Bombardier bond yield curve

Bombardier’s bond yield curve has gone much more favourable over the past couple months. Their March 2018 bond issue (the nearest maturity) is trading at par (coupon is 7.5%), while going out to January 2023 the yield to maturity is trading just north of 10%.

(Update on April 18, 2016: After rumours of Delta Airlines close to purchasing C-Series jets and the rejection of the Canadian government’s bailout offer, the yield curve has compressed even further – the January 2023 yield to maturity is now at a bid of 9.5% – the rejection of the bailout offer has to be a positive signal for the company, i.e. they have the financial wherewithal to go on their own without further equity injections).

So while the company isn’t completely out of the woods yet, the market is giving them an opportunity to refinance debt if they choose to do so – However, it is unlikely a bond offering will be made until 2017.

On the preferred share component of their capital structure, their BBD.PR.B series (floating rate) is trading a shade under 10% eligible dividend yield, while the BBD.PR.C series is at 12.7% – somewhat reflecting an increased relative risk of dividend suspension, coupled with a conversion risk (as the company has the right to redeem for equity at the greater of $2/share or 95% of VWAP).

Also muddling the market news is the proposed federal government investment in Bombardier which would likely cement its ability to maintain its credit rating and dividend-paying ability of its preferred shares.

I continue to remain long on the preferred shares.

Pengrowth Energy Debentures

This will be a short one since my research is done and my trades have long since executed. I will not get into the sticky details of the analysis.

Pengrowth Energy has CAD$137 million outstanding of unsecured convertible debentures (TSX: PGF.DB.B), maturing March 31, 2017. The coupon is 6.25%, and the conversion rate is CAD$11.51/share (which is unlikely to be achieved unless if oil goes to $200/barrel in short order).

Because of what has been going on in the oil and gas market, the debt has been trading at distressed levels. It bottomed out in January at around 47 cents on the dollar (this was a one day spike on a liquidation sale), but generally hovered around the 60-65 level. It is trading at 88 cents today.

It is much, much more likely than not it will mature at par.

There are a few reasons for this.

The debentures are the first slice of debt to mature. Pengrowth’s capitalization is through a series of debt issues with staggered maturities.

Pengrowth has a credit facility which expires well past the maturity date and is mostly under-utilized and can easily handle the principal payment of the debentures.

Pengrowth’s cost structure is also not terrible in relation to the operations of other oil firms.

Today, Seymour Schulich publicly filed his ownership of 80 million shares of Pengrowth, which equates to just under 15% of the company. Seymour Schulich owned 4% of Canadian Oil Sands before it got taken over by Suncor, so I’m guessing he was looking for another place to store his money in the meantime. I think he picked well. Schulich also owns 42 million shares (28%) of Birchcliff Energy (TSX: BIR), so with these two holdings, he owns a very healthy stake in both oil and gas.

This last piece of information seals up the fact that barring another disaster in the commodity price for oil that the debentures will mature at par. The only question at this point is whether they’ll redeem for cash or shares (95% of VWAP), but I am guessing it will be cash.

Even at 88 cents on the dollar, an investor would be looking at a 13.6% capital gain and a 6.25% interest payment for a 1 year investment. This is under the assumption there is not an earlier redemption by the company.

I was in earlier this year at a lower cost. I will not be selling and will let this one redeem at maturity.

Pinetree Capital will undergo a change of control

A company that I used to write about in the past, Pinetree Capital (TSX: PNP), will finally be undergoing a change of control.

I own a small portion of their senior secured debentures (TSX: PNP.DB). This holding was much larger earlier in 2015, but they were mostly liquidated through redemptions throughout 2015. By virtue of the last redemption (which was partially paid out in equity) I also own a small amount of equity in Pinetree Capital that I have not bothered to selling yet as they were trading below my opinion of fair value.

I anticipated that the final liquidation of the public entity would be in the form of a constructive sale of its sizable ($500 million+) capital losses. Instead, it comes in the form of a rights offering. I’m not sure what the formal terminology of this is, but I would call it a passive takeover.

Pinetree will issue rights that are exercisable at 2.5 cents per share (which is about a penny, or nearly 1/3rd, below their existing market price). If no more than 40% of these rights are exercised, then a numbered corporation entity controlled by Peter Tolnai will exercise the remaining unexercised rights and take control of approximately 30-49.9% of the company. Tolnai also receives $250,000 for his efforts (probably paying for a lot of legal and advisory fees to structure the rights offering) (Update: Only $250k received if there was a superior offer, see the comments below).

Considering only 22 million shares (of approximately-then 200 million shares outstanding) were voted in their last annual general meeting, it would be a reasonable bet that investor appetite to purchase further shares in Pinetree will be most certainly less than 40% of the existing shareholders. A 30% stake in the company is akin to effective control. I have some fairly good guesses why Tolnai would not want more than 50% ownership of the company.

The rights will be traded on the TSX, but my analysis would determine the price would trade at bid/ask $0.005/$0.01 assuming the common shares are trading at bid/ask $0.03/$0.035. As a result, the rights would not be easy to liquidate after transaction charges and would probably remain relatively illiquid.

