Yellow Media recapitalizes

Yellow Media has published a recapitalization proposal. It needs to be approved by the various shareholder parties before it can commence.

To put a long story short, if you were to purchase preferred shares (specifically the “A” series) and the common shares the day before this was floated, you would have made out like gangbusters today.

The surprise here is that the common shareholders and preferred shareholders get quite a bit of value relative to previously trading market values. This is probably structured as such to get the entire proposal passed in a shareholder vote.

Unsecured subordinated debenture holders will, to use less than polite terminology, get screwed – about 0.39% of the shares of the new entity. They are able to get pillaged because of the structure of the recapitalization vote – they are either lumped in with the medium term note/credit facility holders, or lumped with the common/preferred shareholders (if they choose to convert!). In either case they will be dwarfed by a group that has a much higher interest to vote in favour for the restructure.

The debtholders on the top of the food chain will receive 62 cents of debt/cash consideration (48 cents in newly issued debt, 14 cents in cash) plus an 82.6% equity stake in the new company (which can presumably be dumped for some market value). At 12 shares per $1,000 par value, this is around 24 cents extra in consideration, or about 86 cents total recovery. Not bad, and I will see them voting for it. They could get greedy and go for a 100% recovery in bankruptcy proceedings, but this is a much more messy alternative than what is on the table.

The new entity will also have about $850 million in debt outstanding, most of which matures in 6 years. There will be 26 million shares outstanding.

Common shareholders will receive about 10% of the new company, which is a heck of a lot more than they would have had otherwise (zero through a non-structured arrangement) – they will vote yes for the arrangement. Likewise for the preferred shareholders – they receive 7% of the new entity.

My paper napkin calculation suggests that the math behind this recapitalization assumes a $20 share price of the newly issued Yellow Media stock. If this is the case, then present common shares would have a market value of around $0.10/share, and this would also imply the preferred shares are worth… $1.25. They are trading at around half of that right now, and a nimble trader would have been able to make a ton of money on this by reading the 8:45am (eastern time) press release in advance – somebody on the Pacific Coast wouldn’t usually be awake to do, unfortunately.

This implied $20/share value assumes the company’s operational performance remains steady. If their operational performance continues to decline, then this valuation of course gets thrown out the window, so the risk-free trade is not as easy as it may seem. Basically if you weren’t trading the thing in the first hour, there is little point now. Pays to keep awake I guess.

Yellow Media – Stick a fork in the stockholders, they are done

Yellow Media (TSX: YLO) released their first quarter results, and suffice to say, anybody owning equity or debt in the company should be hurting tomorrow.

While the headline EBITDA result of $146 million may seem positive, all other metrics suggest a “steeper than expected” softening of key metrics. I will take some direct quotations from their MD&A:

The decrease [in revenues] for the three-month period ended March 31, 2012 is due to lower print revenues, especially in urban markets where revenues declined at a much higher rate than rural markets. We have identified new trends, which indicate that the print decline will be more rapid and enduring than previously anticipated.

I like the statement “we have identified new trends” since it implies that management did some deep research to discover this when it seems pretty obvious the company had to identify this by experiencing it directly.

Online advertisers, who in the past, purchased our legacy online products, are not migrating to our new products as quickly as we had anticipated. This now suggests that the online revenue growth will be slower than we had projected […] Online revenue growth is not expected to compensate for the declining revenue in our traditional print offerings in the near future.

Uh-oh! Could it be the case that the online advertising market is a hell of a lot more competitive?

In terms of the numbers themselves, the focus should be on the balance sheet: The company on March 31 had $310 million in cash, and on May 7 had $292 million in cash. When you account for the fact the company made a $25 million payment on their non-revolving credit facility, it actually implies they generated $8 million during those 5 weeks. I wouldn’t extrapolate this for the whole year!

The “adjusted earnings”, which is roughly a modified free cash flow calculation, was $67.3 million, down from $133.6 million from the quarter in the previous year. While the company is still generating a good deal of cash, the amount is declining at an alarming rate.

