Why the junk debt market is not dead yet – Alaris Royalty Corp convertible debt offering

Somehow the junk debt market is not dead yet – I see offerings like this (Alaris Royalty Corp. Announces A $100 Million Bought Deal Financing) – unsecured debt, 5-year term, 5.5% coupon, and 30% out-of-the-money conversion rate (noting that the underlying equity is already giving out a dividend at nearly a 9% yield at the closing price of the day the bought deal was announced).

Talk about a low return, high risk deal! That said, Alaris should be giving their underwriters (CIBC Capital Markets, National Bank Financial Inc., RBC Capital Markets and Scotiabank) full price for finding investors to actually buy this offering, let alone $100 million of it.

Just glossing through the preferred share markets, one can speculate on a better risk/return scenario. There are many examples I can give, but I will choose one at random. Believers in Brookfield Asset Management can pick up a preferred share series (e.g. TSX: BAM.PR.Z) and buy an easy 6% tax-preferred yield, with a reasonably decent potential for capital appreciation (it is trading well below par), and BAM’s underlying business provides significantly better inherent diversification, coupled with a much better credit profile.

Is the equity call option of Alaris’ unsecured convertible debenture worth it? Why not just buy the common instead and pick up a 9% dividend? I can’t see any realistic scenario where an investor would choose purchasing the unsecured debt instead of the equity – and if you think the underlying company was questionable, why invest in this at all?

No positions in any names mentioned, and most definitely not going to be in Alaris’ convertible debt at par!

The death of Bitcoin – not so fast!

Bitcoin has been going through a remarkable surge in the past few months:

It looks like a classic short squeeze, but the open interest on the CME futures (4,800 times 5 coins) is not a material portion of trading that occurs on the higher volume exchanges (which is cleverly charted here).

So who the heck is firing a bunch of capital at Bitcoin? Good mystery.

There is no fundamental case to be made for any price of bitcoin at this level (four thousand, eight thousand, twenty thousand…) – its utility ultimately is derived from its participants and right now, it is clearly higher than it was a couple months ago!

When things start getting interesting again will be if it goes above USD$10k again – that should be the price level where it will start getting a lot more mainstream media attention.

Read the fine print! Going-private transactions

Dynasil (Nasdaq: DYSL) is a micro-cap company in the business of selling specialized optics. Their company fundamentals (or how they got to be on my radar) is not terribly relevant to this post.

Their market cap is US$19 million at present. Compliance costs for micro-cap companies are extremely expensive in relation to their capitalization, and hence they want to go private, which they announced on May 2nd (form 8-K). The terms and conditions were that they were going to do a 8000-for-1 reverse share split, and subsequently split the stock 1-for-8000 and this would cash out sufficient numbers of stockholders to less than 300, which is the number required in order to enable them to go through with their privatization.

The stock traded down to about $1.02-$1.03 after their announcement – nobody wants to hold an illiquid stock in a privately held firm. In addition, people holding more than 8,000 shares in non-multiples of 8,000 would have their residual portion taken away without compensation (which would prompt a bunch of people to sell to a division of 8,000 shares).

Specifically, the Board recommended and approved a transaction whereby the Company would effect a 1-for-8,000 reverse stock split of the Company’s common stock (the “Reverse Stock Split”), followed immediately by a 8,000-for-1 forward stock split of the Company’s common stock (the “Forward Stock Split,” and together with the Reverse Stock Split, the “Transaction”). Stockholders owning fewer than 8,000 shares of common stock at the effective time of the Transaction would receive $1.15 in cash, without interest, for each share of common stock held by them at the effective time of the Transaction

It would make sense to buy 7,900 shares of the company at $1.03 and then have them cashed out by the company at $1.15, correct? That sounds like a nearly risk-free $948 before commissions and taxes.

Not so fast… reading the fine print later on, we have the following passage:

If consummated, the Reverse Stock Split and Forward Stock Split would apply directly only to record holders of the Company’s common stock. Persons who hold shares of the Company’s common stock in “street name” are encouraged to contact their bank, broker or other nominee for information on how the Transaction may affect any shares of the Company’s common stock held for their account.

