Just Energy – Unjust Recapitalization

I wrote about Just Energy (TSX: JE) last December after they suspended their preferred share dividends and were obviously awaiting a recapitalization.

A memory refresher on their debt structure:

A couple days ago the proposal came out.

Given all of the classes of debt, this is a messy proposal to read through all the relevant terms. It involves a debt/preferred share conversion, a 33:1 reverse split, and then a follow-on offering of equity.

* Exchange of C$100 million 6.75% subordinated convertible debentures due March 31, 2023 (TSX: JE.DB.D) and C$160 million 6.75% subordinated convertible debentures due December 31, 2021 (TSX: JE.DB.C) (the “Subordinated Convertible Debentures”) for new common equity;
* Extension of C$335 million credit facilities by three years to December 2023, with revised covenants and a schedule of commitment reductions throughout the term;
* Existing senior unsecured term loan due September 12, 2023 (the “Existing Term Loan”) and the remaining convertible bonds due December 31, 2020 (the “Eurobond”) shall be exchanged for a New Term Loan due March 2024 with initial interest to be paid-in-kind and new common equity;
* Exchange of all 8.50%, fixed-to-floating rate, cumulative, redeemable, perpetual preferred shares (JE.PR.U) (the “Preferred Shares) into new common equity;
* New cash equity investment commitment of C$100 million;
* Initial reduction of annual cash interest expense by approximately C$45 million; and
* Business as usual for employees, customers and suppliers enhanced by the relationship with a financially stronger Just Energy – they will not be affected by the Recapitalization.

In total, the Recapitalization will result in a reduction of approximately C$535 million in net debt and preferred shares.

Translated:

1. Convert C$260 million of convertible debt into equity
2. Convert US$117 million par of preferred shares = ~CAD$160 million in equity
3. Add CAD$100 million in equity financing
4. Convert ~CAD$15 million in the “Eurobond” to equity

This is where they get the bulk of the CAD$535 million figure from – from the publicly traded JE.DB.C/D and JE.PR.U securities.

None of the other tranches of debt receive a haircut – instead, they get extended. I will note that the holders of debt is that is the (unlisted) US$207 million unsecured term loan receives relatively preferential treatment in this recapitalization. The likely reasons for this: “The US$14 million draws were secured by a personal guarantee from a director of the
Company.”, and the fact that this tranche of debt was loaned from Sagard Credit, who is backstopping the equity offering.

The CAD$260 convertible debentures will be converted into 56.7% of the equity of the company, prior to the CAD$100 million equity financing.

JE this second is trading at 49 cents per share. At their existing market cap, JE equity is valued at $74.3 million. Convertible debt holders are being asked to convert CAD$260 million into $42 million of pre-diluted equity. This would also explain why the debentures presently are trading at about 18 cents on the dollar.

Preferred shareholders receive 9.5%, and this works out to 4.4 cents on the dollar. This class of shareholder is lucky to get anything.

The common shareholders will retain 28.8% of the company, and they should be even luckier to hold onto anything.

The convertible debentures are subordinated unsecured obligations of the company, which means that they are the lowest tranche of debt in the pecking order. However, the convertible debentures upon maturity can be converted into shares of JE with a standard VWAP clause:

The Corporation may, at its option, on not more than 60 days and not less than 30 days prior notice, subject to applicable regulatory approval and provided no Event of Default has occurred and is continuing, elect to satisfy its obligation to repay all or any portion of the principal amount of the Debentures that are to be redeemed or that are to mature, by issuing and delivering to the holders thereof that number of freely tradeable Common Shares determined by dividing the principal amount of the Debentures being repaid by 95% of the Current Market Price on the date of redemption or maturity, as applicable.

Presumably, if the convertible debentures were allowed to be exchanged for shares under this formula they would be receiving more than 56.7% of the pre-diluted equity. This is not allowed to happen because the senior creditors (the facility due on September 1, 2020) want to squeeze them out for a lot less.

This is what I’d call a fairly “unjust” recapitalization of Just. Caveat Emptor for those that were holding onto any of these securities! In particular, the purchasers of the February 22, 2018 offering of the 6.75% convertible debentures have realized an approximate 70% loss in their investment over the 2 years they’ve been holding it, which is fairly impressive.

No positions, never had any, do not intend on taking any either, and also commend management for ruthlessly taking out more retail capital – this is a textbook case.

Cineplex raises a quarter billion

(Thanks to Marc for commenting on this offering in the Debentures comments section)

Cineplex (TSX: CGX) was about to exit the escape room for CAD$34/share. Their timing was nearly perfect (December 16, 2019 announcement), but COVID-19 struck during the closing process. Now they’re a $8.40 stock and their business has been decimated due to the reaction over COVID-19 – movie theaters were right up there with cruise ships as being COVID disaster zones.

However, yesterday they raised $275 million in unsecured convertible debt financing! 5.75%, convertible at $10.94/share.

Quite frankly I was surprised. Maybe it is a sign of how frothy the market environment is. Their last published financial statements were from March 31, 2020 and I will dissect them:

Balance sheet, assets:

The highlights here are little cash, coupled with a large amount of right-of-use assets (leases) which are worthless if you can’t perform business in them, and about $820 million in intangibles and goodwill. In relation to their $412 million of equity (below), this pulls them very deeply into a negative book value, which is generally my metric to value companies as a cash flow vehicle.

Balance sheet, liabilities plus equity:

There’s a few adjustments to be made here. One is that the “deferred revenues” is mostly unused gift cards, which means if you haven’t used them yet, this is where they are represented on the books. If the business isn’t operating, this “liability” virtually amounts to a zero cost equity injection by hapless consumers.

