Cineplex raises a quarter billion

(Thanks to Marc for commenting on this offering in the Debentures comments section)

Cineplex (TSX: CGX) was about to exit the escape room for CAD$34/share. Their timing was nearly perfect (December 16, 2019 announcement), but COVID-19 struck during the closing process. Now they’re a $8.40 stock and their business has been decimated due to the reaction over COVID-19 – movie theaters were right up there with cruise ships as being COVID disaster zones.

However, yesterday they raised $275 million in unsecured convertible debt financing! 5.75%, convertible at $10.94/share.

Quite frankly I was surprised. Maybe it is a sign of how frothy the market environment is. Their last published financial statements were from March 31, 2020 and I will dissect them:

Balance sheet, assets:

The highlights here are little cash, coupled with a large amount of right-of-use assets (leases) which are worthless if you can’t perform business in them, and about $820 million in intangibles and goodwill. In relation to their $412 million of equity (below), this pulls them very deeply into a negative book value, which is generally my metric to value companies as a cash flow vehicle.

Balance sheet, liabilities plus equity:

There’s a few adjustments to be made here. One is that the “deferred revenues” is mostly unused gift cards, which means if you haven’t used them yet, this is where they are represented on the books. If the business isn’t operating, this “liability” virtually amounts to a zero cost equity injection by hapless consumers.

We see the discounted cost of lease obligations, for the first year it represents a $115 million outflow. This is a large number but it isn’t crushing. These leases are long-term in nature, which is the “WOW” $1.23 billion figure. Most of this is property and a tiny bit is equipment.

Finally, they do already have $665 million of debt on the books.

Income statement:

Note the industry is seasonal in nature, so taking one quarter and extrapolating it to the full year is not appropriate.

I work through the line items and I do not see much in the way of revenues when the business is closed due to COVID-19. I then try matching up the costs that would be reduced as a result of COVID, and most of this is the “Note 12”, and lease (depreciation of right-of-use assets) costs, coupled with depreciation of film rights, and financing expenses.

We look at this “Note 12” which represents a large expense:

Presumably the executives and administrative staff of the corporation are still employed, but the various people involved in box office operations (e.g. retail cashiers, cleaners, film technicians, etc.) are off on CERB. I don’t know what fraction of the $53 million are ‘baseline’ employment expenses. I’d guess they’d be able to shed about 80% of their employment expenses?

They will still have to pay realty fees, occupancy taxes, and so on.

Just as a very broad proxy, let’s say that Note 12 expenses can be reduced to $50 million a quarter.

So just as a ballpark figure, when incorporating lease expenses and financing expenses, the entity is burning about $100 million a quarter, very roughly, when it has zero revenues. They might have given some guidance in their last quarterly conference call (I have not paid attention).

The fact that they can raise $275 million, unsecured, and at such a low rate of interest I find amazing. Am I that seriously out to lunch on the valuation of Cineplex?

I haven’t even evaluated the question of whether people actually want to go back to movie theatres, but this is an age-old question that has predated COVID-19. I recall a posting back in August 2014 where I was wondering how the heck they were doing so well despite the internet age.

Delphi Energy – proposed recapitalization

Delphi Energy (formerly trading as DEE, and with a second-lien secured note trading as DEE.NT) went belly-up into CCAA on April 14, 2020.

The last trade on DEE.NT was at 55 cents on the dollar before the company was delisted.

Today, we have the following proposed recapitalization plan:

The claims of creditors in respect of:

approximately $13.5 million outstanding under the Company’s debtor-in-possession interim loan financing secured by a Court-ordered priority security interest,

approximately $13.0 million outstanding under the Company’s senior credit facility secured by a first lien security interest, and

approximately $119.7 million outstanding under the Second Lien Notes secured by a second lien security interest,

will be settled in exchange for approximately 14.7%, 14.2% and 36.5% of the issued and outstanding voting common shares of a newly created class of shares of the Company (the “New Shares”), respectively, subject, in the case of the Second Lien Notes, to the Second Lien Opt-Out Election (as defined below);

Assuming a 100% recovery on the DIP financing, this works out to an equity valuation of $92 million. The second lien notes thus are looking at 28 cents on the dollar in the proposal, with the following alternate option:

Subject to the terms and limits set out in the Plan, beneficial holders of Second Lien Notes holding an aggregate principal amount of Second Lien Notes equal to or less than $200,000 will have the opportunity to elect (the “Second Lien Opt-Out Election”) to receive cash in the amount of $0.25 per dollar of outstanding principal amount of Second Lien Notes in lieu of the New Shares that they would otherwise be entitled to receive pursuant to the Plan; provided that, in the event that the aggregate of all payments pursuant to the Second Lien Opt-Out Election would exceed the aggregate amount of $1 million, such payment will be reduced on a pro rata basis so that total payments pursuant to the Second Lien Opt-Out Election do not exceed $1 million;

So their options are either 28 cents on the dollar (implied value) of equity, or a 25 cent on the dollar cash-out, or roughly half of the last trading price of the notes. It doesn’t look like there will be a Twin Butte Energy here!

Owners of Hertz stock should be aware that in the instance of Delphi Energy the proposal, if agreed upon, will rendered the common shares worthless.

The COVID quarter where everything gets written off

Most companies have a fiscal year corresponding with the calendar, and most of them will be reporting April to June results in the last week of July and in early August.

Q1’s results were in the onset of COVID-19, so results were only partially affected (the sanctions required due to the pandemic really only took effect in the middle of March).

Q2 will contain the full brunt of the economic consequences of COVID-19.

The results posted are going to be horrible for a lot of companies, especially on a GAAP basis. You’re going to see a whole bunch of write-downs of various assets that have been lingering on balance sheets for far too long, but Q2 will be the best time to formally impair them and get past mistakes out of the public consciousness.

The markets are not going to care. This has long since been baked in.

The next consequence of this is that you’re going to see headline computer generated metrics from company financial statements (price to earnings, EPS, etc.) over the next twelve months get wildly misstated due to the inevitable Q2 reporting of losses. This will also affect ROE/ROA, growth percentages, and almost anything relating to earnings in the calculation.

As a result, stock screens looking for value will be twisted unless if forward-looking adjustments can be made. A common forward-looking metric is “consensus analyst estimates”, but this figure is what an investor is looking as a rough short-term measuring stick in relation to the price the market is offering (indeed, if something looks ‘cheap’ solely on the basis of price to consensus analyst estimates, I’d view that much more as an alarm bell than a reason to buy).

The contamination of financial data coming from the COVID quarter will be the worst since the 2008-2009 financial crisis. While individual stock selection is always important, the COVID quarter should create an even better environment for stock selection than other times.

Tailored Brands: Not looking good

Tailored Brands (NYSE: TLRD), retailing as Moore’s in Canada, filed on Form 8-K that they were not paying their unsecured debtholders:

On July 1, 2020, The Men’s Wearhouse, Inc. (“Men’s Wearhouse”), a subsidiary of Tailored Brands, Inc. (together with Men’s Wearhouse, the “Company”), elected not to make the interest payment due and payable on July 1, 2020 of approximately $6.1 million (the “Interest Payment”) with respect to its 7.00% Senior Notes due 2022 (the “2022 Senior Notes”). Men’s Wearhouse has a 30-day grace period to make the Interest Payment before such non-payment constitutes an “event of default” under the indenture governing the 2022 Senior Notes (the “Indenture”). If an event of default under the Indenture occurs as a result of such non-payment, it would result in a cross-event of default under both the Company’s term loan facility and asset-based revolving credit facility (collectively, the “Credit Facilities”). Men’s Wearhouse has elected to enter into the 30-day grace period with respect to the Interest Payment. During the grace period, Men’s Wearhouse may elect to pay the Interest Payment and thereby remain in compliance with the Indenture.

On July 1, 2020, the Company made its scheduled interest payments required under the Credit Facilities and therefore, as of the date hereof, is current with respect to its interest and principal payment obligations thereunder.

Per their last financial snapshot, and 10-Q, it appears they have approximately $1.2-$1.3 billion in senior debt, coupled with $174 million in unsecured notes, which last traded at 7 cents on the dollar. The company itself, by virtue of drawing its asset-backed facility, has about $200 million in cash (and approx. $90 million in restricted cash) in early June.

It looks like they are engaging in a “Mexican Standoff” strategy that will not go very well for everybody involved – implicitly they are trying to get the unsecured noteholders to concede with the threat that they will go to zero in a Chapter 11 proceeding. The question is what price has been negotiated?

The company, similar to most other retailers, has massive lease liabilities and even if they resolve the unsecured debt situation, still has to face that challenge.