I ignore the $3 billion write-down of goodwill – for the uninitiated, they will now see the $785 million stockholders’ deficiency when normally they are accustomed to seeing it called stockholders’ equity. Any analyst worth his/her salt would have made that mental adjustment from day one, and this will hopefully silence the lunatics citing Yellow Media as a good value because of its exceedingly good price to book ratio.

In the raw calculus, the company has $292 million in cash, and they have to pay back $394 million by February, 2013, another $130 million by July 2013, and $125 million by December 2013. If you take the optimistic approach and assuming their decay in cash generation will flatten, they can barely pay off the maturities to the end of 2013, but who in their right mind would believe that things have flattened out?

The company is most likely going to go into some form of restructuring that will address its debt issues. This is likely to be very punitive toward equity holders and also the subordinated debenture holders. They will probably be given a few scrap bones to expedite the process.

Medium term notes are at around 67 cents for the near maturity, and about 60 cents for further maturities on the ask. Debentures are at 17 cents, and perpetual preferred shares (TSX: YLO.PR.C / YLO.PR.D) received a speculative spike over the past few days from 3 cents of par to 4. Suffice to say, the dividends on those preferred shares aren’t coming back anytime soon.

Thankfully, no positions in YLO – I’ve already taken my lumps previously and am just watching how this very unusual financial train wreck unfolds.

Yellow Media – alive for how much longer?

I notice that Yellow Media did not announce it was suspending interest payments on its convertible debentures (TSX: YLO.DB.A). If they would have done so it would have guaranteed them going into creditor protection.

They have about 11 months to figure out a solution to their imminent debt situation before they will go into default. The medium term notes (which are equal in level to the bank debt in seniority) trade at around 50 cents on the ask at present. The convertible debentures (junior to the MTNs and bank debt) are at about 12 cents on the dollar, while preferred shares are at about 3 cents on the dollar.

The logical investment conclusion is to buy the MTNs if you believe the entity has value after restructuring, or buy the preferred shares if you believe there will be a hugely messy process but not something that wipes out the preferred shareholders. The “middle ground” debentures will probably profit less than the preferred shareholders if there is some sort of recovery.

Yellow Media Q4 projections

I made a pretty good estimation of Yellow Media’s Q3 projections, my range was EBITDA of $160.4M to $175.8M with them achieving an actual of $166.0M.

Modelling Q4, there are two significant factors worth considering. One has to adjust an amount due to the impact of the LesPAC disposition. There may be an impairment expense dealing with the CanPages fallout that will take effect in Q1-2012. A parenthetical note that has to do with the “I” in EBITDA; one has to make a subtle adjustment to the amount of cash interest the corporation is paying – it will be about $7M less due to debt repayments.

In Q3-2011, the corporation did $166.0M EBITDA; in Q4-2010, the corporation did $192.7M, but Trader Corporation needs to be removed from the equation, thus this is adjusted down to $161.3M. This number itself is artificially low because the company expensed the majority of its income trust to corporation expenses in this quarter. With Trader Corporation, the number is $225.2M, and adjusting Trader out of this was $193.8M as a baseline.

Leaving out my distillation which can compete with alchemy, leaves the following projection, which uses a 14% decay and plus or minus 4% for error bounds:

Higher than expectations: $174.4M or above;
Lower than expectations: $158.9M or below.

I also anticipate the company will announce it will convert the Preferred Shares Series 1 into equity, but this should not surprise the market. A potential surprise, and one I cannot predict, is whether the company will suspend preferred share dividends completely – my model shows that in 2013 the company will face a cash crunch if it cannot renew its credit facility as the Medium Term Notes become due. This does not assume any further asset sales.

There becomes a bit of psychology involved. Payment of preferred share dividends will cost about $29M for 2012, and this is assuming Series 1 and 2 convert into equity at the earliest date. If dividends are suspended, the company will save cash flow but this will not be sufficient to pay off the 2013 Medium Term Notes with existing operational cash flow. If the dividends are not suspended then the company will still not make the 2013 MTN payments unless if they can raise cash through an extension of their credit facility or an asset sale.

However, the market perception might be better later in 2012 than it is currently. It is also more likely that it is more likely there would be some sort of recovery if the company paid preferred share dividends than if it did not.

