Still watching and waiting

My writings have been relatively less frequent over the past month, but this is because I’m waiting for some opportunities to reveal themselves in the marketplace. There has been some renewed volatility over the past couple of weeks and some momentum-reversing trends (e.g. spot natural gas is finally showing an uptick), but other trends are back to their usual self (e.g. US 30-year treasury bonds at a very low 3% yield).

All I know is that reaching for yield becomes more and more risky. Avoid the yield since it is most likely an illusion that will give you a few pennies of income in exchange for a few dollars of capital.

Yellow Media – Stick a fork in the stockholders, they are done

Yellow Media (TSX: YLO) released their first quarter results, and suffice to say, anybody owning equity or debt in the company should be hurting tomorrow.

While the headline EBITDA result of $146 million may seem positive, all other metrics suggest a “steeper than expected” softening of key metrics. I will take some direct quotations from their MD&A:

The decrease [in revenues] for the three-month period ended March 31, 2012 is due to lower print revenues, especially in urban markets where revenues declined at a much higher rate than rural markets. We have identified new trends, which indicate that the print decline will be more rapid and enduring than previously anticipated.

I like the statement “we have identified new trends” since it implies that management did some deep research to discover this when it seems pretty obvious the company had to identify this by experiencing it directly.

Online advertisers, who in the past, purchased our legacy online products, are not migrating to our new products as quickly as we had anticipated. This now suggests that the online revenue growth will be slower than we had projected […] Online revenue growth is not expected to compensate for the declining revenue in our traditional print offerings in the near future.

Uh-oh! Could it be the case that the online advertising market is a hell of a lot more competitive?

In terms of the numbers themselves, the focus should be on the balance sheet: The company on March 31 had $310 million in cash, and on May 7 had $292 million in cash. When you account for the fact the company made a $25 million payment on their non-revolving credit facility, it actually implies they generated $8 million during those 5 weeks. I wouldn’t extrapolate this for the whole year!

The “adjusted earnings”, which is roughly a modified free cash flow calculation, was $67.3 million, down from $133.6 million from the quarter in the previous year. While the company is still generating a good deal of cash, the amount is declining at an alarming rate.

I ignore the $3 billion write-down of goodwill – for the uninitiated, they will now see the $785 million stockholders’ deficiency when normally they are accustomed to seeing it called stockholders’ equity. Any analyst worth his/her salt would have made that mental adjustment from day one, and this will hopefully silence the lunatics citing Yellow Media as a good value because of its exceedingly good price to book ratio.

In the raw calculus, the company has $292 million in cash, and they have to pay back $394 million by February, 2013, another $130 million by July 2013, and $125 million by December 2013. If you take the optimistic approach and assuming their decay in cash generation will flatten, they can barely pay off the maturities to the end of 2013, but who in their right mind would believe that things have flattened out?

The company is most likely going to go into some form of restructuring that will address its debt issues. This is likely to be very punitive toward equity holders and also the subordinated debenture holders. They will probably be given a few scrap bones to expedite the process.

Medium term notes are at around 67 cents for the near maturity, and about 60 cents for further maturities on the ask. Debentures are at 17 cents, and perpetual preferred shares (TSX: YLO.PR.C / YLO.PR.D) received a speculative spike over the past few days from 3 cents of par to 4. Suffice to say, the dividends on those preferred shares aren’t coming back anytime soon.

Thankfully, no positions in YLO – I’ve already taken my lumps previously and am just watching how this very unusual financial train wreck unfolds.

Chesapeake Energy – What a basket case

Chesapeake Energy (NYSE: CHK) is the second largest natural gas producer in the USA.

It has a few claims to fame. The most positive and negative aspects of the company seem to be directly related to its CEO, Aubrey McClendon. Concentrating on the negative side of the story, is that McClendon formerly owned about 5% of the company, got liquidated out on a huge margin call in the 2008 economic crisis. He was forced to liquidate his stake in the company at very adverse market prices. This would be a pretty good signal to anybody that the main person at the top is one tremendous risk-taker, but that risk is a double edged sword.

The corporation’s board of directors are directly in McClendon’s pocket as they subsequently awarded him a $75 million bonus in deferred compensation relating to well drillings and other such matters, but this presumably related to rubbing a salve on the huge financial wound that was incurred back in 2008.

His financial troubles have recently re-emerged when it was revealed that he had partial ownership stakes in natural gas wells that were also jointly owned by the corporation and this created a conflict of interest with respect to liquidation. Basically the conflict is that McClendon was in a position to front-run his own company or otherwise receive preferential treatment. Compounding the matter was the rumour that he apparently has a billion dollars that he loaned to take such an interest in these wells.

It is not helping the company that natural gas prices have reached record lows, which will be depressing the company’s profit margins.

So why the heck would anybody want to invest in this basket case? The only rationale is that investors would have to believe that the board of directors would be overturned and they would be able to no longer be in the back pocket of management.

Perhaps the way out for the company is an outright buyout, but this is assuming there are no other lingering financial matters within a corporation that has management that does not exactly seem to be aligned with shareholders’ interests.

I haven’t had time to do a more rigorous financial analysis on the firm, but it appears to be another oil-and-gas type company that is blowing more money out on the capital expenditure side than receiving in operating cash flow, and with the decrease of natural gas prices, those capital expenditures will have to slow down quite quickly.

Despite all of these internal struggles, the bond market appears to be somewhat calm with the credit-worthiness of the company – an example would be their bonds maturing in 2020, trading from a yield to maturity of about 6% to about 7.25% in recent times over the past three months. Preferred shares are also trading at around the 6% level, which is odd to say the least.

Yellow Media – alive for how much longer?

I notice that Yellow Media did not announce it was suspending interest payments on its convertible debentures (TSX: YLO.DB.A). If they would have done so it would have guaranteed them going into creditor protection.

They have about 11 months to figure out a solution to their imminent debt situation before they will go into default. The medium term notes (which are equal in level to the bank debt in seniority) trade at around 50 cents on the ask at present. The convertible debentures (junior to the MTNs and bank debt) are at about 12 cents on the dollar, while preferred shares are at about 3 cents on the dollar.

The logical investment conclusion is to buy the MTNs if you believe the entity has value after restructuring, or buy the preferred shares if you believe there will be a hugely messy process but not something that wipes out the preferred shareholders. The “middle ground” debentures will probably profit less than the preferred shareholders if there is some sort of recovery.