Late Night Finance with Sacha – Episode 26

Oh my, this one is a little late!

Date: Thursday November 16, 2023
Time: 7:15pm, Pacific Time *** NOTE the odd start time
Duration: Projected 60 minutes.
Where: Zoom (Registration)

Frequently Asked Questions:

Q: What are you doing?
A: Quarterly review, quarter-to-date review, reviewing the losers of 2023, economic thoughts, and some crystal ball gazing, and finally time permitting, Q+A. Please feel free to ask them on the zoom registration if any questions.

Q: How do I register?
A: Zoom link is here. I’ll need your city/province or state and country, and if you have any questions in advance just add it to the “Questions and Comments” part of the form. You’ll instantly receive the login to the Zoom channel.

Q: Are you trying to spam me, try to sell me garbage, etc. if I register?
A: If you register for this, I will not harvest your email or send you any solicitations. Also I am not using this to pump and dump any securities to you, although I will certainly offer opinions on what I see.

Q: Why do I have to register? I just want to be anonymous.
A: I’m curious who you are as well.

Q: If I register and don’t show up, will you be mad at me?
A: No.

Q: Will you (Sacha) be on video (i.e. this isn’t just an audio-only stream)?
A: Yes. You’ll get to see me, but the majority will be on “screen share” mode with MS-Word / Browser / PDFs as I explain what’s going on in my mind as I present.

Q: Will I need to be on video?
A: I’d prefer it, dress code is pajamas and upwards.

Q: Can I be a silent participant?
A: Yes.

Q: Is there an archive of the video I can watch later if I can’t make it?
A: No.

Q: Will there be a summary of the video?
A: A short summary will get added to the comments of this posting after the video.

Q: Will there be some other video presentation in the future?
A: Most likely, yes.

Aimia – the gift that keeps on giving

I just can’t keep my eyes away from Aimia (TSX: AIM) which is a huge corporate soap opera that I am so glad I do not own.

According to Aimia’s posted statement of claim, we have one of the Mittlemen brothers going rogue, coupled with a Saudi-owned Cayman Islands corporation (Mithaq) that chose one of the worst Canadian publicly traded companies to target with their excess in capital. While they have likely blown over a hundred million or so on this venture, they apparently could not hire some junior security lawyer to write up a two paragraph memo explaining that once you get over the 20% threshold that some special rules take place. Or perhaps if they couldn’t afford a few billable hours, they could have just used Google.

84. Mithaq was aware of the take-over bid regime and understood the implications of crossing the 20% threshold. On February 2, 2023, Mr. Seemab sent an email to Mr. Mittleman with the subject line “Exceeding 20%?” and asked for help understanding “the process/implications if an investor exceeds the 20% equity threshold in the Canadian market?”

85. Mr. Mittleman advised Mr. Seemab that “if an activist’s goals can be achieved without incurring the complications of crossing the mandatory build [sic] threshold, that’s probably the easier / less expensive / better path. So I think 19.9% is probably sufficient”.

Oh my, this made for entertaining reading.

Reviewing the past week

The past week was relatively interesting.

The 10-year bond yield went down about 0.25% from the beginning to the end of the week. Likewise, the long part of the yield curve also dropped (prices rose) and a whole flurry of the usual interest rate sensitive subjects got taken up VERY sharply. I’ll just give a few of them, but you get the idea – these four are from very different industries:

(But also take a look at REI.un.to, CAR.un.to, etc. – also dramatically up over the past few trading days).

REITs, lumber, sugar, and fast food. All of these are yieldly and leveraged. Don’t get me started on other components of the fixed income markets either, but I’ll throw in the 30-year US treasury bond yield:

There is a cliche that in bear markets, bull trap rallies are the sharpest. This is usually the case because short sellers are a bit more skittish than in the opposite direction.

My suspicion is that the bears on the long side of the bond market got a bit too complacent.

The calculation of the risk-free rate is a very strong variable in most valuation formulas. If you can sustain a 5% perpetual risk-free rate, there is no point in owning equities that give a risky 4% return. The price of the equity must drop until its yield rises to a factor above 5% (the number above 5% which incorporates the appropriate level of risk).