My guess is that the company will continue paying preferred share dividends for this quarter, but I am not completely sure. I do believe the preferred shareholders will become more vulnerable later in the year when Yellow Media tries to renegotiate the credit facility – if their operations are not to snuff, the bank(s) that are willing to lend to Yellow will likely have as a covenant that preferred shareholders cannot be paid unless if Yellow Media is below certain debt coverage ratios.

I also believe management will bring up the idea of doing a reverse stock split, as the dilution after the conversion of Preferred series 1 and 2 will likely keep the stock price below the psychological barrier of one dollar for some time.

This continues to be a high risk, very high potential reward situation if the company gets it right and stems the decay in revenues. However, it will be a long and drawn out battle as it struggles to raise cash to slay its debt albatross. If you assume the company will not go into creditor protection, the unsecured convertible debentures (TSX: YLO.DB.A) has great value, but again, they are trading at 21 cents to the dollar for a reason – you never know if/when they are going to do a pre-packaged CCAA deal, at least if you are not an insider. Since the unsecured convertible debentures are subordinated to the other components of the debt structure, they will likely be offered a pittance compared to the Medium Term Note holders in such a deal, which explains why they are trading at about half of the Medium Term Notes of comparable coupon and duration.

Yellow divests a business

I don’t have enough time to fully write about it, but here are some low quality notes for Yellow Media (TSX: YLO).

Yellow Media announced they are divesting their LesPAC Inc. business unit for $72.5 million in cash. The company basically operated a craigslist-type pour les Quebecois, pardon my mauvais Fran├žais! The company generated $12.7M in revenues for the 2010 fiscal year, so on first glance, a sale at 5.71 times revenues seems good. It would probably be a more depressing figure how much they spent to build the service, so it wouldn’t surprise me in the least that with the disposition of that business there would be another chunk of goodwill and intangibles off the balance sheet if they did have to purchase some technology in order to build the site.

Now if they can just sell the rest of their business at 5.71 times revenues, then they won’t have much of a debt problem anymore. Equity holders will get $15/share and everybody will be happy. Don’t hold your breath.

That said, $72.5 million is not an inconsiderable chunk of change and increase the chances the company will be able to chip away at its credit facility due February 2013. Preferred shares C and D are trading a shade lower, yielding 38% at the bid, while debentures are trading a shade higher on reaction to this news at roughly 29 cents on the dollar. The market continues to be deeply skeptical on the ability of YLO to pay back its debt and obviously this depends on whether the “transformation to digital” will be a profitable one or not.

Yellow Media – Q3-2011 Results

There is a reason why Yellow Media (TSX: YLO) is trading at 30-some odd cents per share, and the preferred shares are trading at 40% yields: it isn’t entirely clear whether the company will make it out of the doldrums or not.

The last quarterly report was not a home run, nor was it a strike-out; instead, it is a continuation of the fine line between the company going broke or the company making it.

Cash flow continues to be relatively poor, especially with the addition of income taxes after the trust conversion. The only solace there is that the federal corporate rate drops from 16.5% to 15% in 2012. Normally companies trading this low usually don’t have taxes as a problem (since they are typically not making money) but in this case, the federal-provincial tax bite becomes material since debt has to be paid off with after-tax dollars.

The tax tidbit that are sending analysts into negative mode again is that their estimate is their tax cash outflow of $250M in 2012 based off of a 27% tax rate; 2012 is a double taxation year because they will have to pay in installments for two years worth of taxes; if you do the simple division by two and divide by 0.27, that gives you an estimated pre-tax income of about $463M. At a 27% rate, that is about $338M after tax.

The company has the following debt maturity schedule:

February 18, 2013: $266M + $35M Credit Facility / CP
July 10, 2013: $130M MTN maturity
December 3, 2013: $125M MTN maturity
April 21, 2014: $254.7M MTN maturity
Feburary 2, 2015: $138M MTN maturity
February 15, 2016: $319.9M MTN maturity

The company has $52M cash currently. Assuming they have zero access to the credit market for the next couple years, they will need to generate roughly $50M in free cash flow each quarter, which is a tall order given their declining revenue base. That said, if they can actually stabilize their cash situation, they will likely be able to get an extension to their facility and figure out a way how to re-finance their MTN maturities. It will not be an easy climb up from the abyss, however.

