Effect of Egyptian civil disruption

The first geopolitical detonation has happened in the month of January, primarily the overthrowing of the Tunisian government, and the ongoing attempted ousting of the Egyptian government.

My knowledge of that part of the world is very limited, but I do know that part of Northern Africa should affect Europe much more than it would affect Canada or the USA. However, one has to ask themselves what the secondary or tertiary effects of what we are seeing – and right now, I have no idea other than to watch and wait.

I have sufficient idle cash in the portfolio that if the markets decided to crash, I would be relatively well-positioned to start looking for pricing inefficiencies.

Learning to read statements faster than others

First Uranium posted a production report for their last quarter. In the Thursday morning very long release contained the words that all equity investors dread:

The Company’s current cash resources may be insufficient to address its medium-term working capital needs. Accordingly, the Company has retained RBC Capital Markets as its financial advisor to review all funding alternatives.

Nobody appeared to read this paragraph until the opening of trading on Friday when presumably all the analysts released negative reports on the company.

The company’s common stock declined significantly Friday – from about $1.17/share to about $1.05/share presently. What is interesting is that this is purely from the news contained in the Thursday release – so institutional investors and analysts could not interpret the statement until given an evening to doing so.

I sold all the debentures (TSX: FIU.DB) out of my TFSA on Thursday for 80 cents on the dollar, but this was strongly instigated by the report. Most people on Thursday mis-interpreted the report as “steady as she goes” for the company operationally when they likely missed the critical part concerning the future capital requirements.

I also had some debentures in my non-registered account that I jettisoned, but still have some position.

First Uranium will likely have to raise further equity or debt capital to bridge their capital expenditure requirements. After that, presumably their existing Ezulwini mining operation could be cash flow positive. The equity is a high risk, high reward situation that I have not invested in. Depending on how such financing is structured it could be positive for debenture holders (e.g. a straight equity raise), but the company is otherwise restricted in terms of raising secured debt because of an existing agreement with noteholders (of which I own some as well).

Federal Reserve and the long-term bond yield

The US federal reserve today released a “business as usual” statement, leaving their short term rates between 0 to 0.25%. Most relevantly:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

This QE2 (Quantitative Easing #2) capital will fund the US government’s fiscal deficit. Normally when the federal reserve purchases long-dated treasury securities, you would expect the yields of such bonds to decrease, but ever since the last imminent threat of QE2 last October, long-term bond yields have done nothing but rise. The following are 1-year charts of the 30-year and 10-year US treasury bond yields:

If these yields rise further, it affects valuations of other yield-bearing securities since these bonds are considered to be “risk-free”. In addition, the value of companies with long bonds in their portfolios will decline, and companies will be taking comprehensive losses to account for the market value decline in treasury prices.

Will interest rates rise further? Time will tell. Just be prepared for volatility.

It should also be noted that Canadian equivalents are trading at less yield than US counterparts – e.g. the Canadian 10-year note is trading at 3.27%, while the US 10-year treasury note is at 3.43%.

Priszm Income Fund – Specified Defaults

Priszm (TSX: QSR.UN) filed in the documentation pertaining to their bridge loan, and when going through it, came up with the following summary as to what conditions the business defaulted on their senior loan obligation:

I notice that the senior noteholders are three related companies – The Prudential Insurance Company of America, Pruco Life Insurance Company and the Prudential Retirement Insurance and Annuity company. Whoever was the investment manager that picked Priszm for investment isn’t feeling too good right now – and presumably forced to sinking in $4M more into this train wreck in order to salvage the remainder of their investment.

The subordinated debentures (TSX: QSR.DB) traded down today to about 20 cents on the dollar as investors question their sanity for putting money into this venture. To figure out if there is any value left, one has to figure out whether management’s motivation is to eventually resurrect the company, or to generate a tax-loss write-off that works in their own favour (and not necessarily investors). One thing that I believe is virtually guaranteed is that the units are nearly worthless.

Disclosure: I own $200 market value of debentures, which I still believe offers a better payoff ratio than the upcoming Lotto MAX.

Equal Energy debentures – a lock at par

When a company rolls over its debt and extends the maturity, a call on the previous debt is not too far away. Equal Energy (TSX: EQU.TO) announced a bought deal for $45 million in face value of debentures, with a 6.75% coupon, maturing in just over five years (March 31, 2016) and a conversion premium of approximately 40% over common share price ($9/share).

They have two debenture issues on the marketplace, $80M maturing December 31, 2011 (TSX: EQU.DB) and $40M maturing June 30, 2012 (TSX: EQU.DB.A). Both of these have a conversion price well over the price of the common shares.

Most importantly for existing holders is the current phrase in the press release:

Proceeds from the offering will be used to retire a portion of the 8.00% convertible unsecured subordinated debentures due December 31, 2011 (the “8.00% Debentures”). Equal intends to call the 8.00% Debentures for redemption as soon as practical. The Company intends to fund the balance of the redemption cost of the 8.00% Debentures from its operating bank line.

…

Closing of the offering is expected to occur on or about February 9, 2011. The offering is subject to receipt of normal regulatory approvals, including approval of the TSX.

The company has been clearing away its debt at a fairly rapid pace over the past couple years and has sufficient room in its line of credit to pay off the debentures (currently $115M of room at a relatively low rate of interest). It is likely to assume that December 2011 debenture holders can expect a call by around mid February of the year. They will receive 102.5 for the debt. Investors paying this amount would receive interest at a minimum or about a 5% YTM, while investors paying less than 102.5 will receive a higher short term reward assuming a call. There would be a minimum of 30 days notice for a call and a maximum of 60 days.

The June 2012 debentures are a little more complicated – on July 1, 2011 they can be redeemed for 102.5 cents on the dollar, and 105 cents on the dollar before. So management will likely redeem these on July 1, 2011.

I own the December 2011 debentures, purchased during the economic crisis in 2009 at a price that made me wish I bought more of them compared to alternatives at the time. I am also finding it difficult to reinvest this capital in other ventures with similar risk-reward profiles.