Almost all investors that do their transactions through brokerage platforms have their shares held in street name. The registered owner is typically the brokerage firm, while the beneficial owner is the account holder. So if a brokerage firm has three customers, and each customer has 7,900 shares of DYSL, there might be a hidden consequence – the brokerage will receive 2 shares of the company after the reverse split, and has to figure out how to divide that among their 3 customers. Each customer would subsequently be beneficial owner of 5,333 shares of an illiquid private company and not receive any anticipated returns of a cash-out!

It sometimes pays (or avoids unintended consequences) to read the fine print.

Atlantic Power – slow and steady

Atlantic Power (TSX: ATP) announced a week ago that they purchased equity interests from Altagas (TSX: ALA) in two biomass plants for $20 million. Altagas is looking to shed assets, while Atlantic Power is looking for opportunities – biomass is something they have an operational specialty in, so this works out.

Key quotation in the press release:

Since last summer, we have announced the acquisitions of five plants – Craven County and Grayling; the remaining ownership interests in the Koma Kulshan hydro facility, which we acquired in July; and the Allendale and Dorchester biomass plants in South Carolina, on which we expect to close later this year. The PPAs for these acquired plants run through December 2027, March 2037 and October 2043, respectively,” said James J. Moore, Jr., President and CEO of Atlantic Power. “The acquisitions represent a meaningful addition to the level and length of our existing contracted cash flows, and we estimate they will contribute Project Adjusted EBITDA of $8 million to $10 million annually on average through the date of the first PPA expiration. We acquired the five plants at what we consider to be attractive prices.

Acquiring the remaining 50.25% of Koma Kulshan (Hydro) was $13.2 million.

Allendale and Dorchester (Biomass) was $13 million.

Craven County and Grayling (Biomass) was $20 million.

At the midpoint of the projected EBITDA contribution of $9 million, this represents an investment at a 19% EBITDA return. As ATP has a term loan that is LIBOR plus 275bps, this is a 5.1% pre-tax cost of capital, or approximately $2.36 million, so the EBTDA (EBITDA minus I) is $6.64 million. ATP has a massive tax shield so effectively this will flow to the bottom line directly. It works out to 6 cents per share.

This would explain why the company has not been buying back many of their own common shares in calendar 2019 – they found a better place for the money.

Enough decisions like these and the company will eventually see higher share prices. It will take time, but it is a very low risk and moderate return situation. Company management has stated in the past that at the right price, they will even sell themselves outright. I don’t think this will be coming anytime soon, but in the meantime, they continue to build value.

I also own some of their preferred shares, although they are trading at less attractive yields than they used to. In a takeover scenario, however, they will probably trade a couple hundred basis points tighter.

(Subsequent update, May 21, 2019: Their stock has been trading quite a bit higher than the US$2.20-ish they were half a year ago when they were buying back their own stock. They’re now up to US$2.60. Given how they’ve deployed cash, I do not view it likely that they will be too aggressive with their common share repurchases for the duration of the year – they have been very active at reducing debt.)

Teekay Offshore – sad end to the story

There is always a risk in investing in companies that are incorporated in offshore domains. Teekay Offshore is a partnership incorporated in the Marshall Islands jurisdiction. Normally this doesn’t make much difference, but sometimes the geography of incorporation makes a huge difference – laws that apply in Canada and the USA may not necessarily apply to other jurisdictions.

I’ve written about Teekay Offshore (NYSE: TOO) before (a bunch of posts here), but today, Brookfield initiated a “take-under” offer, offering to buy back the 49% of the company they do not own. They already took control from Teekay corporation (who themselves were over-leveraged and needed the cash). TOO was trading at $1.16 last Friday, and the offer was at $1.05/unit.

The issue is that one has to read the legalese on the partnership units, and the cross-section with applicable Marshall Islands law to figure out what they can and can’t do to make this transaction occur.

Of particular note are the preferred shares, which on paper have very good yields. For instance, TOO.PR.E has an 8.875% coupon and is now trading at $16/share (par value is $25) which gives it nearly a 14% yield.

Looks like a good return on investment, eh? Brookfield will certainly continue to pay those preferred dividends since they will want to certainly make distributions with the common units when offshore drilling becomes profitable again, right?

Not so quick.

We are dealing with Marshall Islands law, where wild west type rules prevail.

What makes preferred investors think that the wholly-owned partnership won’t have their assets stripped away and the preferred unitholders stranded? In Canadian jurisdictions, this would be a constructive dissolution, but who wants to take their chances in the Marshall Islands, a territory with 53,000 residents?

No positions but watching the whole story unfold.