Corus Entertainment – quick look

Corus Entertainment (TSX: CJR.B) is a well known company. They have various media assets in Canada on television and radio. At one point I was considering a purchase, but held back because they are highly leveraged and I didn’t have a solid grasp on the risk/reward profile – I suspect they do have competitive advantages but the broadcasting industry is shifting so much (“cord-cutting”, Netflix, etc.) it is difficult to tell whether it is sustainable.

Reading their year-end financial statements, there are a few interesting wrinkles which caught my attention.

0. Fiscal year ends August.

1. They historically have generated a lot of cash. FCF in FY2018 was $344 million, and $307 million in 2019. In 2019, they chipped away $250 million on their debt (which stood at a FY year end balance $1,732 million). Most of this debt was issued to facilitate the acquisition of Shaw Media. $258 million is due November 2021, $869 million on May 2023 and $639 million on May 2024. Clearly they won’t stand much of a chance of paying back the 2023 and 2024 tranches, but one would presume if they rake in $300 million a year in free cash, this won’t be a problem to refinance. The effective rate on the debt is 4.3%.

If for whatever reason this future operating cash flow were to drop at a more accelerated pace, however, the equity is going to suffer badly.

But needless to say if one believes that $300 million is the norm, $1.42/share in cash means the Class B shares trade at a 3.5x multiple…

2. The amount of dividends issued is structured in a peculiar manner:

Corus slashed their dividend 80% last year so they can concentrate their capital on deleveraging. However, the amount of dividends going to non-controlling interests is quite high.

The concept of non-controlling interests is not easy to explain in accounting terms, so I will try here.

Let’s pretend you own a holding company, but this company’s only asset is the ownership of 70% of voting and common shares of an operating entity. If the operating entity makes $100 of income, you consolidate the operating company’s financial statements into your own, but $30 of that income is attributable to non-controlling interests. Shareholders of the holding company effectively only “see” 70% of the operating company’s income.

This is most prominent in a case like Interactive Brokers (Nasdaq: IBKR) where a shareholder of IBKR (76.7 million shares outstanding) owns 18.5% of IBG LLC, which is the entity that actually owns most of the assets. In the 3 months ended June 2019, for example, IBG LLC reported $210 million in net income, but $178 million goes to non-controlling interests (the 81.5% that owns IBG LLC, mainly Thomas Petterfy) while IBKR holders effectively see $32 million. Indeed, IBKR holders will only be able to “cash in” if IBG LLC is generous enough to distribute earnings to it (which they do through a nominal dividend, and control is not an issue because the entity has the same controlling shareholders).

Indeed, when we look at Corus’ income statement, we see that various entities contribute a 13.6% slice on net income:

So one obvious question is the following: what is the agreement governing the non-controlling interest and Corus? It appears that the non-controlling interest has favourable agreements with respect to cash distribution than common shareholders. What entitles these non-controlling interests a $30 million slice of income each year when common shareholders get 56% of the dividends paid by Corus?

I haven’t been able to figure this out.

However, on page 51 of their financial statements, we have the list of subsidiaries, and the non-controlling interest must come from these entities:

I never knew the Food Network and HGTV was so profitable!

What sort of agreements are stripping so much value away from common shareholders? I tried looking into the MD&A and AIF, but couldn’t find any relevant answers.

3. Here is the biggest issue I have with Corus – alignment of interests.

Shaw used to own 38% of the non-voting Class B shares of the company (the only shares which are publicly traded). They dumped this stake for CAD$6.80/share on May 31, 2019. However, the Shaw family trust still owns 85% of the Class A voting shares (3,412,392 shares outstanding) which means they have an economic stake in the company of 1.6% but still total control. Now that Shaw is virtually out of Corus, the incentive structure is completely mis-aligned with common shareholders. Right now the 24 cent/year dividend is the only thing they have going for it. One wonders what sort of value-stripping agreements might take place in the future (similar to my suspicions on the relatively high cash drain coming from non-controlling interests – where is this value going?).

It is one thing if the controlling shareholder has a significant economic interest in the firm they are leading (e.g. one would suspect that Genworth Financial is not going to take actions that will hurt the economics of the underlying Genworth MI entity). It is completely another thing if somebody has control but no economic interest – this sort of alignment asks for common shareholders to get the short end of the stick.

