeem up to 1/3rd of the debentures in the form of Pinetree equity. The equity redemption of the remaining debentures would dilute existing shareholders by a significant fraction at current market prices (6 cents per share).

Another solution is a monetization of the capital losses the company has incurred to date in a financial transaction. Pinetree has had the dubious distinction of losing half a billion dollars in its investments over the past few years and these tax losses can theoretically be monetized by some sort of recapitalization transaction. Using a theoretical capital gains tax rate of 13% and a willing partner buying the tax credits at 40 cents on the dollar would suggest there’s about $20-25 million left to be harvested here after legal expenses. This is really the only reason why I’m holding onto the secured debt.

Either way, management is still going to be financially creative to get their debt albatross off their backs. It still does not look good in any manner for the equity holders and the debtholders will actually face some risk in terms of getting paid their due in cold, hard cash.

Disclosure: Still holding onto some of those debentures!

A nice time to be holding cash

This is a rambling post.

Downward volatility is the best friend of an investor that has plenty of cash.

You will also see these punctuated by magnificent rallies upwards which will get everybody that wanted to get in thinking they should have gotten in, until the floor drops from them again which explains today.

By virtue of having well over half cash and watching the carnage, I’m still not finding anything in fire-sale range except for items in the oil and gas industry which are having their own issues for rather obvious reasons. Examples: Penn West (TSX: PWT) and Pengrowth (TSX: PGF) simultaneously made announcements scrapping and cutting the dividends, respectively, and announcing capital expenditure reductions and their equity both tanked over 10% today. Crescent Point (TSX: CPG) had a fairly good “V” bounce on their chart, but until oil companies as an aggregate start going into bankruptcy and disappearing, it is still going to be a brutal sector to extract investor value from.

I just imagine if I was one of the big 5 banks in Canada and having a half billion line of credit that is fully drawn out in one of these companies. Although you’re secured, you don’t envy the train wreck you have to inherit if your creditors pull the plug.

The REIT sector appears to be relatively stable. Looking at charts of the top 10 majors by market capitalization, you don’t see a recession in those charts. If there was a true downturn you’d expect to see depreciation in the major income trusts. I don’t see it, at least not yet.

Even when I exhaustively explore all the Canadian debentures that are publicly traded, I do not see anything that is compelling. The last debt investment which was glaringly undervalued was Pinetree Capital (TSX: PNP.DB) – but this was in February. They recently executed on another debt redemption which puts them on course to (barely) fulfilling their debt covenants provided they can squeeze more blood from their rock of a portfolio. I wouldn’t invest any further in them since most of what they have left is junk assets (Level 3 assets which will be very difficult to liquidate). One of those investments is a senior secured $3 million investment (12% coupon!) in notes of Keek (TSXV: KEK) which somehow managed to raise equity financing very recently.

The preferred share market has interesting elements to them as well. Although I’m looking for capital appreciation and not yield, it is odd how there are some issuers that are trading at compellingly low valuations – even when factoring in significant dividend cuts due to rate resets (linked to 5-year Government of Canada treasury bonds yielding 0.77%!). I wonder if Canada’s bond market will go negative yield like some countries in Europe have – if so, it means those rate reset preferred shares will have even further to decline!

The continuing saga of Pinetree Capital

Pinetree Capital (TSX: PNP) announced it will be redeeming another $10 million in its debentures on June 5, 2015. This is on top of the $10 million that was already redeemed on April 30, 2015.

For those of you following the Pinetree Capital saga (history of posts here), I continue to hold Pinetree debentures (TSX: PNP.DB) as I believe it is more probable than not they will be made whole at maturity.

On December 31, 2014 Pinetree Capital had approximately $107 million of investment assets on its balance sheet (at fair value, $75 million level 1, $8 million level 2 and $23 million level 3) and $54.8 million in debentures that are now senior and secured by all assets of the company. They have no other debt. When the debtholders got three of their directors on the board when Pinetree defaulted on their debt covenants in late January, presumably on February they start on their liquidation spree. On March 29, 2015 they had $14.3 million cash in the bank which they used to redeem the first $10 million of debt. After June 5, 2015, they will have $34.8 million in debentures outstanding.

