Canadian Finance, Economics and Fiscal Analysis
It looks like the risk-off trade is “on” again!
This risk-off, risk-on type market environment reminds me of this very classic scene that people of my era would remember, except dealing with wax:
Risk on… risk off. Master this and win the tournament, or rather have the pleasure of stuffing your wallet at the expense of other people that have decided to get bullish.
Yellow Media (TSX: YLO) common shares have climbed up from their ultimate low of 12.5 cents on October 3, 2011 to 32 cents presently. There has been no news from them other than a press release stating they have been named one of Canada’s top 100 employers for the 6th year running.
Instead, this appears to be a matter of the stock being taken down to the basement level by a stampede of funds trying to desperately get out. Now that anybody that wanted to get out did, supply in the market seems to have been alleviated and the price is now rising.
The business fundamentals remain the same after a month – the company is highly leveraged, but is cash flow positive and has a feasible plan to paying off its debt through internal operations assuming the revenue decay is not too extreme.
Preferred shares continue to trade strangely, with the Series 3 (TSX: YLO.PR.C) trading with a yield about 4.5% higher than Series 5 (TSX: YLO.PR.D). I guess nobody reads the prospectus on these things anymore.
The equity-linked preferred shares, Series 1 (TSX: YLO.PR.A) and 2 (TSX: YLO.PR.B) continue to be coupled to the price of the Yellow Media equity. Series 1 will probably be converted into shares of Yellow Media (12.5 shares per preferred share if the common stock price is less than $2.05/share) on April 2012, while Series 2 stands a good chance of being converted in July 2012, depending on financial results.
While the Series 3 preferred shares trade at around 19 cents of par, convertible debentures are at around 33 cents.
The next big data point for the company is November 3, 2011, where they have already pre-announced a $2.9 billion goodwill write-down. While this will of course result in a grossly negative earnings per share for the year, it is a non-cash charge and the remaining questions for investors will be focusing on the cash flow statement at this release date. As I have repeatedly stated, if the company can produce results that are less than disastrous, they will stand a very good chance of surviving and being able to pay generous cash flows to their shareholders that are senior to the common.
In the favourable scenario, I would expect the market would see that Yellow Media will have the capacity of being in the position of paying off its obligations through internal cash flows and be in a position to raise financing sometime in the second half of 2012. If this occurs, the common shares should trade higher, but the preferred shares should also slowly rise to the 8-10% yield level, which translates into a $17-21/share price for the Series 3. The debentures in this case would also trade 1-2% richer than the preferreds, around 90 to 98 cents on the dollar.
The risk is that they won’t be able to make these financial targets and will be forced to restructure. The preferred shareholders will get wiped out along with the common shareholders. The unsecured debenture holders will likely get very little in such a reorganization.
The risk-reward was high and very high, respectively, and this is why I continue remaining long the preferred shares and debentures of Yellow Media. This is a relatively binary outcome with little middle ground which makes it a fairly unique opportunity.
Sterling Shoes (TSX: SSI) went into creditor protection today. The shares were halted at 1:27pm and the CCAA protection announcement came at 1:48pm. The TSX will delist the shares and debentures.
Investors would have had some advance warning given the announcement the company made on September 27, 2011 that they would not be able to make an interest payment on their convertible debentures. Their credit facility with the Bank of Montreal would have prevented them from making the payment.
At this point anybody that held equity in the company should have firmly jettisoned it and the company shares tanked from 37 cents the day before to about 12 cents after.
There still may be value in the debentures, although whatever slice of the company they are given in the post-restructuring is difficult to determine. The company had about $13M in secured debt and $25M in subordinated debentures. When compared to sales metrics (2010: $127M revenues, $54M gross profit) and potential profitability (i.e. there is ample room to cut SG&A by getting rid of under-performing stores), the company should be worth more than what the secured line of credit is worth – certainly, debenture holders going into the bankruptcy had not expected much, with the last trade going off at 13.5 cents on the dollar at closing.
The following is a chart of the debentures:
It is impossible for retail investors to get a fair shake at a company during a restructuring, but I do notice that Belkin Enterprises Ltd., lead by BC businessman Stuart Belkin, took a $2.573M face value stake in the Sterling Shoes debentures and announced this on September 2, 2011 on SEDAR. Was this a mis-timed investment or are they planning on participating on the subsequent recapitalization and capture value in a post re-organization stake?
I would expect such holders to get equity and warrants in the subsequent recapitalization.
Yellow Media (TSX: YLO) has all sorts of securities where investors can lose their money, but some securities are more stranger than others.
In particular, there is a prevalent oddity I have been noticing in trading of preferred shares of Yellow Media. These are the Series 3 (YLO.PR.C) and Series 5 (TSX: YLO.PR.D) series of preferred shares, which essentially are identical in all respects except for their stated dividend payout.
I will refer to Series 3 as being the “C” series and Series 5 as being the “D” series. The C series pays out $1.6875/share/year while the D series pays out $1.725/share/year. Both contain a rate reset feature, where after 5 years from initial issuance, the C series will be reset to the 5-year government bond rate plus 4.17%, while the D series will be at the 5-year government bond rate plus 4.26%. The 5-year bond is currently yielding 1.57%, but the C series will have their reset in 2014 and the D series will be in 2015.
There are also 8.1 million “C” shares outstanding, while the “D” series has 4.9 million outstanding. There is more trading volume for the C series than the D series.
Taking the midpoint of the closing bid-ask quotation, the C series is trading at $4.24 and the D series is trading at $5.15. Using some very elementary math, this translates into a yield of 39.8% and 33.5%, respectively. Obviously these very high yields are a function of the embedded risk within the underlying company’s ability to actually pay such dividends – the huge issues the business has been facing has been well publicized.
You can arbitrage the difference between the C and D series by going long 102.22 shares of C, while going short 100 shares of D. Using the quotations above, such a transaction would be income neutral and net a capital gain of approximately $81.59 per 100 shares traded.
Practically this is not possible unless if you can locate cheap shares to borrow, but investors looking at both classes of shares should clearly choose the “C” series.
Other than supply-demand dislocations because of the different number of shares outstanding of both series, I am at a loss to figure out why there is such a huge yield differential between the preferred shares. One would think the more liquid series (C) would trade at a slight premium due to liquidity. Does anybody else know?
As a disclosure, I own some of the preferred shares of Yellow Media.
Sun Life (TSX: SLF) reported on Monday that when they report their next quarterly result, it will contain a very negative quarter. In the event of this quarter, it will be negative $621 million, operating amount negative $572 million.
By definition, financial insurance companies (such as those that provide annuities and “guaranteed income funds”) make their living by hedging. If they sell Joe Retail a product that will guarantee them 4% for the duration of the investment, the company will usually have a way of finding somebody else to give them 5% for the same period of time so they can skim the 1% in the meantime. Banks operate under the same principle, except for some strange reason they do not call it insurance.
When financial insurance companies cannot hedge properly, it will result in losses. In the event of SLF, and indeed, in the event of others such as Manulife, they have not hedged against the drop in equity markets and also the low rate environment and have been caught exposed – subsequently forced to take losses.
I have no idea whether SLF or other similar companies are under or over-valued at present. They are not easy companies to analyze and to determine where the risk is compared to the broad market.