My quick guess is that an easy $10.7M annual after-tax cash flow will be saved by converting the Series 1 preferred shares (TSX: YLO.PR.A) into equity as soon as possible. My other guess, and this one is not a guarantee by any stretch, is that they will opt to convert their Series 2 (TSX: YLO.PR.B) preferred share series as quickly as possible to save another $7.6M/year of after-tax cash flow. This then leaves the question whether the company is going to suspend preferred dividends entirely, and if they do, then Series 2 will not be converted, at least not until 2017. This is why the preferred shares are trading as low as they are – the company can pull the plug on the dividends. They will likely make this decision after the first quarter of 2012, depending on results. Series 3 and 5 of the preferred shares (TSX: YLO.PR.C and YLO.PR.D) both add up to about $22.2M/year in dividends.

Yellow Media should survive operationally, but the question at this point is whether they will survive financially. Who will reap the rewards of the cash flow of this over-leveraged entity? Certainly not common shareholders at this point, but right now the marginal question is whether the preferred shareholders will come out of this looking like geniuses or will they be burnt as well? This is increasingly looking like a binary situation, with either the preferred shareholders going to zero (in a recapitalization), or seeing the company slowly trudge their way back up to credit-worthy status over the process of a few years. The big hurdle is 2013.

Yellow Media Q3 projections

Here are some estimates regarding benchmarking Thursday’s earnings report for Yellow Media.

(2011 / 2010 / % change)
For the 6-month period of 2011 vs. 2010, we have:
Revenues: $692.1M / $699.8M / -1%
EBIDTA: $366.5M / $402.6M / -9%
Cash Flow from Ops: $199.6M / $293.5M / -32%
Adjusted free cash flow: $206.2M / $273.2M / -25%

For the 3-month period of Q2-2011 vs. Q2-2010, we have:
Revenues: $342.7M / $360.1M / -5%
EBIDTA: $176.5M / $204.0M / -13%
Cash Flow from Ops: $87.9M / $165.8M / -47%
Adjusted free cash flow: $89.2M / $136.2M / -35%

It is this deviation from the above two that show an accelerating decay in projected cash flows. Specifically the EBITDA number is going to be an easy way of determining a hit or a miss – if this number exhibits accelerated decay beyond -17% or so from Q3-2010, then this will not be a “good thing”.

Readers should also be advised that recent releases of information include the impact of the Trader Corporation disposal such that revenues and cash flows from prior statements are not directly comparable without doing digging in the proper documents.

Specifically, Q3-2010 results excluding Trader Corporation is revenues of $355.9M and EBITDA of $193.2M.

So with that, we have the following for Q3-2011:

Better than expected – EBITDA of $175.8M or above;
Worse than expected – EBITDA of $160.4M or below.

Brace for impact.

Yellow Media Q3-2011 release

Investors are likely skittish with the upcoming release of Yellow Media’s (TSX: YLO) quarterly results. When looking at the other earnings release dates this year, we had the following results:

February 10, 2011: YLO lost -0.33%; common shares were $6.09 at the previous close and $6.07 at the close.
May 5, 2011: YLO gained 1.58%; common shares were $4.44 at the previous close and $4.51 at the close.
August 4, 2011: YLO lost -43.30%; common shares were $1.94 at the previous close and $1.10 at the close (went as low as $0.72 four trading days later);
November 3, 2011: Common shares are $0.33 at the close of November 1 trading.

I’m guessing the selling we have been seeing in the last few days is consolidation and profit-taking after the huge run-up the stock had over the past month – it has gone from a low of 12.5 cents up to 61 cents. Preferred shares and debentures are also trading implicitly with the assumption that the company faces a high chance of going into creditor protection sometime in 2013 (which is fair considering this is the maturity of their credit facility and the beginning of the maturities for their Medium Term Notes).

