Category: Equity

The last chapter on Gran Colombia Gold’s senior secured notes

Quoting the press release:

Gran Colombia Gold Corp. (TSX: GCM) announced today that it has successfully priced an oversubscribed offering of US$300 million in senior unsecured notes due 2026 at a coupon rate of 6.875% (the “2026 Notes”) pursuant to Rule 144A and Regulation S of the U.S. Securities Act of 1933, as amended, (the “Act”), with closing expected to occur on or about August 9, 2021.

The proceeds from the 2026 Notes will be used to: (i) to fund the development of our Guyana operations, (ii) to prepay the remaining Gold-Linked Notes, and (iii) for general corporate purposes. The 2026 Notes have been assigned a rating of B+ by Fitch Ratings and a rating of B+ by S&P Global Ratings.

That’s a lot of money they raised, and in unsecured form! It’s quite the turnaround from years ago when they had to struggle to raise capital through the gold-linked notes (TSX: GCM.NT.U).

It looks like the remaining US$18 million of notes will finally get called out at 104.13. GCM has to provide 30 days of notice of redemption and this will likely happen once the deal closes.

(Update, August 9, 2021: This redemption notice occurred, slated for September 9, 2021).

Robinhood IPO

The true top in the dot-com bubble had to have been the public offering of Palm in the year 2000. Does anybody remember that?

Likewise, Robinhood’s IPO portends to be the equivalent for retail investors gamblers. These sorts of things can only be determined in retrospect, so such statements are not predictive.

That said, Robinhood’s metrics are actually pretty good!

As of March 31, 2021, they have $81 billion in assets under custody and 17.7 million active users. After the IPO they will have 842 million shares outstanding, for a market cap of about $30 billion.

What do we compare this with? Interactive Brokers is a logical counterpart – both companies have functional controlling shareholders, so public investors are simply there for the ride.

IBKR’s public offering is about 22% of the “real” company, but I’ll put a lot of technical stuff aside and state their total market cap is $26 billion on 417 million shares.

This is very similar to Robinhood.

IBKR also provides very good data to the public. More so than Robinhood. For example, Robinhood does not disclose how many trades it executes, while IBKR does.

At Q1-2021, IBKR executed 306 million trades. They have 1.3 million customer accounts and total customer equity of $331 billion. Almost ten times less customers, but four times more customer equity.

In terms of the balance sheet, IBKR has a book value of $9.4 billion, and HOOD post-IPO is around $7.3 billion.

HOOD, however, is growing like a weed. Their Q2 estimate is 21.3 million active users and $102 billion in assets under custody.

The big difference is that HOOD isn’t making that much money (most of their revenues are being sucked up by operating costs), while IBKR is making a ton of money.

But given the amount of capital people are willing to dump into the Robinhood brokerage, coupled with encouraging them to gamble and/or pitch them financial products, makes me think that their valuation isn’t ridiculously stupid. It’s in the ballpark of where it should be.

Despite loving the IBKR platform (it truly is the best, once you use it, you can’t go back), I would not be an IBKR investor at this valuation, nor am I interested in HOOD stock.

My primary concern for HOOD investors is not the valuation. It is that their technology has some sort of problem where they end up like Knight Capital and simply blow themselves up. It’s a much more relevant possibility for them (simply because they are so new) compared to very seasoned brokers like IBKR that have been at it for decades.

Corporate earnings for the quarter – Oil and Gas

The next couple weeks will be busy processing quarterly earnings reports.

Oil and gas, however, will be the most interesting. There will be a bonanza of cash flows.

MEG Energy (TSX: MEG) was the first off the bat.

I’ll spare the details and focus on the following line in their PR:

Based on the current commodity price environment, MEG anticipates generating approximately $275 million of free cash flow in the second half of 2021, which will be directed to further debt repayment.

Just below that they talk about one of the worst hedges I can think of, which was to hedge for oil prices in Q2-2020 in a US$39-46 WTIC band. They have about 1/3rd of their production hedged at this level (29k BOE/d) which has lost them a gigantic amount of money. Fortunately it is done after the year is over, but it will be another $125 million of damage (lost potential) at current prices. The hedges cost them nearly half a billion dollars in lost opportunity in the first half of the year.

Adjusting for their hedge disaster, the “true” projected free cash for the second half is closer to $400 million.

Considering the enterprise value of the company is around $5 billion, that’s trading slightly above 6x EV/FCF. This isn’t a case of some US shale driller with a 35% annual decline rate – MEG’s asset is much longer lasting.

MEG currently does not give out a dividend. They are pouring free cash into reducing their debt – they announced they are paying back US$100 million of their existing US$496 million 6.5% senior secured second lien notes (matures 2025). At the rate cash is being generated, they will be able to retire debt this sometime in 2022, and after they will be able to work on the US$1.2 billion 7.125% senior unsecured notes. This tranche matures in 2027.

If oil stays at current pricing, the debt gets removed pretty quickly (in addition to saving money on interest expenses).

Eventually there is a point where it becomes logical to buy back stock, assuming they stay at 6x EV/FCF. It’s a matter of whether management wants the sure 6.5 to 7.125% return, or whether they want to buy back stock at a 16% return on equity.

I speculated that somebody else might be happy to do that for them.

