“Bittersweet” is the word I used to describe the acquisition of Atlantic Power (TSX: ATP), and also the words that James Moore used as well in his conference call.
“Bittersweet” is also the word I’m going to use to describe my exit out of the stock yesterday.
I did not view the chances of a higher bid to be likely and I should have pounded my shares out of the exit a couple days after the merger was announced (which got up to a high of US$3.06, compared to the proposed cash acquisition of US$3.03 – this was on January 20th and the merger announcement was on the evening of January 14th). Instead, I took a ~5% hit from the proposed price and paid a fairly hefty merger arbitrage spread.
The reason was simple – they announced they received 90% of the medium term note holders’ consents for the merger, but the following paragraph was in yesterday’s press release:
Atlantic Power also announced today that the meeting (the “Debentureholder Meeting”) of holders (“Debentureholders”) of its 6.00% Series E convertible unsecured subordinated debentures due January 31, 2025 initially scheduled to be held on March 18, 2021 at 10:00 a.m. ( Toronto time) is being adjourned to Wednesday, April 7, 2021 at 12:00 p.m. ( Toronto time) to allow additional time to solicit proxies.
This is not good news.
All parts of the capital structure require a 2/3rds vote to approve the merger. Quorum is 25%, which should not be the limiting constraint at this point.
If proxies were received that already expressed approval for the merger to that quantity, the meeting would have been held and one more hoop would have been jumped through for merger completion. It is a virtual guarantee that an insufficient number of votes or an insufficient number of affirmative votes has been received to date.
If they held the meeting and did not receive the 2/3rds supermajority, the vote would have failed and the merger would have to been renegotiated (which leads to all sorts of other risks).
The adjournment of this vote does not bode well for the overall merger.
We do not know how many votes have been received in favour or against.
The risk has been elevated significantly leading up to the April 7th shareholder vote.
Although iSquared is raising debt financing in preparation for the merger, if the entire capital structure of Atlantic Power does not go along with this, iSquared has the right to terminate the merger.
This will most certainly involve the common shares trading back down to the US$2.00-$2.20 level (and the preferred shareholders will most certainly head down to around the $17-18 level).
Just imagine you are the management of the company and the merger fails due to a negative vote. Mentally, you’ve already checked out and are preparing to transition out of the company. Instead, your shareholders (or possibly in this case, your debtholders) have blocked your exit. What do you do? It’s not an easy position to be in. You can sell your stake in the company (Moore owns more than a million shares and was prepared to receive a significant golden parachute) and get out of there. Another option is staying on board and just keep status quo and clipping paycheques while the stock languishes.
Another possibility is that iSquared will pay off the debentureholders. Indeed, given how ATP.DB.E is virtually guaranteed to get paid out no matter what happens (maturity is January 2025), why not be a pain in the ass and ask for more?
I’d estimate the risk of a failed vote happening to be about 20% at present. Not too high, but enough for me to punch out the clock and take the bird in the hand rather than two in the bush. To say the least, this has been a sloppy exit, but at least the rapidly depreciating cash that is sitting in the account will eventually find a better home.
I have not written about Cervus Equipment (TSX: CERV) before, but I took a small position in them last autumn. Unfortunately the size I received was less than what I wanted, because the stock took off shortly after. You can see the candlestick where my limit orders were filled (I won’t highlight it, but it definitely sticks out):
This is part of my ‘real world’ economy theme, where Cervus is a farm equipment retailer and practically anything relating to agriculture post-Covid is going to be heading up. They used to be twins with their competitor, Rocky Mountain Equipment (now delisted because they went private in a management-assisted buyout), but aside from John Deere (NYSE: DE), there aren’t really any good comparables in the farm space.
Given the business of selling equipment and servicing, perhaps the best analogy is with an auto dealership, and Autozone / AutoCanada (NYSE: AZO / TSX: ACQ) fit this particular bill.
Indeed, given the record level (both quantity and price) of used automobile sales occurring, perhaps it is not that surprising that the same is being encountered in the agricultural equipment space. The company has markedly improved its inventory balances ($320 million at end-of-2019 to $229 million at end-of-2020). The question is whether this had anything to do with management’s explicit actions or whether they are just the recipient of people spending money on farm equipment since they can’t do anything else during the Covid lockdown.
In a retailing environment, there is high sensitivity to gross margins and also the cost of getting those margins (SG&A). In 2020 vs. 2019, the contrast was pretty clear, revenues were up, margins were up, and SG&A was down, so this made for a very successful year (about $25 million in income, plus some favourable FX to boot). Balance sheet-wise, tangible book value is $12.26/share, and they eliminated the majority of their bank debt (clearing out net $91 million in inventory would help, noting that a good chunk of that is supported by short-term vendor floor plan financing, note 11 on the financials for those interested in following along).
During the year, CERV was able to repurchase approx. 290,000 shares at an average of $7.35 a piece, which offset some dilution on the share purchase plan. They also have financial room to raise the dividend, which they did – from $0.06/share quarterly to $0.11/share, which is what the dividend was before this Covid-19 mess began.