If anybody has answers on this one, or if I’m completely out to lunch, I’d like to know.

Atlantic Power – good quarter

Other than Atlantic Power’s (TSX: ATP) Cadillac biomass plant blowing up on September 22, 2019 (see my writeup here), it was a very good quarter for the company.

The quantification of the Cadillac power plant situation is the big news of the quarter. Most notable is that while this incident took the stock price down about 25 cents per share (my worst estimate was 39 cents per share, present value, for a complete write-off of the whole project permanently), the actual impact has been quantified by management as approximately $3 million as insurance will pick up the reconstruction bill in excess of a $1 million deductible and business interruption will cover the cash flow shortfall at an expense of 45 days deductible. Dividing this by 109 million shares outstanding gives an estimate of about 3 cents per share of damage that this accident caused.

It’s pretty obvious since playing defence since 2015 (which consisted of a major de-leveraging and expense reduction campaign by new management), they have been making smaller acquisitions here and there that will likely contribute to 15%+ returns on investment. In Williams Lake, BC, the company struck a 10 year deal with BC Hydro to operate their biomass plant in non-peak snowmelt season. While management has not quantified the exact impact on the financial returns on this (citing procurement of fuel costs and other competitive aspects) reading between the lines it appears this will contribute reasonably well to the bottom line after some initial start-up costs.

As the company has been busy using discretionary capital to fund future 15%+ acquisitions, they have been lighter on share repurchases. There has been a nanoscopic amount of share buyback activity (2,067 shares) at US$2.27/share, while they bought back 12,000 preferred shares (AZP.PR.B) which continues to chip away at the cash burn from those financial instruments. The company still has $24 million in discretionary cash – if they choose to do nothing, this will continue to build while the debt gets paid off.

Eventually the equity market will start to ramp up the share price to reflect this. I don’t know whether it will be tomorrow, next month, or next year, but the 5 year stock chart is very deceptive and not a reflection of where the stock should be (which is higher than the prices in the past 5 years). Yield investors can also do well by buying the preferred shares, but why settle for a volatile 8% yield when you can get a probable 50% in the next couple years on the equity?

Another mid-stream Canadian oil and gas producer bites the dust – Pengrowth Energy

… I’m not talking about Ovintiv either (TSX: ECA), which is pretty much an admission that any dot-com name for a company has already been taken up, so companies now have to resort to pharmaceutical-style naming conventions for their firms.

Pengrowth (TSX: PGF), which I have written about extensively in the past on this site, announced on Friday they were going to accept a takeover bid of CAD$0.05/share plus the payout of debt. The amount of debt outstanding was approximately $700 million and the total purchase price is $740 million.

The effect on their stock price was fairly dramatic:

It reminds me of the expression I tell people around me when they mention that something is cheap at 20 cents per share – “When it goes to zero, your loss is always the same – 100 percent”. In this case, investors took a 75% haircut on the last Friday of trading after the announcement.

This is the next (former) mid-tier oil and gas player to effectively go belly-up, the previous one being Bellatrix Exploration. At the rate things are going, only Suncor will be the last one standing in Canada.

The buyout of Pengrowth is going to be interesting for a couple reasons.

One is that the press release does not make mention in any way of any shareholder consent agreement from Seymour Schulich, who owns 28% of the company. Perhaps he is planning on taking a huge capital loss. One does not do big merger deals without getting consents from major shareholders with deep pockets, so the absence of this is very mysterious. To reverse the merger will cost some other suitor $45 million dollars – in light of the existing deal, this is a huge windfall that would be paid out if somebody were interested in the assets.

However, I deeply suspect in the shopping around process they couldn’t find anybody that was willing to finance the company at an acceptable price. The management information circular that will come out should yield some further clues on the process they undertook.

The other is how the deal is structured – Cona Resources used to be public, but it was majority owned by the Waterous Energy Fund, which is relatively secretive in its dealings (it is private). Waterous took its minority share of Cona private in May 2018 and we can infer from its SEDAR filings that were available that this entity is still not making money. Cona was bought out at about 45% of book value ($2.55/share on 101 million shares) coupled with $332 million in debt.

That said, Pengrowth, stripped of its leverage situation, actually makes money. Not a lot (especially in the current Canadian context), but while I am not surprised that shareholders are taking a massive bath on the company, I am surprised that this is the best agreement they could find. I am guessing the existing debt holders were completely unwilling to consider a debt-for-equity swap.

