Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Amended Exchange Offer

You can read my previous analysis piece on the original exchange offer here.

Dundee Corporation has announced a revision to the exchange offer. This offer would have never been made if there were sufficient votes to accept the original exchange offer (2/3rds of votes required).

The management information circular has not been posted yet, but James Hymas beat me to the punch to providing some of his always excellent analysis on anything relating to preferred shares.

My own quick summary is: the deal stinks less compared to the original offer, but it still stinks.

The revised terms of the amended offer compared to the original exchange offer include:

– The removal of the $0.223/share consent payment for shareholders voting yes to the proposal before a specified date.
– The ability to redeem 15% of the issue on June 30, 2016 and a further 17% of the then-issue (i.e. another 14.45% of original issue size) on June 30, 2018January 31, 2018;
– An increase of the dividend rate from 6% to 7.5%;
– Granting of 0.25 warrants to buy DC.A stock with a strike price of CAD$6.00 with an exercise price of June 30, 2019 (which will be listed on the TSX).

Closing Market Prices for Reference

DC.A: $5.95/share (no dividend)
DC.PR.B: $12.00/share (11.9% yield)
DC.PR.C: $14.43/share (6.2% yield)
DC.PR.D: $9.50/share (11.8% yield)

Analysis

The meeting date has been postponed to January 28, 2016, but shareholders of record on December 3, 2015 (per the original exchange offer) will have a vote on the matter. They chose to keep the original record date – a revised record date would include shareholders that were more willing to buy into the terms of a sweetened exchange offer.

By far and away the most important provision is the removal of the $0.223/share consent payment. This consent payment introduced the concept of a prisoner’s dilemma where if you believe the deal was going to pass, you would be incentivized to vote in favour of the deal despite how bad it was.

Without a prisoner’s dilemma, there is no incentive to voting yes for a marginal or mildly adverse offering (which was the only way the previous offering had any chance of passing).

This deal still stinks, but the removal of the $0.223/share carrot will remove votes in favour because (and this is my personal speculation) most of the shareholders are angling for the June 30, 2016 redemption.

So now, shareholders can vote against the proposal and face no “punishment” of having missed out on a consent payment.

Notably the consent payment for the intermediaries is still in effect – brokers will receive $0.1784/share for each vote in favour received by January 21, 2016 and $0.0892 by January 26; so if you are indeed in favour of this bad deal, it would be in your best interest to vote your shares at the actual meeting so the company doesn’t have to pay out consent payments to third parties!

The ability to redeem 15% of the shares on the original June 30, 2016 redemption date is “nice”, but not of material economic consequence. The subsequent tranche (14.45% of the original offering size) on June 30, 2018January 31, 2018 is long-dated enough that credit risk considerations come into play (for instance, the company’s credit facility would have to be renegotiated at this point and you would expect their subsidiaries would actually start making money at this point).

The increase of the dividend rate to 7.5% reflects the very weak trading performances of the other two preferred share issues (yielding nearly 12% at current prices). James Hymas has done a much better job than I could explaining the quantitative details of this component. Credit risk, especially by redemption time, becomes a huge factor in properly determining the course of action for this exchange offer. Dundee is good for a June 30, 2016 redemption through the unused portion of their credit facility. After this, who knows?

I will attempt to ballpark a valuation of the warrants. The company stated the warrants would be listed on the TSX if the exchange offer is accepted and this would give preferred shareholders a venue to liquidate for immediate cash proceeds. While the historical volatility of Dundee common shares as of the past 30 days has been around 80%, their at-the-money options currently trade at an implied volatility of 42%. Using Black-Scholes valuation (which is not the best way to value long-dated options, but is good enough for paper napkin purposes such as this post) we get an option value of $1.84/share, or about 46 cents per preferred share (as each share would receive a quarter warrant).

Using some more formal methods involves different results – if you are that bullish on Dundee’s common stock, why bother playing around with the preferred shares when you can simply buy the common shares or even the other preferred shares?

Doing some simple sensitivity analysis, if Dundee traded to $8 (25% higher) between now and the January 28, 2016 special meeting, the implied value of the warrants per preferred share would be approximately 83 cents (50 cents intrinsic value and 33 cents time value), assuming implied volatility doesn’t drop (in reality – it would slightly). 83 cents does not come close to mitigating the capital losses that have occurred between the initial offering (when shares were trading at CAD$17) and when the exchange offer was proposed. Right now preferred shareholders are sitting on a $2.60 drop in market value and this exchange offer will come nowhere close to compensating them even with the increased coupon and partial early redemption rights.

I also find this statement to be amusing:

The determination of the Board of Directors is based on various factors, including a fairness opinion prepared by GMP.

Apparently the original exchange offer was fair, but the amended one is as well! Is there any offer that wouldn’t be considered fair by GMP?

Conclusion

Preferred shareholders have an even easier decision this time around – vote against the offer. It is still terrible compared to the existing Series 4 preferred shares.

As I have disclosed in my prior post, I sold out my DC.PR.C position between $17.20-$17.44/share in late November/early December. I’m a spectator at this point.

Update January 9, 2016: The initial part of this post had the second redemption date as June 30, 2018 when it should be January 31, 2018. The above has been corrected and the 5 month difference does not materially change the above analysis.

