Equity – Page 63

Thoughts on Teekay Offshore have not changed

Teekay Offshore (NYSE: TOO) reported their Q1-2017 results last night and they were lacklustre. In particular, the introduction of a litigation dispute with their largest customer, Petrobras, in respect of the operation of an offshore rig is not helping matters for them.

Last quarter I wrote about how Teekay Offshore units are “not going anywhere“, and that was an understatement considering this stock graph in the interm:

The next pillar to fall is their common unit dividend. Teekay traditionally declares dividends at the beginning of the calendar quarter and pays them out mid-quarter. I would expect there would be a 50/50 chance that they will suspend common dividends at the end of June or early July, and this would probably have a negative impact on their unit price. There is also an outside chance that they would decide to suspend their preferred unit dividends at the same time until they have shored up their financial resources.

The reason for this would be that they have not stabilized their financial position. With approximately 149.7 million units outstanding, the cash outflow of $16.5 million/quarter is something they really need to be putting into their outstanding debt. Preferred units receive around $11 million/quarter in cash in distributions and in a couple years, another series of preferred shares will switch from payment-in-units to payment-in-cash distributions (another $10.5 million/year).

Saving $27 million a quarter in distributions has to be attractive for a management that needs to repay $589 million in 2017 (this information is from their 20-F filing for their 2016 annual report). Cash flows through vessel operations will bridge some of this, but they are still missing some capital to make it through. They are also uncomfortably close to a debt covenant that they maintain total liquidity of at least 5% of their total debt (which is about $150 million in liquidity).

If you remember this chart from an earlier presentation when they got investors to chip in another $200 million in equity (April 2016):

CFVO (Cash flows through vessel operations) in Q1-2017 was $141.3 million, while net debt is ($3.12 billion gross minus $0.29 billion cash = $2.83 billion) – doing the math, we have ($2,830 / 4*$141.3) = 5.00 Net Debt/CFVO ratio!

This is way off the original 4.5x target as projected by management and this is getting into very dangerous territory where management has to take other measures to get the balance sheet back into a reasonable condition.

The only silver lining I can think of is that net debt has dropped $13 million for the quarter, but this is such a minor fraction of the overall net debt that it is relatively inconsequential.

Thus, I will predict that short of another form of recapitalization (or extremely dilutive equity offering), management will likely cut distributions from Teekay Offshore.

On a side note, I have gotten used to the “personality” of their quarterly reports and presentations as they release them and they are quite skillful at illuminating the information that they want you to be seeing and not paying any attention to the worms and termites that are crawling under the rocks. These nuggets of information are usually buried in the subsequent (weeks later) 6-K filings they report to the SEC. Also they are quite good at not reconciling their current situation with past expectations as you can see in the above post of their CFVO/Debt chart.

Yellow Media – are they done?

Yellow Media (TSX: Y, and thankfully no positions in equity or debt) reported today what can only be described as a near-disaster of a quarter.

The elephant in the room is what will be (after May 31, 2017) $295 million of 9.25% senior secured notes which mature on November 30, 2018. About 95% of this debt is owned by Canso Investment Counsel Ltd., who also owns 23% of the company’s equity.

In other words, the corporation’s future, short of a surprise turnaround in financial results, completely depend on what Canso’s intentions are. Presently they are able to extract a 9.25% coupon out of the corporation via the senior secured debt and I very much think they would be reluctant to relinquish what is a first-in-line cash stream.

There is a $107 million issue of 8% unsecured debentures trading on the TSX (TSX: YPG.DB) which is also about 30% owned by Canso (maturing on November 2022). The power of this class of securityholder is much more tenuous than it was before Yellow’s recapitalization (in other words – at 98 cents on the dollar it is trading too high given the risk profile). The conversion rate is at CAD$19.04/share which is has little value at the existing equity price of CAD$5.80/share.

The financial situation at Yellow has deteriorated and although they project $50-55 million in free cash flow for 2017, their revenues are continuing to decay and this trend is likely to continue as they morph into a digital consulting firm.

Since their market cap (after today’s 25% decline) is $160 million, it might appear the stock is cheap from a market cap to free cash flow basis. But this is a total illusion for two reasons. One is that the enterprise value of $562 million makes it expensive in light of the decaying free cash flow. The second and more powerful factor is Canso’s control motivation. The return opportunity for shareholders is going to be quite stunted, absent of some surprise takeover bid (doubtful, but this is up to Canso) simply because Canso has too much power and ability to extract capital in what is a financially unfavourable position to Yellow.