All things considered, a very good quarter for the company. While not at a valuation I would purchase the company, they are not in nosebleed territory by any stretch. If they receive a growth valuation, there’s further room to go on the stock price.
(Update, March 12, 2021: After hitting the “post” button, I noticed on my Twitter feed that Jason at Chapter 12 Capital did a small bit on it, a few hours before this article went out. Great minds think alike… let’s hope.)
Normally this ETR has traded at a premium to spot gold, but for whatever reason, today they are trading at a 2% discount. I noticed this when MNT was down 3% today while gold was flat.
This is like getting a US$35/ounce discount on spot gold. Physical gold typically has around a 4% mark-up.
Redemption costs are relatively reasonable – a 10,000 ETR redemption (the minimum) incurs a 0.9% fee (to get delivered 3 kilogram gold bars plus some residual cash). Getting your gold out in 1 ounce gold coins is considerably more expensive – about 5%.
I have no idea why the discount is suddenly happening today, perhaps a fund or somebody wants to unload it into the market, especially considering the rest of the market is on fire. Gold is a yellow metal that just sits there and looks pretty, and in the form of an ETR, it is even less exciting than a cryptographically-encoded digital collectible. Gold earns a negative income sitting there, compared to Gamespot or some other instrument of legalized gambling.
Sprott has a 64% gold and 36% silver hybrid (TSX: CEF) which has an even higher discount (about 3.9%), but it is considerable more expensive to hold – 0.53% MER. Sprott’s physical gold equivalent (TSX: PHYS) has a 2% discount and a 0.45% MER.
Perhaps there is some sort of arbitrage going on between these two funds.
Teledyne (NYSE: TDY) is undergoing the process of acquiring FLIR (Nasdaq: FLIR) for half-cash, half-stock.
The cash component is about US$3.7 billion.
They have a credit facility for $1.15 billion and they performed the following bond offering for $3 billion total:
$300 million aggregate principal amount of 0.650% Notes due 2023
$450 million aggregate principal amount of 0.950% Notes due 2024
$450 million aggregate principal amount of 1.600% Notes due 2026
$700 million aggregate principal amount of 2.250% Notes due 2028
$1.1 billion aggregate principal amount of 2.750% Notes due 2031
Needless to say, considering the 10-year government bond yield is around 155bps, this is cheap financing.
From their GAAP earnings, FLIR earned $1.60/share diluted in 2020 and at an acquisition price of US$56/share (assuming TDY at $390), that’s 2.9% without growth or synergies.
There’s still a bit of a merger arbitrage (about $1.30/share) which is a moving target because TDY has been gyrating since the merger announcement, but I am looking to dispose of the stock eventually once I have found a more suitable USD target for capital.
I don’t talk about IPOs very often, but this one caught my attention because of its presence in the agricultural space. Farmer’s Edge (TSX: FDGE) went public at an IPO price of $17/share, raising $125 million in gross proceeds ($117.5 net), and started trading on the TSX on March 3rd. Unlike many other technology IPOs, they have at a modest premium to their offering price:
There is a customary 30-day option by the underwriters to purchase more shares, which at the current market price of CAD$18.80 is likely to happen. I will assume so – the company will have 41.8 million shares outstanding if this happens.
Fairfax (TSX: FFH) owns 60% of the company after the offering and is the only 10%+ shareholder.
(Update March 8, 2021: The stock is now trading under CAD$17/share, that was quick… FFH will own 62% without the exercise of the over-allotment).
(Update March 9, 2021: Underwriters have exercised the over-allotment option – gross proceeds $143.8 million).
Company’s Operations
FDGE offers a package called FarmCommand. It is a piece of software which integrates with provided hardware (CanPlug) which facilitates a data conduit to the software relevant to measuring grain weight by location during a harvest. The software beams the information to the cloud using cellular data, and the software crunches the metrics and presents it to the end-user. Likewise, they also sell weather probes and soil moisture probes that can send data to the server (and this data can be used to make correlations at future times). Finally, they do have a soil sampling service that looks painfully manual and will test the soil for composition, using their own lab equipment. This information can be used later to suggest fertilizer solutions.
They use Google to store the data to the cloud, and Airbus to provide satellite imagery.
Revenues are obtained by selling farmers the FarmCommand package on a per-acre-per-year basis and also collecting such data to sell to crop insurance companies.
Relevant quotes:
FarmCommand is sold on a subscription basis, per acre per year, and is offered in five principal tiers. We focus on selling our $3.00 Smart package but offer price points starting at $1.50 for a basic Smart Imagery package, scaling to $6.00 for our comprehensive Smart VR package, with these list prices and packages varying marginally by geography. Our customers have historically subscribed to four-year contracts. Recently, we have introduced our Elite Grower program which allows our customers to trial our platform for free for up to one year before subscribing to a four-year contract.
…
Crop insurance partners form part of our go-to-market strategy and we expect them to sell our subscription products to their agriculture customers. Once our program is deployed on the farm by a crop insurance company, Farmers Edge will be able to provide reporting, analytics and predictive modeling to the crop insurance industry players on demand.
