Equity – Page 23

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.

I might be too old to be investing anymore – Mogo Finance

Look what popped up on my radar today – Mogo Finance (TSX: MOGO), primarily due to its massive price increase.

I’ve been looking at them on and off since they merged with Difference Capital a couple years back (this was to save MOGO as an entity since they were heavily indebted and no proper refinancing routes with their ultra-expensive line of credit). I had a prior investment in the debentures of Difference Capital, and hence the interest (they had an equity interest in MOGO).

Mogo also had a matter with their convertible debentures, which were extended, this was back in April of last year.

My very quick take of Mogo at the time was that they were not making money, and they were quite unlikely to make money given that their credit facility was priced at 12.5% plus LIBOR, although this was re-priced to 9% plus LIBOR (effectively 10.5%). They also had a non-publicly traded debenture that was also expensive (note 10 in their Q3-2020 financial statement if you care to look).

So when you look at the stock chart above, instantly, you realize that the business is now going to get an extension on its life because they will be able to raise equity financing.

Why did they get such a bounce?

Just take a look at their website. They are trying to be like a Canadian version of Robinhood, mixed in with some consumer finance.

And now, of course, they are getting into Bitcoin.

I can see why the market is ramming up the stock of this company, which did $2.3 million in operating income for the first nine months in 2020. A market cap of CAD$500 million is cheap in comparison to what Robinhood’s last secondary offering was reported to do (apparently during the Gamestop fiasco their revised valuation was at US$30 billion).

I am somewhat mystified and frustrated at my lack of imagination to correlate the two together. Was this thing worth a stab at a valuation of CAD$50 million (plus debt?). The convertible debentures would have been a relatively cheap entry point, with some seniority over the common.

When I look at my portfolio at present, it is most definitely an “old man’s” portfolio of very real-economy type stocks. The most technological of them is Corvel (Nasdaq: CRVL) which produces software that is in a dominant niche (my one and only post on it is here), but this is hardly a millennial starling! I can’t be the only investor out there that is getting this type of feeling that I am getting too old for the markets.

The most profitable industry on the planet

At this time, the most profitable industry has to be mortgage insurance in Canadian real estate markets.

Genworth MI (TSX: MIC) reported Q4 earnings.

The loss ratio reported was 10%. The expense ratio was 21%.

This means out of every dollar recognized in revenues leads to 69 cents of pre-tax profit.

Needless to say, this is a gigantic amount of economic extraction from an industry that is somewhat protected (by virtue of the federal government taking the mountain’s share of profits through CMHC).

It is funny how the public hasn’t connected the dots on how this makes borrowing with large-ratio mortgages extremely expensive – a 10% down mortgage can incur a 3.1% mortgage insurance fee. While 3.1% may not intuitively seem expensive, it is a huge fee considering that the bulk of the risk of default in a mortgage occurs in the first 5 years (where in a typical 25 year amortization, about 15% of the loan is amortized) while the rest of the time period is generally “home free” for the loan provider. This effectively results in a 60bps accretion to a loan’s profitability (compare that to a bank that makes less spread than that on the mortgage loan itself!).

Brookfield is in the very late stages of taking MIC into its fold at CAD$43.50/share. At the rate they reported net income in 2020, that works out to about 8.5 times earnings.

Normally industries with such large profit margins attract competition. The barrier to entry is access to the Government of Canada guarantee (CMHC gives a 100% guarantee, backed by the Crown, while MIC is 90% guaranteed by the Crown, with the residual guaranteed by their shareholders), and access to the mortgage networks (which can give approvals based off of customer profiles). Not an easy industry to crack for a new entrant, and the only real basis of competition would be price.

Enbridge Line 5 and pipeline politics

It is going to be very interesting to see what happens with Enbridge and Line 5.

The reason why the Federal Government cares about keeping Line 5 operational is because it processes about half of the crude oil that is refined for southern Ontario and Quebec. You can take a car to Sarnia and see the refineries.

A shutdown of Line 5 would, needless to say, be very disruptive for the region. There isn’t a good way to get additional capacity into the area – the other routes are fully utilized.

The federal government only cares about what is good for, roughly, the traditional boundaries of Upper and Lower Canada. Any policies that are tailored for areas away from this geography is strictly coincidental.

Thus, the Keystone XL cancellation was of little concern to Ottawa. The usual lip service of condemnation by politicians, when it is so obvious they don’t mean it.

I am still somewhat mystified today that the federal government bought out the Transmountain pipeline project – most people do not know that there is an existing (profitable) pipeline in place. Its existence does not matter an iota to Ottawa.

Line 5, however, is different. It fuels Ottawa’s core geography.

It was not longer than a decade ago when this strategic and political vulnerability was identified and hence the Energy East project was conceived. After the Liberals got into office in October 2015, they proceeded to kill the project with a never-ending wall of regulation.

We fast forward today and see where such lack of strategic thinking is par for the course in Canada.

It is not my job to moralize about the inadequacies of government thinking, but rather to pick out winners and losers.

I am still puzzled why so many people are in love with Enbridge as being a staple in their yield portfolios. There is far more risk than they imagined.

The sentiment will change when there is a real connection between very poor decisions and actual hardship experienced by people. The lag between the two, however, could take many, many years and attribution of blame may be misdirected.

Likewise, few lament over how much richer we could have all been, collectively as a society, had we had our act together to begin with.

Politicians, however, are not rewarded for making optimal or efficient decisions. In fact, they have a gigantic incentive to not solve problems, lest their purpose of existence be threatened.

Dorel’s going private takeover bid increased

Dorel (TSX: DII.B) was in the process of going private. Their previous bid had been CAD$14.50, but today they announced this will rise to CAD$16.00.

This post is not to discuss the valuation of the offers, but to highlight a trend of increased bids:

Rocky Mountain Equipment: CAD$7.00 -> CAD$7.41
Great Canadian Gaming: CAD$39.00 -> CAD$45.00
Dorel: CAD$14.50 -> CAD$16.00

Dorel’s bid was already somewhat anticipated by the market, where at around Christmas they started to trade over the CAD$14.50 threshold:

One can have hope for Atlantic Power, but I’m not holding my breath!