On the nature of inflation

Michael Burry linked to the following paper – Dying of Money: Lessons of the Great German and American Inflations. He is trying to make an analogy to present times with past times and some of it is reasonably convincing:

Stock market speculation, which adds nothing to the wealth of any nation, is the inflationary activity preeminent, and it was the craze of America in the 1960’s as it had been of Germany in 1921. A buoyantly rising stock market marks the opening stages of every monetary inflation. A sharply rising stock market proves to be an unfailing indicator of monetary inflation happening now, price inflation coming later, and a cheap boom probably occurring in the meantime. The stock market boom like the prosperity is founded on nothing but the inflation, and it collapses whenever the inflation stops either temporarily or permanently. American investment in the 1960’s, with its instant fortunes, its swamping volumes of turnover, and its absurdly high prices for incredibly useless ventures, underwent a species of insanity that was quite typical of inflationary booms. In 1968, the last year of full bloom of the inflationary prosperity, the volume of trading on registered stock exchanges alone was $200 billion, or more than four times what it had been in 1960. The income of the securities industry increased from $1.2 billion to $4 billion. The exchanges were compelled by the overwhelming volume of trading to close for part of the week, as the German Bourse had done in 1921. Capital gains of individuals reached $36 billion, more than three times the levels prior to 1962, and more than the income generated by the entire American gas and electric utility industry and agricultural industry combined.

There are many other damning paragraphs in this book worthy of note, but I will leave it at this.

Cineplex – Second-lien secured bonds

According to a Bloomberg article, Cineplex (TSX: CGX) is receiving a positive reception for a second-lien secured bond offering:

The company plans to issue C$250 million ($196.5 million) of second-lien secured senior notes due 2026 to yield 7.5% to 7.75%, according to people familiar with the matter. That compares with preliminary discussions with investors yesterday for 8% to 8.25%, said the people, who asked not to be named before the deal is completed. Bookrunners had gathered around C$1 billion in preliminary indications of interest as of Thursday.

Even before COVID-19, the only thing the business had going for it was near-monopoly status for in-person cinema. Otherwise, it is a financial mess of lease liabilities and an overall market that continues to be supplanted by Netflix and other content providers.

When reading Note 16 of their last audited financial statements, they have CAD$506 million already outstanding in first-lien term and revolving facilities (and Cineplex received a covenant relaxation until the end of 2021 for this facility). In a CCAA arrangement, I would suspect this tranche of debt would get mostly everything. Perhaps there is more than half a billion in franchise value in a bankruptcy sale, but even then, who would want 750bps in compensation?

Good on Cineplex management for striking while the iron is hot – I would be doing the same, and would try to up-size the offering while I’m at it. I guess in a topsy-turvy world where huge entities are throwing away capital into digital beanie babies, it makes sense. I was busy pooh-poohing the convertible debt offering (TSX: CGX.DB.B), which is now trading at about 30 cents over par value, so what do I know? Nothing.

Atlantic Power merger arbitrage

There’s quite the spread developing on Atlantic Power’s shares and preferred shares.

A special meeting of shareholders (record date February 16, 2021, special meeting date April 7, 2021) is going to be held. The Debentures (TSX: ATP.DB.E) have their special meeting on March 18, 2021. The deal after the special meeting of shareholders should close shortly after (presumed) approval.

(NYSE: AT) – US$2.95 (US$3.03 if completed) – +2.7% or +16% annualized

The preferred shares are all in a tight range and roughly the same as well. I will use AZP.PR.A as the lead example:

(TSX: AZP.PR.A) – CAD$21.71 (CAD$22 if completed + $0.30 dividend) – same spread

The management information circular should be coming out very shortly.

Right now I’m happy to leave this as “near-cash” in my consolidated portfolio, earning a return that will not amount to be a gigantic amount in absolute terms, but percentage-wise it doesn’t make financial sense for me to bail out on it unless if I have a really compelling alternate. I’m guessing the relatively wide arbitrage spread is because most others have already bailed out and wanted to take the cash today instead of the cash in April.

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Inter Pipeline / Brookfield hostile bid

Brookfield Infrastructure (TSX: BIP.UN) is offering C$17.00 to $18.25/share for Inter Pipeline (TSX: IPL).

Inter Pipeline is a relatively small pipeline operator, with well-placed lines criss-crossing Alberta and Saskatchewan with oil and gas and natural gas liquid refining capacity. They have spent a ton of money on a polypropylene plant which was a fairly game-changing move for the company strategically, representing a horizontal move into refining petrochemical products. The quantum of debt they took out to build this plant is such that their leverage is quite high given their existing financial situation. The rest of the pipeline business is solid. They had a storage operation in Sweden and Denmark which they also are in the process of disposing of.

I’ll reserve judgement other than stating that I have consistently noted that Brookfield tends to try to acquire things for about 15-20% less than what such entities normally would/should be bought out for. I’m not criticizing their actions (it works very well for them!) but if I was a shareholder in a target of Brookfield, I would be very cautious on valuation.

The next comparator in this space would be Keyera (TSX:KEY), which is in a similar space but its geography is concentrated in the Montney/Deep Basin area of Alberta (the area hugging east of the Rocky Mountains). Next up would be Pembina Pipeline (TSX: PPL) but they have been the positive recipient of the entrails of Kinder Morgan’s Canadian unit, and are considerably bigger in scope.

We have seen a ton of consolidation in the oil and gas space – just yesterday, ARC (TSX: ARX) and 7 Generations (TSX: VII) announced a nearly equal share swap merger. The list of individual names in the public space is shrinking by the week.