So what we see here is the strong variable (risk-free rates) moving down and hence the valuation of yieldy and leveraged equities rising accordingly, coupled with some likely short squeeze pressure on the most leveraged entities.

There are likely powerful undercurrents flowing in the capital markets – the tug-of-war with the ‘higher for longer, inflation is here to stay’ crowd competing with the ‘Economy is going bust, the Fed has to lower rates!’ group.

The last chart, however, I must say was not on my bingo scorecard for 2023 – Bitcoin is up over double from what it was trading at the beginning of the year:

I should have just pulled a Michael Saylor and gone 150% on Bitcoin. Go figure.

Yellow Pages – Drawing more blood from the stone!

Some history – last year, Yellow Pages announced a $100 million share buyback at a set price and shareholders almost unanimously agreed to a pro-rata buyback at $12.58 per share. They bought back 7,949,125 shares and at June 30 they had 26,607,424 shares outstanding. I wrote a little about it here.

Fast forward to today, and we have the following announcement:

Yellow Pages Limited (TSX: Y) (the “Company”), a leading Canadian digital media and marketing company, today announced that the Board has approved a distribution to the Company’s shareholders (the “Shareholders”) of approximately $50 million by way of a share repurchase from all shareholders pursuant to a statutory arrangement under the Business Corporations Act ( British Columbia ). The arrangement will be effected pursuant to a plan of arrangement (the “Arrangement”) which provides that the Company will repurchase from Shareholders pro rata an aggregate of 4,440,497 common shares at a purchase price of $11.26 per share, which represents the volume weighted average price for the five consecutive trading days ending the trading day immediately prior to October 19, 2023.

Yellow has 18,658,347 shares outstanding as of June 30, 2023, so this share buyback will result in a reduction of 23.8% of shares outstanding and bring them to about 14.2 million shares. At June 30, 2023 they had $64 million of cash on the balance sheet.

In the past four quarters, they have been able to generate $90 million in adjusted EBITDA, or about 1.6 times EV/EBITDA. The ITDA is about $10 million and the large cash drain has been the maintenance of the corporate pension plan which is still listed as a $37 million net liability, but this is slowly getting rectified.

Here is the really interesting proposition – the dividend is currently a $3.55 million quarterly cash outflow. The company is easily generating enough cash to cover the dividend. After the buyback is concluded, the 20 cent quarterly dividend could be raised to 26 cents per share and be cash neutral. At 26 cents per share, the company trades at a 9.2% yield. This is going to be difficult for algorithmic traders to avoid especially considering that the “melting ice cube” business is not melting nearly as quickly as one would expect, considering it is the Yellow Pages, after all.

If Yellow manages to generate another $80 million adjusted EBITDA over the next four quarters (this is not a given – my own model has them closer to $75), about $55 million of that will be pure cash flow and they’d be able to repeat this same maneuver again in 2024. If their stock price doesn’t move from there, another $50 million buyback would render the dividend yield at 13% – would the market be able to resist?

The funny thing is that there is a low enough price that one would actually want to purchase more Yellow Pages. Good luck, however – it takes about 2,000 shares of trading to move the stock price 70 cents per share!

I have had countless amusement and bewilderment, not to mention immediately dismissive and credibility-destroying reactions when telling people this is my longest lasting investment currently in my portfolio. For good memories, read my coming out of the Yellow Pages closet here.

