Category: Equity

Yellow Media

Yellow Media (TSX: YLO) is an interesting case on how to value a company in an industry clearly in collapse (in this case, collecting advertising dollars by selling paper bricks known as phone books). They are trying to desperately diversify into the 21st century, but just like how newspapers have felt it very difficult to doing so with the same financial models in place, Yellow Media is also in an equivalent state. Although the company currently is cash flow positive, it is diminishing – the exercise in valuation is the future assumption of how rapidly this is diminishing and also whether there will be any flattening of the decay.

That said, the top-line operating cash flow number for the first half of 2011 was $199.6M vs. $293.5M in 2010; still a healthy amount of cash coming into the coffers. Common and preferred share dividends (at the annualized rate as of this writing) is about $118M ($59M for the half-year period at the newly reduced dividend rate), so there is currently room to accumulate cash and reduce leverage.

The company is quite heavily leveraged. As of June 30, 2011, senior to everything are the Medium Term Notes (with a varying series of staggered maturities) – $1,644M; and a $636M credit facility. Junior to this are the convertible debentures (TSX: YLO.DB), a $200M issue. The annualized interest bite on these securities is about $129M a year.

There are also four publicly traded series of preferred shares outstanding. Series 1 and 2 (YLO.PR.A and YLO.PR.B) have approximately 16.9M shares outstanding; these are convertible into YLO common at various dates at $2/share (or 95% of market value if YLO equity ever goes above $2.11/share). The principal value of these shares is $422M. The other series of preferred shares are perpetual with only a call feature (YLO.PR.C and YLO.PR.D) – both of these series give out a dividend and there are 13.6M shares outstanding, face value of $339M.

Yellow also sold Trader Corporation for a net $708M, which closed after the June quarter-end. During the release of this quarter, the company announced it was slashing its dividend from $0.65/share to $0.15/share and also stopping its share buyback so it can concentrate on repurchasing debt and preferred shares. At the end of August they have repurchased approximately $238M in Medium Term Notes, and some preferred shares.

A brief look at the valuation of the various securities – currently, the common shares are trading at 68 cents (giving the company a market cap of $348M, 511M shares outstanding). One item that is clear is that the common dividend is likely to not be sustained at the existing level – the $77M in after-tax cash flow out the window is going to be required to assist in the de-leveraging effort. Once dilution of the convertible preferred shares are factored in, another 210M shares will be added to the share count.

The convertible preferred shares are trading primarily as a function of the common shares (due to the fact that the company will likely convert the preferred shares into common shares as early as possible, especially as they cut the common dividend). This will save the company about $19M/year in after-tax cash flow. The perpetual preferred shares are trading roughly at 28 cents on the dollar (about $7 per share) and this translates into yields of over 20% – the risk is that the company will suspend dividends once they suspend the common share dividends. The market is obviously predicting that this will happen. If they do, they will save $22.4M/year in after-tax cash flow.

The next item on the seniority chain are the convertible debentures, which are currently trading at 41 cents. These convertibles mature in October 2017 (6 years to maturity), and have a 6.5% coupon, giving the debt a 15.9% current yield. Yellow cannot defer the interest payments or it will face default, so it is likely as long as the company has cash flow they will be able to pay interest on the debt.

The question for an investor is whether the company will be able to shore up its cash flow situation, and if so, whether it will be able to sustain indefinitely payments on its preferred shares or debt.

Interactive Brokers increasing margin thresholds

Interactive Brokers is the best accessible brokerage with respect to margin. They are also exceedingly inexpensive (for Canadian currency, their rates are currently 2.5% between $0 and $100k, 2.0% for $100k-$1M, and 1.5% above that). I have not employed margin for quite some time, but others can borrow money at low rates. Considering the prevailing interest rates, others see it suitable to leverage by borrowing very cheap money and investing it into income-yielding securities, while skimming the few percentage points. That said, the securities that are now available to leverage from now has a market cap limitation of US$250M or above, as they announced today:

As a result of recent market volatility, please be advised that IB is increasing the margin rates on low capitalization stocks (currently defined as companies with less than $250 million in market capitalization). The margin increases will occur in three steps beginning on Wednesday, September 21, 2011 and ending on Friday, September 23, 2011. The margin rates will increase to 50%, 75% and 100% at the open of business on 9/21/2011, 9/22/2011 and 9/23/2011, respectively.

