Sterling Shoes not so shiny

Sterling Shoes (TSX: SSI) went into creditor protection today. The shares were halted at 1:27pm and the CCAA protection announcement came at 1:48pm. The TSX will delist the shares and debentures.

Investors would have had some advance warning given the announcement the company made on September 27, 2011 that they would not be able to make an interest payment on their convertible debentures. Their credit facility with the Bank of Montreal would have prevented them from making the payment.

At this point anybody that held equity in the company should have firmly jettisoned it and the company shares tanked from 37 cents the day before to about 12 cents after.

There still may be value in the debentures, although whatever slice of the company they are given in the post-restructuring is difficult to determine. The company had about $13M in secured debt and $25M in subordinated debentures. When compared to sales metrics (2010: $127M revenues, $54M gross profit) and potential profitability (i.e. there is ample room to cut SG&A by getting rid of under-performing stores), the company should be worth more than what the secured line of credit is worth – certainly, debenture holders going into the bankruptcy had not expected much, with the last trade going off at 13.5 cents on the dollar at closing.

The following is a chart of the debentures:

It is impossible for retail investors to get a fair shake at a company during a restructuring, but I do notice that Belkin Enterprises Ltd., lead by BC businessman Stuart Belkin, took a $2.573M face value stake in the Sterling Shoes debentures and announced this on September 2, 2011 on SEDAR. Was this a mis-timed investment or are they planning on participating on the subsequent recapitalization and capture value in a post re-organization stake?

I would expect such holders to get equity and warrants in the subsequent recapitalization.

A Yellow Media oddity

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.

Sun Life and financial insurers

Sun Life (TSX: SLF) reported on Monday that when they report their next quarterly result, it will contain a very negative quarter. In the event of this quarter, it will be negative $621 million, operating amount negative $572 million.

By definition, financial insurance companies (such as those that provide annuities and “guaranteed income funds”) make their living by hedging. If they sell Joe Retail a product that will guarantee them 4% for the duration of the investment, the company will usually have a way of finding somebody else to give them 5% for the same period of time so they can skim the 1% in the meantime. Banks operate under the same principle, except for some strange reason they do not call it insurance.

When financial insurance companies cannot hedge properly, it will result in losses. In the event of SLF, and indeed, in the event of others such as Manulife, they have not hedged against the drop in equity markets and also the low rate environment and have been caught exposed – subsequently forced to take losses.

I have no idea whether SLF or other similar companies are under or over-valued at present. They are not easy companies to analyze and to determine where the risk is compared to the broad market.

The end of the volatility?

Volatility (VIX) has gone under 30% for the first time since the whole mini-meltdown in August occurred.

I’m still remaining very cautious. I have not been in a very literate or concentrative mode over the past few days and thus whenever I have found myself in that situation, do not make investment decisions.