Debentureholders will also receive their semi-annual interest payment (10% annual coupon) on May 31, 2015.

As part of their forbearance agreement (to stave off their debt being declared fully payable with likely CCAA implications), Pinetree Capital was required to redeem a minimum of $20 million face value in debentures by July 31, 2015. They had the option of redeeming the debentures with 1/3rd equity, which they have not done so to date. They are also required to maintain a debt-to-assets ratio of 50% until October 31, 2015 and then 33% afterwards.

When doing a quick and dirty pro-forma with no change in assumed asset value other than the payment of interest and principal on debentures, after the June 5 redemption they will have a debt-to-assets ratio of 40.5%. If Pinetree were to redeem another $11 million in principal by the end of August, this would bring the ratio to 33%. Presumably they would want a little bit of a margin of error to work with, so it is likely before October 31, 2015 that they will redeem around $15-20 million in further principal which would bring them safely below the 33% mark.

Not surprisingly, the market has picked up on this and has bidded up the debentures to 88 cents on the dollar. What has previously been a 75 cent dollar is now considerably more expensive and will likely converge to par throughout 2015 with diminishing market liquidity as the debenture supply dries up.

Disclosure: Still long on PNP.DB, but as the redemptions occur, my portfolio weighting decreases.

Pinetree Capital – Redeeming debentures

Pinetree Capital (TSX: PNP) today has announced it is redeeming $10 million of its debentures, at par value plus accrued interest, effective April 30, 2015.

As readers are aware by my previous rantings about Pinetree, their debt has been a remarkably good deal, especially around the 70 cent range, but they are still a reasonable risk/reward at 80 cents. The extra security that was arm-wrestled from management once they blew the covenants is icing on the cake.

Debenture holders will be cashed out pro-rata, which works out to an 18% redemption of debt. I’ll be hard-pressed to find a better alternative for the cash, but I’ll be happy to have it sitting in the bank account until such a time.

The market value of the debentures was bid/ask 80/83 cents and considering the cash-out is at par, this will likely result in an increase in the quoted price for the remaining debentures.

Notable to this announcement is that this is going to be funded by cash on hand, which implies that the company has been doing some liquidation of its non-disclosed holdings (these would be less than 10% ownership stakes in various firms). There has only been a minor trace of activity on SEDI on their 10%+ ownership stakes (the two largest that are publicly known is POET Technologies (TSXV: PTK) and Sphere 3D (Nasdaq: ANY)).

Also notable is that this is the first $10 million of the $20 million that is required to be redeemed by July 31, 2015. Up to half of the remaining amount can be done through open market transactions and also the company has the option of redeeming 1/3rd of its debentures in the form of equity, which has not been the case to date.

Finally, Pinetree has not released its 2014 year-end audited financial statements, but one can assume that they will be able to with this redemption notice. The annual statements are due on March 31, 2015 otherwise very bad things happen to reporting issuers that do not report.

Pinetree must have a debt-to-assets ratio of 50% up until October 31, 2015 and then after that it must be below 33% otherwise it will be in default of its debt covenants (once again). We should get a better view of what may occur once they file their 1st quarter report. Achieving 33% is going to be made much easier once they complete $20 million in redemptions and the question is whether debenture holders are going to receive equity or not (which would likely give debtholders control of the firm).

I’m expecting there will be a reasonably decent chance that investors in the senior secured convertible debentures will be made whole and also be able to collect a 10% coupon between now and the May 31, 2016 maturity date.

Pinetree Capital Debentures – Buying a dollar for 80 cents

The ongoing saga of Pinetree Capital (TSX: PNP) continues.

After coming to an agreement (after what functionally amounted to a financial game of chicken when management “blinked”) with over 2/3rds of the debenture holders in a very private setting, management has been ousted, and a new agreement has been put in place that grants debt holders security over the assets of the entire company.

There is also a provision to repurchase debentures as follows:

On or prior to July 31, 2015, the Company shall reduce the aggregate principal amount of the outstanding Debentures by at least $20,000,000 by redeeming outstanding Debentures and, at the Company’s discretion, repurchasing outstanding Debentures up to a maximum principal amount of $5,000,000 pursuant to a normal course issuer bid.