If Canadian oil and gas does come back from the dead, however, Pengrowth’s thermal oil assets are top notch and Waterous will be making a mint on this one. They effectively are going to wait this one out until the climate gets better. Parking $740 million of capital to do this seems like a reasonable gamble. I can see why they made it.

My last position in Pengrowth was in their unsecured convertible debentures, which matured at par in early 2017. I’ve been tracking it ever since and have taken no positions in their stock.

Genworth MI Q3-2019: Steady as she goes

I’m catching up on quarterly reports, so these posts are coming in a little late. This will be a short one.

Genworth MI (TSX: MIC) reported their third quarter results. They are largely unsurprising and they continue to be a cash machine as there have been no material issues concerning the Canadian housing market (as it relates to the mortgage-insurable side of the business – the high end market in Vancouver, BC is getting slammed because the provincial government is massively increasing the cost of carry for $3 million+ assessed value properties). Loss ratio is 18%, expense ratio is 20%, and they continue to take in a ton of cash simply because mortgage delinquencies and defaults are incredibly low.

As a result in this year, they’ve declared special dividends of $1.85/share so far and also have spent some capital on share buybacks – although since their currently share price is above book, management opts for the special dividend route.

There are only two issues that I will note.

One is that there is a brief mention of the impact of transition away from Genworth Financial’s shared services – since MIC’s majority stake (56.9%) is being bought out by Brookfield Business Partners, MIC will have to build its own services currently being purchased from Genworth, and this will cost money. It is also not entirely known about the exact impact of this, whether Brookfield intends on using Genworth MI as a currently existing cash machine, or whether they have strategic plans for the entity. The common shares are also at $53, which is significantly above the book value of $46 (which historically has been a rare situation) and it is almost as if the market will expect a follow-on bid to take the rest of the 43% out of the market. We will see.

The other note is that the company’s portfolio of preferred shares has also been a victim of the 5-year rate reset plague which has depressed prices of such preferred shares – they are now sitting on a $107 million unrealized loss on their current fair value of $494 million – or 18%.

Otherwise, the company seems to be doing very well. There does not appear to be any hints that CMHC wishes to apply any semblance of pricing pressure in the marketplace, which would be the biggest risk to MIC’s share price. One would have presumed that the Government of Canada would want to make life more affordable for the middle class homebuyer, but I am the first one to know that the words coming out of politicians’ mouths should always be verified by the actions of the bureaucracy underneath them!

Altagas Canada – my worst missed investment

I’m going to talk about the Canadian election results in a subsequent post. Something more mundane here.

Altagas Canada (TSX: ACI) was spun off from Altagas (TSX: ALA) in the depths of ALA’s de-leveraging attempts. Unfortunately, this was my worst “miss” that I never invested in, because of my normal policies which go against investing in initial public offerings. Altagas went public at $15 in October 2018 and I was intending on buying shares when it inevitably dropped to $12 (if I was going to buy a new public offering, why would I pay face value?), but it never got there. Sadly, my parsimonious nature got the better of me.

There is a second rule which I should have remembered: If a company goes public as a result of a forced de-leveraging or firesale, it probably is worth a consideration beyond that of a more standard IPO. Another IPO that fit this description was Genworth MI, which was spun off from Genworth Financial (NYSE: GNW) for deleveraging purposes. They do not happen very often, but when they do, you get gains like what happened with ACI.

ACI received a buyout offer from the Federal public pension board and the Albertan pension plan for CAD$33.50/share, so if I had just sucked it up and bought shares on IPO day at $14.53, I’d be sitting on a 130% gainer in the span of a year, not factoring in the $1.04 dividend. Oh well!

In terms of valuation, the pension plans are buying for a billion in cash a company that also has net $640 million in debt on the balance sheet. At an EV of $1.6 billion compared to 2018 operating cash flow of $90 million (not even factoring in capital expenditures), this isn’t the cheapest acquisition on the planet. It’s easy to see why they agreed to be bought out, and also why I wasn’t interested in them for $25/share either!

This, however, does show that pension boards are looking for cash flowing assets to park their capital into. Looking at Atlantic Power (TSX: ATP) anybody?