Canadian Convertible Debentures – Maturing 2023

I’ve been looking at the Canadian Convertible Debentures that are scheduled to mature between now and December 31, 2023. Some observations:

Medexus (TSX: MDP.DB, October 16, 2023 maturity) – This will mature on Monday for a cash payment at 125 of par (a very unique offering). To be honest, this one surprised me in that I was expecting some sort of distressed debt situation, but the company managed to scrape enough pennies together through a newly minted credit facility in early March 2023, some decent financial results posted on June 2023 and finally a secondary equity offering that concluded a week ago – striking while the equity was hot. Management navigated this whirlpool quite well, and at 24 employees, each person’s individual effort really counts for these types of companies. Before they get delisted I’ll post their chart, again noting that payout at maturity is 125 of par:

The rest are December 31, 2023 maturities:

Aecon Group (TSX: ARE.DB.C) – $184 million due. The company has a $600 million credit facility, of which $188 million was drawn out on June 30, 2023. Conversion is at $24/share and the stock is at $10.59/share, so very likely a cash maturity. Even a mediocre execution in the next six months will not result in these debentures getting in trouble and hence the 99% of par trading price at present. This engineering firm has been kind of lost since the Canadian government shot down its acquisition by a Chinese national firm many years back, but they continue to meander along despite being in a market where there is going to be plenty of demand going forward. The problem is that engineering firms need to retain talented individuals that need enough motivation to stay in such firms, which facilitates both the precise costing and execution of projects. It is one thing to get contract wins, it is another thing entirely to discover that your costing is so out of whack that in order to execute on such projects that you’re going to be losing money. A great example of this is the construction of the North Vancouver sewage plant which appears to be a case of a company being completely out of its depth.

Firm Capital (TSX: FC.DB.G) – $22.5 million due. Conversion is $15.25 with the stock price at $9.80. Firm Capital has many issues of convertible debentures outstanding at various maturities, trading roughly 4-5% above the government yield curve. The company proactively sent out a financial release on September 19, 2023 which attempted to reassure the market that despite their mortgage portfolio outstanding shrinking in size, that they are solvent. In particular, a $180 million credit facility remains untapped and combined with cash, this is comfortably facilitating a cash maturity of this particular issue. However, it is pretty clear that FC is going to have to make some tough choices – they traditionally have funded their loans through convertible debentures at really cheap coupons – the latest ones (FC.DB.K, FC.DB.L) were a combined $90 million out for 5 years with a 5% coupon with a conversion price well out of the money ($17.75 and $17.00/share!) – the last offering was done in January 2022 and this was PERFECT timing by management – there is no chance at all of them doing this again in the current rate environment.

Northwest Healthcare Properties REIT (TSX: NWH.DB.G) – $125 million due. Conversion is $13.35/unit with a current unit price of $4.57. The quick summary here is that the trust is in serious financial trouble. I remember this REIT being one of these “dividend starlings” that the usual retail crowd hyped up on financial twitter and the like, and unless if management is skillful, this one is potentially heading down to a zero. With specific regard to the ability to redeem this debenture, the trust is hitting a financial limit with its term facility (on June 30, 2023 there is $165 million available to be drawn). The minutiae in their last quarterly filing includes distressed paragraphs like this:

On August 2, 2023, the REIT executed an interim non-revolving tranche under its revolving credit facility to increase availability by $50.0 million. The tranche matures in October 2023 and can be extended until January 2024 under certain circumstances. The facility is secured by certain assets in the REIT’s Americas portfolio and it bears interest ranging from 10.6% to 13.8%.

… 10.6% to 13.8%! Ouch!

Subsequent to June 30, 2023, the REIT extended the maturity date of its revolving unsecured credit facility with an outstanding balance of $125.0 million credit facility by one year to November 2024, The facility bears interest ranging from 8.73% to 10.01% (previously 8.23% to 9.51%).

Banks are ratcheting the screws on the trust…

They released a September 22, 2023 financial update trying to assure the market that with some “non-core” asset sales coupled with some other measures they are “fortifying” the balance sheet, but there is indeed a danger that this convertible debenture will be partly redeemed in units by the company. While writing this post, I notice the “fantastic” SEDAR Plus is down for maintenance so I could not confirm directly that the indenture allows for this, but a previous MD&A does allude to this being an option for the company. The two other outstanding convertible debenture issues (maturing roughly in 4 years) are trading at a YTM of 12.5% so refinancing is not going to be in the cards for this REIT. My guess is that they squeeze out a cash maturity but good luck in the future!