There will likely be some market action in the upcoming months as the company attempts to repurchase its debt. Of course by doing so the price will get closer to par value. There is also a redemption to equity feature which has been opened by the debtholders, as the following language was inserted into the indenture agreement:

The Initial Debentures will be redeemable prior to the Maturity Date in accordance with the terms of Article 4, at the option of the Company, in whole or in part from time to time, on notice as provided for in Section 4.3 for the Redemption Price. The Redemption Notice for the Initial Debentures shall be substantially in the form of Schedule B. In connection with the redemption of the Initial Debentures, the Company may, at its option, and subject to the provisions of Section 4.6 and subject to regulatory approval, elect to satisfy its obligation to pay up to one-third of the aggregate principal amount of the Initial Debentures to be redeemed by issuing and delivering to the holders of such Initial Debentures, such number of Freely Tradeable Common Shares as is obtained by dividing such amount by 95% of the Current Market Price in effect on the Redemption Date. If the Company

The company will have the choice of either paying out the debtholders in cash, or by issuing equity, or a combination of both up to a one-third allocation of equity, depending on what the market price is.

Management will be compelled to dispose of securities from the newly constructed investment committee, which consists of two directors that were nominated by the debenture consortium:

The Company shall adhere to the decisions of the Investment Oversight Committee, except in cases where the Company’s board of directors has overruled a decision of the Investment Oversight Committee. For greater certainty, the Investment Oversight Committee has the power to override a decision of the Company’s management to purchase or dispose of any securities and to make a binding decision to dispose of any security now held or that may be held by the Company in the future, provided that such decisions are subject to the approval of the board of directors of the Company.

In addition to having a net asset value above the market value, in addition to an anticipation of an equity conversion, the equity of Pinetree has risen. It will likely rise to a point that reflects a modest discount to NAV, and the company is required to disclose its audited financial statements by the end of March.

Pinetree’s two largest holdings, Sphere3D (Nasdaq: ANY), and POET Technologies (TSXV: PTK), have done quite well and will likely provide cash for paying off debtholders.

Finally, lest the company gets its balance sheet out of position, it is required to have a debt-to-assets ratio of 50% up until October 31, 2015 and then afterwards it will go down to 33% as per the original covenant. This will assure the debtholders will be in the driving seat until they are paid off in full. If the company defaults on these provisions, the debtholders will set terms of forbearance and will likely be in a position to be paid off no matter what, as at this point there will only be $35 million outstanding and being first in line to collect.

The conclusion is obvious: barring a collapse in Pinetree’s (admitting they are less than AAA quality) holdings, the original thesis as presented holds true. Debtholders will very likely get the chance to get out at par and collect a very happy 10% coupon in the meantime. The fact that debtholders now have a general pledge of asset security over the entire company is icing on the cake – it does not give Pinetree any maneuvering room until they are paid off first (i.e. by pillaging debtholders by putting somebody ahead of line with them – see Armtech Infrastructure for the end of that sad saga).

I will discount the fraud scenario as it is perfectly obvious by the February 19, 2015 SEDAR disclosures that debentureholders got a very good look at the corporation as they made their negotiations. I would expect the audited financial statements to be published in mid-month. The only accounting decision of any substance would likely involve a valuation allowance offsetting their currently existing tax asset of $13 million (this would have an impact on their NAV, but this can get unlocked in some other transaction of substance).

The maturity date for the debentures are May 31, 2016, but effectively debtholders will know the game is over by October 31, 2015 and the market will treat the debt at that time as more or less being a done deal (i.e. at least 95 cents on the dollar, if not more for the 10% interest accrual).

With the conservative assumption that debtholders will get 95 cents on the dollar, it looks like from existing market prices (roughly 80 cents), an investor will achieve a 20% capital gain and another 10% interest coupon between now and whenever they get cashed out. I’ll call that a 30% reward for little risk at this stage of the game.

