Genworth MI – now Sagen MI – going mostly private

This is nearing the end of the story for Genworth MI (TSX: MIC) – Brookfield is offering CAD$43.50 for the remaining 43% stake of the minority shareholders. In addition, they are ditching the Genworth name for Sagen (probably to remove any ambiguity with regards to their discontinued relationship with Genworth Financial). I don’t mind the name change, although I am confused whether it is pronounced with a soft or hard “g”.

Currently MIC shares are trading slightly higher than CAD$44, so there is some sort of anticipation of a minor sweetening to seal the deal (similar to what happened when Brookfield took over the minority stake of Teekay Offshore).

What is interesting is the following paragraph:

Following closing, Brookfield and the Company intend to continue to satisfy the public float requirement of the Insurance Companies Act (Canada) through the issuance of a new class of publicly-traded voting preferred shares of the Company, which preferred shares are intended to be issued prior to or concurrently with closing of the Transaction. A special resolution of shareholders to create this new class of voting preferred shares of the Company will be presented to Company shareholders for approval at the Special Meeting.

I do not know how this will work out in practice. I can’t think of any analogies of such publicly traded firms in Canada that have 100% of the common shares owned by one entity, but the voting rights remaining publicly traded – unless if the public listing is merely symbolic and does not actually trade in any volume. For instance, if the preferred shares have 0% of an economic stake and 100% of the voting rights of the company, what good is it if Brookfield owns 57% of these preferred shares?

In terms of valuation, in Q2-2020, the book value per share of MIC was $41.97, and on the income statement side, was supplemented by a combined ratio of 45%. Although there is a lag effect in terms of the loss ratio rising and an economic calamity (such as COVID-19), they are still minting plenty of cash. At the proposed CAD$43.50 price, shareholders are receiving a somewhat lower premium for their shares than what I would think is warranted, but this is typical to anybody that invests in an entity that Brookfield takes a bit out of – be prepared to get the short end of the stick, always.

I got rid of my shares of MIC in 2018 at a price slightly higher than the proposed takeover price, albeit I would have been a tiny bit richer had I held on – this was before the series of special dividends they declared in 2019.

This news also likely discontinues my coverage of the company – I have been writing about Genworth MI for over 8 years now. My first post about MIC was in June 2012, where I took a position at CAD$18/share. Fond memories.

The liquidity of Yellow Pages

The trading of Yellow Pages (TSX: Y) over the past week has been a relatively fascinating display of liquidity – and indeed because the publicly traded float is so tiny and volume so low, that you can review it trade-by-trade and get some insight on what is going on.

This chart does a poor job of illustrating the tick-by-tick price action of the stock.

Supply is being sucked out of the market by ETFs and algos, plus the fact that Yellow is trying to pull supply out of the market through their NCIB (limit: 2,510 shares daily). There is little demand from the short squeeze angle (short interest is about 11k shares). Although the borrow is available (IB shows 1.77 million shares available to be shorted) it is very expensive presently (30% to short). What’s really interesting are the blocks on display:

Monday (all times Pacific time zone):
12:29 Ask 5,100 @ 11.95 (not filled)

Tuesday:
Same block on the ask, trading was thin this day

Wednesday:
The block at 11.95 disappeared, and instead at the beginning of the trading day, Ask 10,000 @ 12.00. There was a bunch of volume at 11.95, and somebody front-runned the large ask by a few pennies with obvious volume.

Thursday:
The big day. Opening was Ask 10,200 @ 12.09, and there was a sizable bid (Bid 2,900 @ 11.95) which crept up in price over the next four hours. At 12:46 the block was hit, preceeded by some volume before that. The largest trade of the week was hitting the ask at 12:46:36 for 12,460 shares (multiple trades).

Friday:
A bidder appeared at 6:32 at 12.19 (1,600 shares) and this rose over the next couple hours to 12.50 (about 3,967 shares traded from the opening $12.00 to $12.50 at 7:47am). Subsequently some supply hit the market at 9:42 at 12.47-12.52, but this was quickly absorbed. From 9:57 to 12:12, there was some liquidity trading at the 12.50-12.60 level (somebody posted an Ask 5,000 @ 12.50 which was eaten in the course of an hour) and subsequently 14,740 shares traded.

At 12:12:44, somebody posted Ask 10,000 @ 12.74, and it took all of ten seconds before somebody hit the ask and picked up the shares (with 501 hidden shares at 12.70, specifically the 1 share trade was probably for the HFT processor to deliver the information before the remainder of the order was filled).

The bidder after this trade continued to increase the bid, and hit some more supply at 12.80 at 12:21:01, and finally continued to 12:59:26 where the closing trade was at 13.01.

The total volume for Friday was 35,222 shares traded, the highest since August 27.