The current list of stocks which are subject to this margin increase is subject to change. The current list can be found on the following page:

http://ibkb.interactivebrokers.com/node/1788

Upon implementation, any of the incremental margin increases may result in a margin deficit in the account. A margin deficit implies that an account becomes subject to automated liquidation. Please carefully review the current positions within your account and adjust the portfolio accordingly.

I suspect the brokerage firm has done some risk analysis on customer profile accounts and has determined that the concentration within these low capitalization stocks has reached a point where they could not spontaneously liquidate the securities at an acceptable price in the event the stock market crashes. In such an event, the brokerage would be left to cover the remaining shortfall in the customer’s account (as presumably the customer will not be cutting a cheque back to cover such a deficit).

Interactive Brokers (Nasdaq: IBKR) is a very well-run operation and they probably did not make this decision lightly as it will be costing them some money.

Arctic Glacier freezing over

Arctic Glacier (TSX: AG.UN) is in default of its second-lien loans, which means its first line creditors will likely come knocking.

On August 2, 2011, the company invoked a conversion to equity clause upon the maturity of its convertible debentures. The company issued 311 million units in exchange for $90 million face value of convertible debt, leaving those debtholders with trust units at a rate of 29 cents a pop. Miraculously, the units managed to stay at the 20 cent range for a couple days before plummeting to the 10 cent level as investors dumped units.

The company’s financial troubles continue as they still have a significant debt load from other creditors. It appears quite imminent that the unitholders, having faced an approximate 90% dilution, will finally be wiped out at the end of this process. After subtracting the debentures that were converted, the company has about $190 million in debt and annual cash flows have declined significantly to the point where they can no longer afford this leverage.

TD Bank raises $612M in equity offering

A few days ago, TD Bank (TSX: TD) raised $612M in gross proceeds in an equity offering of 8 million shares at $76.50 a share. This was in conjunction of them acquiring MBNA’s credit card portfolio in Canada, announced in the middle of August.

I have stated in the past that when financial companies raise capital it generally is a yellow flag event that suggests something else negative is going on. However, this intuitively (without seeing anything but basic numbers) seems to be a wise decision by TD.

I find it interesting that the exact amount has not been disclosed. It would be interesting to see how much capital in excess of the MBNA purchase has been raised by the bank. TD Bank has 890 million shares outstanding and so thus this equity offering would be less than 1% dilutive to existing shareholders. At the existing dividend rate, TD will also experience a cash outflow of $21.8M more a year in after-tax dividends.

Bank of America / Berkshire Hathaway

The decision to purchase $5 billion of preferred shares (with an under-market value of a 6% coupon, albeit with bonus provisions) in conjunction with the 10-year warrants to purchase BAC shares for $7.142857 (7 and 1/7th for those that do not recognize the string of numbers after the decimal point) has been analyzed to death by others.

The warrants are the golden part of this agreement – it is essentially a binary bet on the bank – if Bank of America does not go belly-up, it should be able to produce sufficient cash after a ten year period to justify a stock valuation significantly higher than $7 1/7 per share. If the company does go belly-up, Berkshire should be able to retain some residual interest in the preferred shares while the common shareholders get wiped out.

There is about $150 billion in tangible equity on the balance sheet to clear through before this would occur, which is why I suspect that this deal is a very good one for Berkshire and Warren Buffett.

I generally do not like it when financial companies raise capital – this is no exception. It makes you wonder how well JP Morgan is doing in terms of their solvency and liquidity situation. Analyzing big banks such as BAC or JPM is essentially a leap of faith more than an informed investment decision.