It is really a sad story for me as I cannot think of any other place where capital could be allocated for such a good risk/reward situation. I am riding the coattails of some financial institutions that have their vested interests in total alignment with mine – i.e. taking the reins of the underlying company to ensure we are paid back. Backing up this claim is the following clause inserted into the indenture:

The Initial Debentures are direct secured obligations of the Company, and rank senior to all other indebtedness for borrowed money of the Company. In accordance with Section 2.12, the Initial Debentures rank pari passu with each other. Notwithstanding anything else to the contrary in this Indenture, no additional Initial Debentures and no additional series of Debentures shall be issued under this Indenture or under indentures supplemental to this Indenture.

I have little opinion on the equity other than that it should trade a shade below net asset value, plus some amount for the implied value of the future capital loss carryforwards for an inspiring acquirer of Pinetree. Unlike Aberdeen International (TSX: AAB), new management at least has the ability to show they pretend to care about shareholders instead of using the publicly traded vehicle as a personal enrichment device.

This might be my last post on Pinetree Capital as the story appears to have come to a close, but “never say never” in these very strange and weird capital markets we live with.

Disclosure – Long on a non-trivial position of Pinetree Capital debentures.

Last second agreement with Pinetree Capital

I thought Pinetree Capital was going into CCAA, but clearly there was enough arm-wrestling behind closed doors to come to the following agreement (which should hopefully be posted in SEDAR fairly quickly):

In connection with the execution of the Forbearance Agreement, each of Messrs. Roger Rai, Sheldon Inwentash and Marshall Auerback will resign from the board of directors of the company. As well, Mr. Inwentash will resign as Chairman and CEO of the company. Richard Patricio, the company’s Vice-President, Corporate and Legal Affairs will assume the responsibilities of Interim CEO.

Management is gone, plus three (of seven) directors, all of which can be considered to be heavy insiders in the company. Needless to say, considering past performance, this can only be a plus.

The CFO and corporate counsel is still on board, presumably to keep continuity in the overall operation.

I had speculated in my earlier post that the reason why Pinetree did not come to any agreement with debentureholders was because they demanded that management be removed, and it looks like management blinked. The reason for this is perhaps because they did not want to be associated with an entity going into creditor protection. This has to get disclosed in any subsequent documents (such as annual information forms) if management is associated with any publicly traded entities.

the Supporting Debentureholders will have the right to nominate up to three directors to the company’s board of directors; two of whom will constitute an investment oversight committee to be established by the company;

The current board (including the three directors that will be leaving) is of seven people; while this is minority representation, one can presume that they will bring in actual investment expertise to ensure that the interests of the debtholders are respected in future decisions. In particular, the hiring of a new CEO will be the most important decision the reconstituted board will make.

the company will grant security over its assets in favour of all holders of the Debentures;

This will ensure that debenture holders will receive proceeds of any sale of the company, including the value of the deferred tax assets. It will also restrict the company from borrowing more money unless if subsequent lenders understand they are subordinated.

the company will utilize at least $20 million to reduce the aggregate principal amount of the outstanding Debentures by July 31, 2015, and will be subject to a debt-to-assets ratio of 50% (in lieu of 33%) for the three-month period of July through September;

$20 million will be utilized and whatever discount there is to market value will result in a higher par value retired by the corporation. At the current quotation of 70 cents, this would retire about $28 million in par value, or about half the current issue.

the Indenture will be amended to remove restrictions on the company’s redemption rights, subject to the approval of the Toronto Stock Exchange; and

I am not entirely sure what this alludes to, but we will see whenever the agreement is posted on SEDAR.

the trustee and the Debenture holders will refrain from exercising any rights or remedies that they may have against the company under the Indenture or otherwise, as a result of the current default and any subsequent default in respect of the Covenant occurring up to October 31, 2015.

This is functionally a 9 month grace period. The maturity of the debentures is May 2016.

You will have the debtholders working to ensure an efficient liquidation of assets coupled with the possibility that they might end up with a significant equity stake if there is a redemption to equity on the May 2016 maturity. The October 31, 2015 restriction is designed to ensure that debtholders have effective control of the company if Pinetree’s debt-to-asset ratio is not less than 33% by October 31, 2015.