Peter Tolnai, judging by his website, feels like somebody I could relate to personally. My guess is that he is taking a strong minority stake in the company for the purposes of obtaining a functional, inexpensive, and public entity to raise capital and utilizing the rich reserves of capital losses to grow capital tax-free. I would deeply suspect he has a team in mind and will be raising capital after the April 22, 2016 special meeting that will authorize a (much needed) 100:1 reverse split.

The net proceeds of the rights offering is to pay off the senior secured debentures, which mature on May 31, 2016. The amount outstanding on the debentures is not huge – $6.7 million principal plus six months’ interest (another $335,000). However, Pinetree has disclosed in its filings that if it is unable to raise money with these rights, they would have to liquidate its remaining privately held investments, implying it does not have anything liquid anymore.

Considering Pinetree Capital has not released any financial information since the end of their September 30, 2015 quarter, it remains to be seen what their current balance sheet situation looks like on the asset column. I’m guessing they sold off all of their liquid publicly traded securities in 2015 (the largest of which was PTK Technologies). Pinetree must release their audited financial statements for the year ended December 31, 2015 by the end of March.

Shareholders as of March 23, 2016 will receive the rights to buy at 2.5 cents per share (which means March 18, 2016 is the last day to purchase common shares if you wish to receive rights), but somehow I don’t think the market will be bidding up Pinetree common shares.

This leaves the last question of the valuation of the final entity, assuming the rights are exercised in full. With the senior secured debentures paid off, there is likely a non-zero value in the company, but a better snapshot can be obtained after the release of the year-end 2015 statements. Another question will be how Peter Tolnai’s team will plan on making capital gains and utilizing the huge tax assets left in Pinetree, but considering he will likely have a 30-49.9% stake in the company, his incentives are well geared towards the passive shareholder base.

Utilizing Pinetree’s capital losses is actually a problem that I would like to help him solve, to quote a line from his “Giving Back” section on his biography, if I was so privileged!

Re-examination of Yellow Media

I’ve written about Yellow Media (TSX: Y) extensively in the past on this site before their recapitalization.

I’ve been generally surprised at their financial performance – from 2014 to 2015, revenues dropped only 5% and while EBITDA margins have compressed (to around 31% from 36% before special items), the negative trajectory is flattening out rather than an accelerated drop. Notably they’ve been generating a ton of cash relative to their market capitalization – $73 million in 2014 and $122 million in 2015.

Balance sheet-wise, they are still leveraged. After their recapitalization, their senior secured debt holders receive a mandatory redemption payment of 75% of free cash flow. In 2015 they repaid about $100 million of debt and since the recapitalization (December 2012) the total has been $393 million, or nearly half the balance outstanding. It is probable that they will be able to redeem another $100 million in 2016 and by that point it should be evident they will be home free (in addition to paying less onerous financing charges).

They reserve the right to redeem more debt prior to May 31, 2017 for 105%, and afterwards at par value. Thus, it would make sense that the company would be aiming for June 1st for a refinancing of existing debt and a removal of the pesky covenants that have been restricting management’s ability to perform other functions with their capital.

The only other debt outstanding are unsecured debentures (TSX: YPG.DB) of which $107 million remain outstanding. These debentures have a coupon of 8% and mature on November 30, 2022 – quite a long-dated debenture. Only after the senior secured debentures are matured, these debentures can be called by the company at 110% of par anytime, or 100% after May 2021. The company can also choose to defer cash interest payments and accrue a 12% payment-in-kind provision but so far they have not exercised this route.

Another feature of these debentures is that they can be converted to Yellow common shares at $19.04 – which is barely above the existing market price of $18.95 on Friday’s close.

This creates an interesting valuation puzzle. Investors have functionally sold a call at 110% of par to the company contingent on the redemption of the senior secured debt, while they have an embedded call linked to the common share price.

In terms of business valuation, if Yellow Media’s revenue/EBITDA margin trajectory remains roughly what management projects (which amazingly to date has been generally the outcome), Yellow Media should be earning somewhere around $70 million in net income. This would work out to $2.50 per basic share outstanding (not accounting for dilution if the debentures convert). If there is a modest growth valuation assigned to the company, one can make a case that Yellow should be trading around $30/share and not the $19/share it is trading at presently.

This would place a valuation of about 150-160 cents on the dollar for the debentures, with relatively little downside from current market prices (the bid of 109 would go down to somewhere around par if the underlying business eroded faster than the current trajectory).

This also does not account for the time value of the at-the-money call option within the debentures – currently their warrants with a strike of $28.16 (nearly 50% above current market value) and an expiry of December 2022 trades at $4.13, so there is clearly time value in the call option.

The warrants are unattractive because break-even would be a common share price of $36/share (i.e. if you bought warrants at $4.13 vs. common shares at $18.96, you would do equally well with an investment if the common went up to $36/share at expiration – note your warrants would do significantly better if $36/share was reached prior to expiry).

While I am not interested in the common shares or warrants, I did buy a small amount of debentures near par in January with the expectation of holding onto them until they are likely redeemed (or if the common shares trade above $20.94, converted). They are a low risk, medium reward type investment. I will caution anybody wanting to trade them that you should be prepared for a very slow market and part of the reason why I have such a small holding is because of the relative market illiquidity.