Category: Equity

Dangers of investing in dual class structures

Apparently some institutional shareholders are feeling the political pressure of the company’s ridiculously high executive compensation schemes. They’re voting against the “say on pay” resolution on the upcoming AGM.

Major Bombardier Inc. shareholder and supporter Caisse de dépôt et placement du Québec is voting against the company’s executive pay practices at its coming shareholder meeting.

It’s one of a number of major North American pension plans that intend to rebuff Bombardier’s compensation program. Some, including the Caisse, have grown sufficiently discontented to oppose reappointing directors to the company’s board.

Bombardier, like most major Canadian companies, submits its compensation program to shareholders for a non-binding “say-on-pay” vote at its annual meeting. Canada Pension Plan Investment Board (CPPIB), British Columbia Investment Management Corp. (BCI), as well as two major pensions from California and one from Florida, also say they are voting “no” Thursday.

At issue this year is Bombardier paying former chief executive Alain Bellemare a severance package of US$12.35-million when he was terminated in March, as well as promised future special payments and potential severance packages to other top executives when a deal to sell the company’s train division closes in 2021.

This is purely political posturing to the public to justify holding Class B shares (2.1 billion outstanding) in the company. Bombardier’s Class A shares (309 million outstanding) have 10 votes each, which give its holders effective control of the company. Bombardier’s Class A shares are currently trading at about a 30% premium over the Class B shares, so the market does ascribe some value to the voting component.

There is little remedy for the subordinate shareholders other than to sell if they wish to voice their opinion. This happens in any dual-class share structure company, where typically the founders get the supervoting majority to stack the board. You have cases like Berkshire (NYSE: BRK.A) and Fairfax (TSX: FFH) where you are being a silent partner to Warren Buffett/Prem Watsa, but you also have cases like Dundee (TSX: DC.A), which have made disastrous capital allocation decisions in the past decade (will they get their act together for the next one? Insiders are at least buying now). There are also firms like Biglari Holdings (NYSE: BH), where the controlling shareholder basically has open contempt for its subordinate shareholders – don’t like me? Go ahead and sell! Zuckerberg at Facebook (Nasdaq: FB) also has expressed the same sentiment – my way or the highway.

In all of these cases, investors, especially institutional ones, should know what they have gotten into. This doesn’t mean they can’t complain, but when it comes to exercising power to compel the board of directors to tell management to change their practices, the influence is very weak since controlling shareholders will always be able to replace potentially dissenting directors with those that favour their interests. In the case of Bombardier, who wants to give up $150-$190k for being a human rubber stamp?

(By the way, this board is far too large).

The only way to get any sort of leverage on an entrenched board is to own enough of the debt in a distressed situation, and then you will be able to get enough attention of management by the time the maturity comes to extract better terms. But these situations are rare, and they more often end up with management engaging in asset stripping and other extraction activities to the detriment of both shareholders and debtholders alike before they finally lose control.

Torstar insider trading before NordStar acquisition announcement

The Globe and Mail is reporting potential insider trading that went on before the acquisition announcement of Torstar (TSX: TS.B).

I posted above this possibility the day after the announcement.

It is pretty obvious from my eyes that there is something worth investigating, albeit the dollar values involved were relatively tiny. The transactions are so obvious that anybody conducting trades like they did were not sophisticated enough to know the liquidity of the stock was like trying to squeeze water out of lava rocks – you can look at the trade history to see it did not take a huge amount of volume to move the price up.

My guess, if there was some insider trading going on, was that some receptionist or office worker saw some prominent individuals (e.g. Rivett and/or Bitove) walk out of an office and then he/she tipped off a friend, who then pumped a bunch of market orders into the TSX, in a very unsophisticated manner.

Tailored Brands – not looking too good

The next clothing retailer that stands a good chance of going to Chapter 11 (to restructure what are fairly onerous amounts of outstanding store leases) is Tailored Brands (NYSE: TLRD).

They filed Form 8-K today and the salient highlights are this:

Cash and cash equivalents at the end of the first quarter of 2020 (this would be May 2, 2020) were $244.2 million;

…

As of June 5, 2020, cash and cash equivalents were $201.3 million, excluding $93.5 million of restricted cash.

That’s a burn rate of about $43 million per month, which should be disturbing to most investors, especially since they have a minimum cash maintenance requirement with their lender.

In order to reduce the cash burn, they need to sell inventory and get their stores up and sell product. However, initial data does not look good:

The Company noted that it is too early to determine steady-state comparable store sales for the second quarter but wanted to provide an update on recent performance. For the week ended June 5th, for stores open at least one week, the average comparable sales performance was:

o Men’s Wearhouse down about 65%,
o Jos. A. Bank down about 78%, and
o K&G down about 40%.

