Versasen – Bought out

Verasen (TSX: VSN) is a relatively boring utility company that had some exposure to a LNG project in Oregon (among other businesses that are less exciting). They’ve been on my radar since early 2016 but I opted for other investments at that time since there were other risk/reward opportunities.

Today they are being bought out by Pembina (TSX: PPL) in a merger that makes strategic sense. The premium over the previous day’s closing price was approximately 22%, depending on whether you can get cash or stock in the transaction.

Pembina is a huge corporation and they trade at a market cap that is well above my normal investment range.

It is always sad to see research candidates where you’ve dumped a few hours learning about the company, industry, competitive advantages, etc., go by the wayside, but that’s life in finance. Onwards to the next target.

Home Capital / Equitable Group Discussion #2

A few news items which are salient as this saga continues:

1. Home Capital announced a HISA balance of CAD$521 on Friday, April 28 and a GIC balance of $12.97 billion. On May 1, this is $391 million and $12.86 billion, respectively (another $220 million gone in a day). Their stock is down 21% as I write this.

2. Equitable announced their quarterly earnings and are up 35%. This was a pre-announcement as they previously stated they would announce on May 11, 2017. They announced:

* A dividend increase.

Between Wednesday and Friday, we had average daily net deposit outflows of $75 million, with the total over that period representing only 2.4% of our total deposit base and with the most significant daily outflows being on the Wednesday. Even after those outflows, our portfolio of liquid assets remained at approximately $1 billion.

Obtained a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of Canadian banks, including The Toronto-Dominion Bank, CIBC, and National Bank (“the Banks”). The terms of the facility include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility, and an interest rate on the drawn portion of the facility equal to the Banks’ cost of funds plus 1.25%. This interest rate is approximately 60 basis points over our GIC costs and competitive with the spreads on our most recent deposit note issuance, and as such will allow us to continue growing profitably.

So their credit facility cost $15 million to secure $2 billion (relative to $100 million for HCG), lasts two years (relative to 1 year for HCG), and also have a standby charge of 0.5% (which is 2.0% less than HCG), and a real rate of interest of approximately 3% (compared to HCG paying 10% for their outstanding amount, and I’m assuming the Bank’s “cost of funds plus 1.25%” works out to around 3%).

I haven’t had a chance to review their financial statements in detail yet. But securing two billion on relatively cheap terms like this is going to be a huge boost to their stock in the short run.

Very interesting.

Genworth MI (TSX: MIC) is also down a dollar or 3.5% today, which is more than the usual white noise of trading. It dipped even lower today.

Administrative note on the site

I have enabled full-text RSS feeds of the site’s posts (instead of just a summary). You will no longer have to click-through your RSS readers in order to view articles on this site. While I am curious who is reading the content on this site, there are RSS readers that are now smart enough to just download the whole content and display it for their readers. I don’t run advertising, but if you are one of those silent viewers, it would be mightily appreciated if you just write a comment saying “hello” and where you initially heard of this site since I get so little traffic from Google for the past few years (one of the consequences of not giving them advertising money). Don’t get me started about the rest of social media either!

I have also updated some site links on the right hand side concerning other Canadian Finance authors. My criteria is that the writer’s name be known and that they’ve written at least four decent pieces in a year. Sadly the quality of writing on the internet has decreased significantly over the years and I do not expect this trend to abate.

DREAM Unlimited and Birchcliff Preferred Shares – cash-like with higher yield

I’ve written in the past about DREAM Unlimited 7% preferred shares (TSX: DRM.PR.A) and the situation still applies today. They, along with Birchcliff 7% preferred shares (TSX: BIR.PR.C) are the only holder-retractable preferred shares trading on the entire Canadian stock market.

They are both trading slightly over par value.

In the case of Birchcliff, the preferred shares only become retractable on June 30, 2020. As such, the implied yield to retraction is around 6.14% (assuming CAD$25.50/share and not factoring in the accrued dividend). You would receive eligible dividends over the next three years and a capital loss upon retraction. The underlying corporation, while somewhat leveraged, is quite well positioned if you assume the North American natural gas market is not going to evaporate. There is also some upside catalyst to the business fundamentals (not to the preferred shares!) if North America finally gets a liquefied natural gas plant on the Pacific Coast, but this is not likely to happen since price spreads have narrowed significantly over the past couple years.

Liquidity on Birchcliff preferred shares is not the greatest – but if you float an ask at the ambient price level you will likely get hit a few hundred shares at a time.

In the case of DREAM, the premium is not extreme when factoring in the amount of accrued dividend (at the closing price of $7.29/share, implies a 6.88% yield with a risk of an immediate capital loss if the company decides to redeem at $7.16/share). It has been quite some time since they have traded at a discount to par, and this is likely due to scarcity of shares – shares outstanding have decreased from 4.87 million at the end of 2015 to 4.01 million at the end of 2016, and this trend is likely to continue. Holders are probably waiting for the inevitable call by the company to redeem the preferred shares. But until this happens, holders receive an eligible dividend of 7% on their preferred shares.

Likewise with Birchcliff, liquidity with DREAM preferred shares is not good. However, there is usually daily activity on the shares and the spreads are typically within pennies. In a financial panic, however, that liquidity might fade and in a quick trading situation you might get a price a percent or two below par value.

There is conversion risk – the company can choose to redeem the preferred shares in DREAM equity, to a minimum of $2/share or 95% of the market price (which is the standard 20 business day VWAP, 4 days before the conversion provision, as defined in section 4.09 on page 68 of this horrible document). With the common shares trading at $6.60 and the business fundamental not being terrible, the risk seems to be quite low that preferred shareholders will leave this situation with anything less than par value.

I have some idle cash parked in both instruments. I consider them a tax-advantaged cash-like instrument and do like the fact that they are margin-able at IB (Birchcliff at 50% and DREAM at 33%!). This is much better than putting the money in a Home Capital Group GIC (earn 2% fully-taxable interest income AND have the privilege of losing principal when they go insolvent)!

Does anybody out there know of any similar situations that relate to US-denominated preferred share securities that are “cash-like” in nature?

KCG cost of capital calculation

I will warn this is a very dry post.

The merger arbitrage spread with KCG has narrowed considerably.

When the $20 cash merger was announced the shares were trading at $19.75. There is little chance of the deal falling through or there being a superior offer.

Today KCG is trading at $19.88. The estimated close of the merger was reported to be “3rd quarter 2017”. The assumption is the mid-range, or August 15, 2017.

So there are 3.5 months until the deal closes.

12 cents appreciation is 0.6% over 3.5 months, which over the course of 3.5 months implies a 2.1% annualized rate, not compounding. This also excludes trading costs.

Because I had a small cash deficit in my USD account and a surplus in CAD, I’ve sold some shares at $19.88 to make up the shortfall. I placed it at the ask to minimize trading costs, which turned out to be 29 cents per 100 shares.

What’s interesting is my trade got hammered away, 100 shares at a time, approximately 2-4 seconds apart per trade. Interesting algorithms at play here.

I also believe Virtu (Nasdaq: VIRT) will have a more difficult time with the integration of KCG than they originally anticipate. The company cultures are significantly different and while the merger makes sense on paper, in practice it is going to be quite different. KCG was also dealing with a non-trivial data migration program on their own, from New Jersey to New York City and these sorts of technical details require highly skilled individuals to pull off without causing trading blow-ups. It might take them a year to get things stabilized after the merger is finished. KCG had huge growing pains of its own after it was reverse-takeovered by GetCo.