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.

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.

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 (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.

Yellow Media (TSX: YLO) has all sorts of securities where investors can lose their money, but some securities are more stranger than others.

In particular, there is a prevalent oddity I have been noticing in trading of preferred shares of Yellow Media. These are the Series 3 (YLO.PR.C) and Series 5 (TSX: YLO.PR.D) series of preferred shares, which essentially are identical in all respects except for their stated dividend payout.

I will refer to Series 3 as being the “C” series and Series 5 as being the “D” series. The C series pays out $1.6875/share/year while the D series pays out $1.725/share/year. Both contain a rate reset feature, where after 5 years from initial issuance, the C series will be reset to the 5-year government bond rate plus 4.17%, while the D series will be at the 5-year government bond rate plus 4.26%. The 5-year bond is currently yielding 1.57%, but the C series will have their reset in 2014 and the D series will be in 2015.

There are also 8.1 million “C” shares outstanding, while the “D” series has 4.9 million outstanding. There is more trading volume for the C series than the D series.

Taking the midpoint of the closing bid-ask quotation, the C series is trading at $4.24 and the D series is trading at $5.15. Using some very elementary math, this translates into a yield of 39.8% and 33.5%, respectively. Obviously these very high yields are a function of the embedded risk within the underlying company’s ability to actually pay such dividends – the huge issues the business has been facing has been well publicized.

You can arbitrage the difference between the C and D series by going long 102.22 shares of C, while going short 100 shares of D. Using the quotations above, such a transaction would be income neutral and net a capital gain of approximately $81.59 per 100 shares traded.

Practically this is not possible unless if you can locate cheap shares to borrow, but investors looking at both classes of shares should clearly choose the “C” series.

Other than supply-demand dislocations because of the different number of shares outstanding of both series, I am at a loss to figure out why there is such a huge yield differential between the preferred shares. One would think the more liquid series (C) would trade at a slight premium due to liquidity. Does anybody else know?

As a disclosure, I own some of the preferred shares of Yellow Media.