Virgin Galactic – Cool but economically challenged

I wrote back in 2019 about the original SPAC that took Virgin Galactic (NYSE: SPCE) public and my thoughts haven’t changed much from today.

Indeed, they had their hype – astute traders gamblers have seen their capital go from $10 up to $35, down to $15, up to $60, down to $15, up to now $50, in what is oddly like the trajectory the Virgin Galactic spaceship flies itself.

Today the main headline is Richard Branson flying out in one of those spaceships, in what was a massive marketing exercise – I bet Branson was jealous of all of the hype that Elon Musk was stealing over the past few years.

Much to their credit, the rocketship flight made it – they got their 70 seconds of propellant out and made it to the height of about 280,000 feet (or about 85 kilometers above the ground).

The marketing exercise is caused by the perverse anticipation of disaster, similar to how some people watch automobile racing to see car crashes.

This is all great and everything, and SPCE is likely going to trade up Monday morning, but I deeply suspect it will be a great time to short the stock. I will not be – I only mentally trade these sorts of situations with a million eyeballs and daytraders that will inevitably be crowding around the stock.

The issue is that the while the venture tries to do cool things, from an engineering perspective sending a craft out 85 kilometers over the surface is much, much more trivial than it is to send it to a practical altitude (low earth orbit) with the energy required to keep it there – Virgin Galactic’s ship just requires it to go up, and it glides to the bottom. A rocket ship going into low earth orbit requires it to go up (for example, the international space station is about 420 km above the surface), but also horizontally (about 28,000km/h) to keep it in perpetual free-fall. This requires a lot more energy to perform, and a lot more engineering with the design frame and engines which need to scale up disproportionately in order to haul these loads into orbit (mainly to handle the amount of fuel required to get there). This isn’t a matter of “extending the frame” to fit further usages – that design is hard-wired.

Amazon’s Jeff Bezos’ Blue Origin has a different system, the New Shepard rocket ship (which unlike Virgin Galactic, starts on the ground instead of on an airplane), which is designed to send people in a capsule up to around 105km – with a 110 second rocket burn. They will launch in just over a week. The same analysis applies to them as well. Scaling up to a point where you can do SpaceX-type activities requires a lot more engineering than slapping on a few extra engines and increasing the size of the fuel tank.

As such, the Virgin Galactic ship, as currently designed, has little use other than a tourism vessel. This was the intent of the design, the company was not meant to be other than an amusement factory. Cool but useless – and it’s a business model that almost guarantees there will be no repeat customers, similar to the skywalk at the Grand Canyon.

Briefing note on Arch Resources

For historical context, read my December 2019 post on Arch Coal where I give a primer on coal mining and discuss Arch Coal.

This is a short briefing update on the renamed company, Arch Resources (NYSE: ARCH).

My timing from the December 2019 post was a bit botched up – indeed, at one point I exited the entire position (during the Covid crisis) but later took a very healthy position at lower prices than they are trading at today. It is a large but not gigantic position currently. I am expecting it to get larger by virtue of appreciation.

Between then and now, other than Covid-19, the other major setback they hit was the regulatory blocking of the merging of their Powder River Basin thermal coal operation with Peabody Energy. This probably cost the company tens of millions of dollars a year in synergies.

It also turned out that they engaged in poor capital allocation. They bought back way too many shares in the 2017/2018 coal boom and were forced to tuck their tails behind their backs when doing some subsequent debt and convertible debt financings to fund the $390 million Leer South Project, but it appears that path is now clear and the need for future capital is gone.

The reason for this is that the Leer South project is due to be operating in Q3-2021 and this project, at current met coal pricing, is going to make a ton of money. The project is anticipated to generate 4 million tons of High-Vol-A coking coal a year for the next couple decades.

Right this very second (partially instigated by the trade war with Australia), prices to China are around US$300/ton. Indirectly, demand from China will continue to suck supply from other suppliers of the world.

Because shipping tens of thousands of tons of material is not an easy feat, transportation logistics became a ‘weighty’ issue. There is a limited capacity to transport from an eastern inland mining area (West Virginia) to the west coast (typically Long Beach, CA), and then onto a freighter across the Pacific Ocean. The opportunities for westward export are limited (indeed, Teck is making a fortune doing this from Elk River mines in southern British Columbia). As a result, the prices that ARCH will be receiving will be well less than US$300/ton, but it will be significantly higher than the averages received in 2019-2020.

High Vol-A, from what I can tell, is around US$190 spot currently. At that price, Leer South, once completed, will contribute an incremental US$500 million or so at existing pricing to the entity, in addition to the existing metallurgical operation. This is crazy amounts of money. Also, by virtue of the entire coal industry being decimated, competitors will have to take their time to open up more met operations (looking at Warrior Met Coal (NYSE: HCC) here), so Arch will eat up the lion’s share of marginal met coal dollars.

There is a lag effect between when coal is mined and when it is sold – contracts and deliveries have to be signed quarters and years in advance, so the pricing seen on GAAP statements will not be see until well after the economic substance of such transactions is actually performed. You can sort of see this being factored in the existing share price (which is the highest it has been since the Covid crisis) but my question will be what sort of valuation the market will ascribe to the company when they generate around $15-20/share next year (current analyst estimates are $7.63). Ultimately it depends on how much this boom for steel production (the primary driver of metallurgical coal consumption) continues world-wide.