Investors already know there is going to be a huge write-down ($2.9 billion) of goodwill, which will create a headline of a multi-billion dollar loss for the company. Major media outlets will probably want to report on this large headline number. However, investors must look strictly at the cash flow statement and determine whether the operating entity is generating cash that will ultimately be servicing the debt. The decay of this number will determine whether the market is likely to be correct (i.e. good luck refinancing) or whether the company can exceed low expectations (a decrease in the cash flow decay). The logical consequence of the scenario where the cash flow decline is stemmed is that they will continue paying preferred dividends and be able to chip away at their debt.

Again, this is a high risk, very high reward type scenario in the event that the company can stop the bleeding.

Yellow Media preferred differentials

As I pointed out earlier, there was a significant yield differential between Yellow Media preferred shares C and D (TSX: YLO.PR.C and YLO.PR.D). The market has closed this gap now to about 0.7% if you use the most generous bid-ask spread quotations (e.g. the ask on the C’s vs. the bid on the D’s).

The common shares have gone on a massive surge over the past couple weeks, and this has translated into strong gains for those that have held their noses and accumulated positions during the meltdown.

The closest analogy I can think of what is happening is what happened to Telus (TSX: T) back in 2002 when the whole market dumped them down to $3.50/share for no real reason other than that they had a lot of debt and old-school telecom was on its way out.

Common shareholders face the most risk and will receive the most reward in a favourable scenario, but preferred shareholders will also come out very well and continue to receive income.

Of course this can all blow up if the next quarterly report is adverse. However, you would think after inking their last credit facility that they would have had some sort of visibility on their results to prevent an early default.

Yellow Media Update

Yellow Media (TSX: YLO) common shares have climbed up from their ultimate low of 12.5 cents on October 3, 2011 to 32 cents presently. There has been no news from them other than a press release stating they have been named one of Canada’s top 100 employers for the 6th year running.

Instead, this appears to be a matter of the stock being taken down to the basement level by a stampede of funds trying to desperately get out. Now that anybody that wanted to get out did, supply in the market seems to have been alleviated and the price is now rising.

The business fundamentals remain the same after a month – the company is highly leveraged, but is cash flow positive and has a feasible plan to paying off its debt through internal operations assuming the revenue decay is not too extreme.

Preferred shares continue to trade strangely, with the Series 3 (TSX: YLO.PR.C) trading with a yield about 4.5% higher than Series 5 (TSX: YLO.PR.D). I guess nobody reads the prospectus on these things anymore.

The equity-linked preferred shares, Series 1 (TSX: YLO.PR.A) and 2 (TSX: YLO.PR.B) continue to be coupled to the price of the Yellow Media equity. Series 1 will probably be converted into shares of Yellow Media (12.5 shares per preferred share if the common stock price is less than $2.05/share) on April 2012, while Series 2 stands a good chance of being converted in July 2012, depending on financial results.

While the Series 3 preferred shares trade at around 19 cents of par, convertible debentures are at around 33 cents.

The next big data point for the company is November 3, 2011, where they have already pre-announced a $2.9 billion goodwill write-down. While this will of course result in a grossly negative earnings per share for the year, it is a non-cash charge and the remaining questions for investors will be focusing on the cash flow statement at this release date. As I have repeatedly stated, if the company can produce results that are less than disastrous, they will stand a very good chance of surviving and being able to pay generous cash flows to their shareholders that are senior to the common.

In the favourable scenario, I would expect the market would see that Yellow Media will have the capacity of being in the position of paying off its obligations through internal cash flows and be in a position to raise financing sometime in the second half of 2012. If this occurs, the common shares should trade higher, but the preferred shares should also slowly rise to the 8-10% yield level, which translates into a $17-21/share price for the Series 3. The debentures in this case would also trade 1-2% richer than the preferreds, around 90 to 98 cents on the dollar.

The risk is that they won’t be able to make these financial targets and will be forced to restructure. The preferred shareholders will get wiped out along with the common shareholders. The unsecured debenture holders will likely get very little in such a reorganization.

The risk-reward was high and very high, respectively, and this is why I continue remaining long the preferred shares and debentures of Yellow Media. This is a relatively binary outcome with little middle ground which makes it a fairly unique opportunity.