It was very interesting week for Yellow Pages, at least in terms of how the stock traded. If they continue to financially perform as they did in Q2-2020, they should rise further. A particular price point is $19.04/share, which is the conversion price of their debentures (TSX: YPG.DB) and although they have the cash already in the bank to pay off these debentures, if the common shares trade above this, it will be akin to them raising equity financing at this price. I do not think most people would have anticipated this, especially in light of COVID-19. I still have a very significant equity position as I believe this will continue higher.

Cheapest TSX Debenture right now – Surge Energy

Just looking at the list of TSX-traded debentures (100 issues from 63 companies), price-wise, the company trading at the lowest price is Surge Energy (TSX: SGY). Their debentures (a total of $79 million, about half of which matures in the end of December 2022) are trading just a shade above 30 cents on the dollar.

Usually when a company’s debt is trading that low, a recapitalization is looming. Indeed, for Surge, it is a likely scenario, if not an outright CCAA proceeding. Q2-2020 was very rough for all oil producers, with WTIC going negative and all the Covid fallout. For Surge, the last corporate snapshot on July 30, 2020 showed a fairly dire financial picture, specifically the $307 million in senior bank debt. This credit facility goes to a redetermination on December 2020, and is otherwise payable on March 2021.

Although in a ‘normal’ environment, the corporation is cash flow positive (even after the capex), it isn’t going to be nearly enough to address the bank debt, let alone when the convertible debentures are due. The absolute amount of product being produced (17k boe equivalent with 80% crude) is well below what it needs to be to support the amount of financial leverage. Hence, the convertible debentures, being very low on the pecking order, are going to be incredibly disadvantaged if it comes to a recapitalization proposal, and are sure to be wiped clean in a CCAA arrangement. Hence, this is why they are trading in the low 30’s.

There is a winning scenario, and that involves a surge (pun intended) in oil prices. Right now the corporation is hoping they get bailed out by the commodity market before the banks close in for the kill.

I took a small loss in September bailing out what was a very small position in the debentures I took post-COVID. Sometimes debt is cheap for a reason! Or another way – just because it’s cheap doesn’t necessarily mean it’s a good value!

The next companies in line in terms of having the lowest trading prices: Supreme Cannabis (FIRE.DB), Invesque (IVQ.DB.U/.V), and Chorus Aviation (CJR.DB.A), all roughly in the upper 40’s or 50’s, and all for fairly obvious reasons when examining the businesses in question.

Diversification and risk

Textbooks in finance are written about the benefits of diversification and how to achieve your portfolio objectives. If you can find two assets that you estimate have the same expected return, in theory it makes sense to split your portfolio 50/50 among them to reduce the risk to achieve the expected value. Implicit behind this is that the returns achieved by these assets are not correlated. For instance, if your two assets are CNR and CP, if Canada goes bust, your diversification is not going to help. But if your two assets are CP and some boring and stable power generation utility out in India, chances are that the returns from the two assets are likely to be much less correlated. Computer algorithms can sort out all of these historical correlations and give you a pretty good idea of the mathematical risk, just from historical trading data.

Then we get into the business of asset allocation. Traditionally, equities and government bonds are inversely correlated to each other, and it has been a layer of portfolio protection when equities rise, you sell a little bit and buy (relative to before, lower priced) treasuries and vice versa.

However, it all goes haywire when traditional correlations do not manifest themselves.

One example is the usage of gold as a “world is going to hell” hedge and also a hedge against inflationary monetary policy decisions. In panicked market conditions, gold is just as susceptible as other asset classes for being liquidated.

Another example is the market for unsecured debt (e.g. TSX debentures or any other corporate bond that trades publicly in a reasonably liquid manner) – although many of these companies are sure-guarantees to pay out at maturity, the value of their debt trades down in market panic conditions.

Finally, another example is the usage of Bitcoin. Since there is limited historical data, there is a considerably higher element of human intuition that goes behind what the true risk profile of this asset is.

When traditional correlations break, it forces portfolio managers to either stay the course (assuming it will regress to some sort of ‘mean’), or to adjust the asset allocation to reflect the new reality with the correlations between various assets. In general, my gut feel is that markets are moving ‘faster’ than they were before, which will make institutional managers that much more challenged to adjust their models to reflect market reality.

Hertz is amazing

Take a look at the stock market’s favourite car rental company Hertz (HTZ):

This is what you call a short squeeze.

The catalyst was an announcement they received $1.65 billion in DIP financing.

Considering the unsecured debt is still trading a tad above 40 cents on the dollar, the bond market still doesn’t anticipate the equity receiving anything when the courts approve the Chapter 11 resolution.

This information (the equity fundamentally being worthless) was already priced into the markets. What rational participants don’t anticipate is a huge wave of paradoxically “rational irrational” behaviour consisting of gamblers, coupled with those trying to induce a short squeeze, which is what we are seeing.

A very fascinating display of market dynamics for the textbooks!