Some remaining questions:

1. Will Pinetree be able to liquidate its holdings efficiently? Reported NAV was 46 cents in November 30, 2014.
2. Final year-end statements must be received and filed publicly by March 31, 2015. At a minimum, it will probably look like their $13 million in deferred tax assets will be vanishing and a valuation allowance put into place. The level 2 and level 3 assets will have to be carefully examined to see if they are worth anything (this was $55 million of the reported $161 million in assets at the Q3-2014 statement).

Finally, the asset remaining on the books that is not going to be seen on the statements will be the half-billion dollar capital loss tax shield. This will get sold, the question is for how much and to who. You would think that the debtholders, compromised mainly of financial firm people, will have a way of getting this into one of their own closed end funds for utilization – funds that generate capital gains to offset such losses.

Currently the equity is getting trashed (at 7 cents per share, down from 11 cents when it was halted), while the debentures are roughly level. My initial suspicion would be that with the removal of management, you would have an increase in valuation, but I guess I was wrong there too.

That’s about it for Pinetree Capital

History: Pinetree Capital previous postings (link here).

January 23, 2015 was the date that Pinetree Capital (TSX: PNP) had to cure a covenant breach of its debt-to-assets ratio (being 33% or less). Unfortunately for them, they failed to obtain a waiver or apparently cure the default.

Before the ordinary time of opening, IIROC put a trading halt with news pending. There hasn’t been any news published so it would lead one to believe that management has failed to cure the breach.

Section 8.1 of the indenture states:

ARTICLE 8
DEFAULT
8.1 Events of Default

(x) in each and every such event listed above, the Trustee may, in its discretion, and shall, upon receipt of a request in writing signed by the holders of not less than 25% in aggregate principal amount of the Debentures then outstanding, subject to the provisions of Section 8.3, by notice in writing to the Company declare the principal of and interest on all Debentures then outstanding and all other monies outstanding hereunder to be due and payable and the same shall thereupon forthwith become immediately due and payable to the Trustee.

One can presume that given the rather speedy notice that was given to the company of the default that the trustee is going to get notified of this breach fairly quickly and on the first business day, January 26, 2015, the principal and interest will become due immediately. Since there is an event of default occurring, the company cannot trigger the common share conversion feature.

My guess at this point is that the trading halt will continue until Pinetree officially declares itself unable to pay its debenture and goes into CCAA. Then TSX rules will suspend trading and eventually delist the company. The subsequent proceeding will involve the bankruptcy trustee being instructed by its creditors (the bulk of which are the debenture holders of which the major players will form a committee) to liquidate and put an end to the terminally ill patient.

My other observation is that Pinetree Capital management should have received the hint back in 2013 that they needed to reduce debt by purchasing debentures off the open market while they were given a 9-month grace period by its debtholders. They instead went recklessly purchasing other penny stock securities and ultimately got what they deserved.

My other guess is that behind the scenes the debtholders told management the only condition they will accept for a waiver is a complete overhaul of the board of directors and management. Clearly management did not agree, nor is it in management’s best interest to re-capitalize their company with fresh equity (i.e. cash) since this cash would most likely end up in debtholders’ hands.

I originally thought management had better self-preservation instincts, but apparently even this was too much for them to handle.

Skimming their last quarterly report (September 30, 2014), we have the following entry:

For the nine months ended September 30, 2014, the Company generated net realized losses on disposal of investments of $334,412, as compared to $14,921 for the nine months ended September 30, 2013. The net realized losses in the current period was a result of the disposition of approximately 68% of the Company’s investment portfolio.

Realize these numbers are in the thousands, so just in the first nine months alone they managed to go through 1/3rd of a billion in realized losses (a lot of which I am sure have been on their books for ages). They also have another $118 million in unrealized losses their portfolio, which will inevitably get liquidated for less than fair value as stated on their financial statements.

My idea for Pinetree’s inevitable exit strategy was that they would sell their corporation off to some hedge fund actually capable of making money. The acquiring fund could use Pinetree’s accrued capital losses as a massive tax shield. There are quite complex rules concerning CCAA (if things get there) and utilization of operating and capital losses that I will not get into this post about, but suffice to say, my original idea for their exit strategy has not materialized.

Somebody give me management’s $1 million a year salary job and I’ll do better, I promise. Heck, I’ll do it for a 10th of that with a bit of an equity incentive.