This reminds me of car insurance companies getting people to voluntarily put a device in their car dashboards for the purpose of insurance assessments. If you are a “safe” driver, as in you don’t drive that much and when you do, you drive at low speeds, then the insurance company will give you a discount. In reality, they will use this information to determine more accurate pricing, which is why there is a significant degree of selection bias with such offerings.
I also believe certain farm operations have proprietary methods that they would not want to disclose, which would work to the detriment of FDGE.
FDGE states they estimate at the end of Q4-2020, they have 23.4 million acres of subscribed farmland, and an estimated revenue of $45-47 million for 2020. 54% of this was Canada, 28% was USA, and 13% was Brazil, and the remaining 5% is Australia and Eastern Europe.
Keep in mind rough estimates are that Canada has 90 million acres of cropland, the USA has 250 million acres and Brazil 150 million. The total addressable market in these geographies assuming 100% penetration and the $3/acre package would be about $1.5 billion a year in revenues.
The company claims it adds value:
The ROI our solutions provide farmers vary by product and region. As additional examples, corn farms implementing our solutions earned farmers roughly $52 more per acre in Nebraska, and $36 more per acre in Kansas, compared to state averages, in 2019.
Clearly if this is the case and if they can establish this with better studies and have a proprietary advantage with their software to make it happen, then one can presume they can capture more margin than $3/acre.
In terms of competition, they list John Deere (NYSE: DE) and Bayer-Monsanto (OTC: BAYZF), but they allude to a “Point and regional solution providers” which is clearly referring to Ag Growth (TSX: AFN), but they are never named quite likely for the reason that they are the true competition.
Finances
The company has lost a lot of money over the past 3 full fiscal years. The “finance costs” is somewhat misleading as the company has been financed with debt before the IPO and this was equitized for the IPO.
In terms of raw EBITDA, and the accumulated non-capital loss for tax purposes (which is a rough proxy for true expense), we have:
2017: $53.8 million loss / $130 million
2018: $76.4 million loss / $199 million
2019: $74.2 million loss / $309 million
9 months in 2020: $42.4 million loss (annualized, $56.5 million) / tax NOLs not disclosed yet
This is also ignoring capital costs, which are not inconsiderable as the company has to get the hardware into the farmers’ hands (in addition to the installation) in order to do the data collection.
The company gave projections for 2020 and is expected to have burnt $52-56 million. Because of the renegotiation of the Google contract and the satellite imagery contract (which has been re-contracted to a subsidiary of Airbus), they are expected to save an annualized $15 million in costs (makes you wonder how they managed to negotiate the deals in the first place – this was not an inconsiderable cost savings).
The company has been mostly funded by Fairfax during inception. There are a couple other under-10% holders, one of which (Osmington Inc.) has the right to a board seat as long as they maintain at least 5% ownership.
After the IPO they will have converted all of their debt into equity, and have a pro-forma $106 million of cash on the balance sheet as of September 30, 2020 and the only significant debt being $6.5 million in future lease obligations.
They claim “break-even for Free Cash Flow in the medium term, assuming growth in Subscribed Acres remains consistent with the above expectations” (45-50% annually). Of course you will if you grow high-margin revenues at that rate! While achieving that percentage growth is indeed possible, the question remains whether they can do it profitably (it is difficult to make money giving out 1-year free trials and not cashing them into 4-year contracts), and the terminal growth rate of the business (it will not be 45-50% annually for a very long time, especially given the acreage penetration they have already achieved).
I’m not going to comment on the management suite or the board of directors, but I have reviewed them.
Some analysis on the software
There’s a lot of interesting information on how to use their product online. For instance here is one particular function within their FarmCommand software, but also as part of a series of instructional videos:
This competes with AGI’s Suretrack Compass software:
I’m finding this comparison between the two softwares to be interesting. AGI’s solutions are obviously vertically integrated with some of their products (their grain silos), while FDGE’s solutions are a horizontal turnkey solution. There is a lot of overlap. I would suspect that part of the reason why FDGE has spent a ridiculously large amount of money to date is to just get farmers aware of the software – they don’t have any inroads to the end-customers that a company like AFN or John Deere would have.
The other observation is that these Youtube videos that I linked to have views that are measured in the low hundreds. Almost nobody has watched these videos. There appears to be zero public awareness of agricultural software. If at some point these companies receive more eyeballs (heaven forbid if /r/WallStreetBets decided to hit it), there aren’t a lot of public companies in this space that would receive instant elevation to their valuations.
Consider that the weekend market capitalization for FDGE is $765 million – higher than Ag Growth’s $715 million (albeit, Ag Growth has a considerable amount of debt on their balance sheet, about $870 million), it makes one wonder how to reconcile the valuation differential. Is this attributed to FDGE as being some sort of “pure SaaS play in the Ag Space”, while Ag Growth is a much larger conglomerate (set to exceed a billion dollars in revenues), primarily concerned with the (relatively more boring) design and construction of grain towers and movers rather than having their own piece of software, which by all accounts does mostly what FDGE does?
I’m not interested in FDGE at current valuations, but I’ll watch it. If it turns out the current valuation of FDGE is “correct”, Ag Growth is incredibly undervalued.
Disclosure – I presently own shares in Ag Growth (posted here).