Clearly buying suits hasn’t been a priority of the consumer public post-Covid-19.

Ignoring the common stock, which has been exceptionally volatile over the past week (it spiked up to US$2.40 two days ago, and is now closed at $1.24), the corporate debt tells the real story:

This is the July 1, 2022 unsecured debt, with US$173.4 million outstanding. It is structurally behind the majority of the company’s asset-backed loan facility which does not bode well for recovery for the unsecured debt. If you have any inkling that the company will make some sort of financial recovery, however, these bonds are trading at roughly a 100% YTM at present.

A sure sign of Chapter 11 will be if the company decides to withhold interest payments on this debt (we will find out by the end of June), or they could be pulling the plug earlier than that. Who knows, with how Hertz (NYSE: HTZ) has traded after its Chapter 11 filing, it might result in an improvement in the stock price!

A side note – famed “big short” investor Michael Burry took his lumps on the stock last month. At one point he had a 4 million share position (8.3% of the company), with his last shares purchased in March 24, 2020.

I have no positions in TLRD or its debt, and not intending on taking one – they need to chop off half their debt, shed half their leases and this can only come in the form of a restructure within Chapter 11. I made my trade for a few cheap suits after they cut their dividend to zero, and closed it out late last year for a mild gain.

Bombardier

Aerospace-related entities today received a bit of a boost up on credit, especially Air Canada (TSX: AC) (they were able to get off a reasonable offering consisting of equity and 4%, 5-year convertible debt, both of which are now significantly doing better).

However, my focus is on Bombardier – their debt has been in the trash heap since Covid-19 and it is finally beginning to normalize – their 2022 issue spiked up 12 cents on the dollar today and the rest of their yield curve is flattening. While they are hardly out of the woods (they have a huge disposition of their Transportation division to finalize), it is looking seemingly apparent this is coming to fruition, which leaves their private jet division.

I believe the remaining private aviation industry will do better post-Covid-19 than most people anticipate.

They will also receive large business subsidies from the Canadian and Quebec governments. Bombardier is oddly reliable in this respect. I mean, just five years ago, I was doing the same thing.

The Alstom acquisition of Bombardier Transportation is the key trigger to the company’s solvency and all indications appear (unlike Cineplex and Air Transat!) that it will continue.

Corvel Corp

Here is another quick post.

I took a substantial position in the past month in Corvel Corp (Nasdaq: CRVL). Now that it’s rocketed up, I can write about it. Corvel’s domain is primarily in the software processing of workers’ compensation, insurance and related claims processing. They are vertically integrated to the extent that they provide the software and management systems.

I have been tracking this company for nearly 20 years, and owned and sold it over a decade ago, but I’ve been keeping an eye on it ever since (which assists the due diligence effort since there is such a long institutional history in my own mind). I finally had my opportunity.

It is a very unusually managed company. The pioneering manager (Gordon Clemons) still owns 9.4% of the company and sells bits and pieces now and then. He came on board 1988. The pioneering shareholder, Jeffrey Michael, owns 37% of the company through a holding company, and this was from 1990. They have since passed the baton to the next round of management, which does provide some succession risk (what happens to those shares?). Both Clemons and Michael have kept very low profile, along with current management. Almost nobody has heard of this company despite them doing over half a billion in revenues a year. They inhabit a niche that has very high barriers to entry. Their capital allocation strategy has also been relatively unusual – the underlying business makes a lot of free cash flow (after R&D) and all of that capital (up to the end of 2019, approximately $514 million) has gone into the repurchase of shares. They do not employ debt – indeed, not only did they not use their credit facility but they got rid of it in September 2019.

Their capital allocation strategy is uncommon. They maintain a cash float, and reinvest the rest of the proceeds in their own stock. As long as you assume the company will continue making money at the rate they are doing, these buybacks are extremely value-added over time. This makes past stock charts less comparable to present day situations. As of December 31, 2019, they have bought back nearly 2/3rds of their shares outstanding, at an average of US$14.25/share.

CRVL’s sensitivity to Covid-19 was primarily related to raw employment figures – their revenues are ultimately derived from employment and insurance factors. Their fiscal year end is in March and they released the annual results, which were in-line. The April to June quarter will show a slowdown, but after that, things should normalize.

While revenues will take a minor hit during COVID-19, as employment normalizes (in whatever form), Corvel will achieve its track record in annuity-like income and will be priced at a higher multiple than it was during COVID-19, which needless to say was lower than its ambient norm.

The company maintains a significant competitive advantage. Their pricing power will not erode too much as a result of the economic turmoil.

Needless to say, this is one trade I wish I made larger. My investment style is far too cautious at times.