End of Canadian tax season

The last chance to dispose of stocks on the TSX will be at 12:59pm EST on December 24, 2015. These trades will settle in the 2015 calendar year. The exchange is closed on December 25, 2015 and also December 28, 2015 (in lieu of the December 26 Boxing Day holiday). Trades conducted on December 29, 2015 will settle in 2016.

Our American cousins journal their trades for taxation purposes on the transaction date and not settlement date, so they have up until December 31 to make their last-nanosecond trading decisions for tax purposes.

I have been insanely busy lately dredging the recent trainwrecks (mainly relating to oil and gas) and have been finding material of value, hence I haven’t been writing much here.

The biggest gainer on December 22 market trading

I will predict the company with a market capitalization of at least $1 billion that will exhibit the largest percentage increase in market valuation on December 22. I am pretty certain of my conviction.

Unfortunately, the company is not publicly traded. It is very likely to be publicly traded one day.

The company is called SpaceX, run by the same genius that runs Tesla Motors (Elon Musk).

Yesterday, they launched a rocket into space. They have done this before and being a private firm, this was no small feat as it was only done before by government-funded/operated space agencies.

The next step in their cost-optimization is being able to get the first stage rocket back to earth in one piece. Since the first stage probably costs around a low 3-digit million amount to construct, you would save a lot of money recovering this piece instead of having it dumped in the ocean.

They managed to do this less than 24 hours ago. Watching this video (the re-entry of the first stage rocket starts around 32 minutes in) is amazing. You can read about their initial attempts here.

My university degree was majoring in physics. I do not believe most people can appreciate how truly difficult this is to get correct.

They still have to figure out some other non-trivial matters, such as how much metal fatigue becomes a factor when reusing rockets, and how to deal with various atmospheric and variable factors that inevitably will come into play when it concerns rocketry, but for the most part, they are very well on their way to total domination of the low-cost space launch market.

After this successful re-entry, if SpaceX was publicly traded, I would guess their market capitalization would be up by 50% in a single day, which will likely top the charts on an ordinarily boring Christmas-time trading day.

Dream Unlimited Preferred Shares

With the calamity hitting the preferred shareholders of Dundee Corp (of which I narrowly escaped), I have long noticed that their spinoff corporation, DREAM Unlimited (TSX: DRM) has a similar situation going on with their own preferred shares.

You will have to dig through SEDAR and look for a May 31, 2013 document that is 8783kb in size and go to page 60 of 141 in the PDF document for a legal definition of what these preferred shares are. They made it so convenient as the documents are not even made searchable with the usual control-F function on Adobe Acrobat.

They trade as DRM.PR.A and they are retractable by the corporation at $7.16/share, and redeemable by the shareholder at $7.16/share, in both cases with accrued dividends (7% coupon on a $7.16 par value). Redemption and retraction are given with at least 30 calendar days of notice.

Unlike Dundee Corp, there is no ability for DREAM Unlimited to sneak a shareholder-hostile proposal to scrap the redemption feature without a significant sweetener – if they did so, you can “vote” by exercising your redemption rights and get your money 30 days later instead of voting your shares against such a hypothetical proposal.

The only risk is the underlying corporation, DREAM Unlimited, elects to pay the redemption with common shares. The provision is 95% of the typical 20 day volume weighted average price scheme that is common to a lot of other offerings out there, or $2/share if this is the higher price. DREAM Unlimited common shares are trading at $7/share and with a market capitalization of $526 million, so a dilution of $36.7 million is not going to hammer the common shares below $2 if they tried an equity redemption – you’d likely be able to get out above par value in such an instance. The underlying business is not prone to “gap risk” (i.e. this isn’t some biotechnology company that will drop 70% one day due to a failed clinical trial), but it is in real estate development – this means that any of their properties that are not in Alberta or Saskatchewan, should be relatively stable (at least until you can get your redemption money in 30 days time).

In typical Dundee fashion, however, while the corporation is reporting considerable GAAP profits, their cash flow statements leave much to be desired. They do have ample liquidity in the meantime, having negotiated a $175 million million first-line facility with the banks expiring June 2018 and also $200 million of spare capacity on their operating line of credit which expires on June 2017. There is easily enough room to pay for a redemption of preferred shares – indeed, the fact that the preferred shares occupy a $36.7 million hole on their balance sheet probably forces them to be more conscious about this liability. I wonder why they haven’t even just bitten the bullet and redeemed this expensive capital.

In other words, the market value of this preferred share issue is going to be anchored around the $7.16/share mark as investors are able to skim off a 7% eligible dividend until such time the corporation bites the bullet and finally redeems the shares. If it goes too below $7.16, it is an easy arbitrage to buy below $7.16 and instantly redeem if you believe there is any sense of credit risk. It is as close to a risk-free 7% as it gets.

I note that the preferred shares were trading as low as $7.00 today and this was likely fueled by some investor out there getting his RBC Margin account spontaneously liquidated – it wasn’t a trivial amount either, around 40k shares worth. About 30,000 of them traded at $7.00 and somebody redeeming them back to the corporation at $7.16 made the easiest CAD$5000 on the planet. Ordinarily DRM.PR.A is not an actively traded stock and with all of the stress occurring in the marketplace, what may be “risk-free” isn’t as liquid as cold hard cash!

Anyway, I bought some shares at $7.00 today.