We see the discounted cost of lease obligations, for the first year it represents a $115 million outflow. This is a large number but it isn’t crushing. These leases are long-term in nature, which is the “WOW” $1.23 billion figure. Most of this is property and a tiny bit is equipment.

Finally, they do already have $665 million of debt on the books.

Income statement:

Note the industry is seasonal in nature, so taking one quarter and extrapolating it to the full year is not appropriate.

I work through the line items and I do not see much in the way of revenues when the business is closed due to COVID-19. I then try matching up the costs that would be reduced as a result of COVID, and most of this is the “Note 12”, and lease (depreciation of right-of-use assets) costs, coupled with depreciation of film rights, and financing expenses.

We look at this “Note 12” which represents a large expense:

Presumably the executives and administrative staff of the corporation are still employed, but the various people involved in box office operations (e.g. retail cashiers, cleaners, film technicians, etc.) are off on CERB. I don’t know what fraction of the $53 million are ‘baseline’ employment expenses. I’d guess they’d be able to shed about 80% of their employment expenses?

They will still have to pay realty fees, occupancy taxes, and so on.

Just as a very broad proxy, let’s say that Note 12 expenses can be reduced to $50 million a quarter.

So just as a ballpark figure, when incorporating lease expenses and financing expenses, the entity is burning about $100 million a quarter, very roughly, when it has zero revenues. They might have given some guidance in their last quarterly conference call (I have not paid attention).

The fact that they can raise $275 million, unsecured, and at such a low rate of interest I find amazing. Am I that seriously out to lunch on the valuation of Cineplex?

I haven’t even evaluated the question of whether people actually want to go back to movie theatres, but this is an age-old question that has predated COVID-19. I recall a posting back in August 2014 where I was wondering how the heck they were doing so well despite the internet age.

Delphi Energy – proposed recapitalization

Delphi Energy (formerly trading as DEE, and with a second-lien secured note trading as DEE.NT) went belly-up into CCAA on April 14, 2020.

The last trade on DEE.NT was at 55 cents on the dollar before the company was delisted.

Today, we have the following proposed recapitalization plan:

The claims of creditors in respect of:

approximately $13.5 million outstanding under the Company’s debtor-in-possession interim loan financing secured by a Court-ordered priority security interest,

approximately $13.0 million outstanding under the Company’s senior credit facility secured by a first lien security interest, and

approximately $119.7 million outstanding under the Second Lien Notes secured by a second lien security interest,

will be settled in exchange for approximately 14.7%, 14.2% and 36.5% of the issued and outstanding voting common shares of a newly created class of shares of the Company (the “New Shares”), respectively, subject, in the case of the Second Lien Notes, to the Second Lien Opt-Out Election (as defined below);

Assuming a 100% recovery on the DIP financing, this works out to an equity valuation of $92 million. The second lien notes thus are looking at 28 cents on the dollar in the proposal, with the following alternate option:

Subject to the terms and limits set out in the Plan, beneficial holders of Second Lien Notes holding an aggregate principal amount of Second Lien Notes equal to or less than $200,000 will have the opportunity to elect (the “Second Lien Opt-Out Election”) to receive cash in the amount of $0.25 per dollar of outstanding principal amount of Second Lien Notes in lieu of the New Shares that they would otherwise be entitled to receive pursuant to the Plan; provided that, in the event that the aggregate of all payments pursuant to the Second Lien Opt-Out Election would exceed the aggregate amount of $1 million, such payment will be reduced on a pro rata basis so that total payments pursuant to the Second Lien Opt-Out Election do not exceed $1 million;

So their options are either 28 cents on the dollar (implied value) of equity, or a 25 cent on the dollar cash-out, or roughly half of the last trading price of the notes. It doesn’t look like there will be a Twin Butte Energy here!

Owners of Hertz stock should be aware that in the instance of Delphi Energy the proposal, if agreed upon, will rendered the common shares worthless.

The COVID quarter where everything gets written off

Most companies have a fiscal year corresponding with the calendar, and most of them will be reporting April to June results in the last week of July and in early August.

Q1’s results were in the onset of COVID-19, so results were only partially affected (the sanctions required due to the pandemic really only took effect in the middle of March).

Q2 will contain the full brunt of the economic consequences of COVID-19.

The results posted are going to be horrible for a lot of companies, especially on a GAAP basis. You’re going to see a whole bunch of write-downs of various assets that have been lingering on balance sheets for far too long, but Q2 will be the best time to formally impair them and get past mistakes out of the public consciousness.

The markets are not going to care. This has long since been baked in.

The next consequence of this is that you’re going to see headline computer generated metrics from company financial statements (price to earnings, EPS, etc.) over the next twelve months get wildly misstated due to the inevitable Q2 reporting of losses. This will also affect ROE/ROA, growth percentages, and almost anything relating to earnings in the calculation.

As a result, stock screens looking for value will be twisted unless if forward-looking adjustments can be made. A common forward-looking metric is “consensus analyst estimates”, but this figure is what an investor is looking as a rough short-term measuring stick in relation to the price the market is offering (indeed, if something looks ‘cheap’ solely on the basis of price to consensus analyst estimates, I’d view that much more as an alarm bell than a reason to buy).

The contamination of financial data coming from the COVID quarter will be the worst since the 2008-2009 financial crisis. While individual stock selection is always important, the COVID quarter should create an even better environment for stock selection than other times.