This is going to hurt the minority equity holders.

The business story is simple and everybody knows it – Yellow Pages used to be the business Google of the offline world. It is no longer.

No positions, not interested in any unless if somebody wants to sell me that senior secured debt, but sadly Canso owns most of it.

Versasen – Bought out

Verasen (TSX: VSN) is a relatively boring utility company that had some exposure to a LNG project in Oregon (among other businesses that are less exciting). They’ve been on my radar since early 2016 but I opted for other investments at that time since there were other risk/reward opportunities.

Today they are being bought out by Pembina (TSX: PPL) in a merger that makes strategic sense. The premium over the previous day’s closing price was approximately 22%, depending on whether you can get cash or stock in the transaction.

Pembina is a huge corporation and they trade at a market cap that is well above my normal investment range.

It is always sad to see research candidates where you’ve dumped a few hours learning about the company, industry, competitive advantages, etc., go by the wayside, but that’s life in finance. Onwards to the next target.

Home Capital / Equitable Group Discussion #2

A few news items which are salient as this saga continues:

1. Home Capital announced a HISA balance of CAD$521 on Friday, April 28 and a GIC balance of $12.97 billion. On May 1, this is $391 million and $12.86 billion, respectively (another $220 million gone in a day). Their stock is down 21% as I write this.

2. Equitable announced their quarterly earnings and are up 35%. This was a pre-announcement as they previously stated they would announce on May 11, 2017. They announced:

* A dividend increase.

Between Wednesday and Friday, we had average daily net deposit outflows of $75 million, with the total over that period representing only 2.4% of our total deposit base and with the most significant daily outflows being on the Wednesday. Even after those outflows, our portfolio of liquid assets remained at approximately $1 billion.

Obtained a letter of commitment for a two-year, $2.0 billion secured backstop funding facility from a syndicate of Canadian banks, including The Toronto-Dominion Bank, CIBC, and National Bank (“the Banks”). The terms of the facility include a 0.75% commitment fee, a 0.50% standby charge on any unused portion of the facility, and an interest rate on the drawn portion of the facility equal to the Banks’ cost of funds plus 1.25%. This interest rate is approximately 60 basis points over our GIC costs and competitive with the spreads on our most recent deposit note issuance, and as such will allow us to continue growing profitably.

So their credit facility cost $15 million to secure $2 billion (relative to $100 million for HCG), lasts two years (relative to 1 year for HCG), and also have a standby charge of 0.5% (which is 2.0% less than HCG), and a real rate of interest of approximately 3% (compared to HCG paying 10% for their outstanding amount, and I’m assuming the Bank’s “cost of funds plus 1.25%” works out to around 3%).

I haven’t had a chance to review their financial statements in detail yet. But securing two billion on relatively cheap terms like this is going to be a huge boost to their stock in the short run.

Very interesting.

Genworth MI (TSX: MIC) is also down a dollar or 3.5% today, which is more than the usual white noise of trading. It dipped even lower today.

DREAM Unlimited and Birchcliff Preferred Shares – cash-like with higher yield

I’ve written in the past about DREAM Unlimited 7% preferred shares (TSX: DRM.PR.A) and the situation still applies today. They, along with Birchcliff 7% preferred shares (TSX: BIR.PR.C) are the only holder-retractable preferred shares trading on the entire Canadian stock market.

They are both trading slightly over par value.

In the case of Birchcliff, the preferred shares only become retractable on June 30, 2020. As such, the implied yield to retraction is around 6.14% (assuming CAD$25.50/share and not factoring in the accrued dividend). You would receive eligible dividends over the next three years and a capital loss upon retraction. The underlying corporation, while somewhat leveraged, is quite well positioned if you assume the North American natural gas market is not going to evaporate. There is also some upside catalyst to the business fundamentals (not to the preferred shares!) if North America finally gets a liquefied natural gas plant on the Pacific Coast, but this is not likely to happen since price spreads have narrowed significantly over the past couple years.

Liquidity on Birchcliff preferred shares is not the greatest – but if you float an ask at the ambient price level you will likely get hit a few hundred shares at a time.

In the case of DREAM, the premium is not extreme when factoring in the amount of accrued dividend (at the closing price of $7.29/share, implies a 6.88% yield with a risk of an immediate capital loss if the company decides to redeem at $7.16/share). It has been quite some time since they have traded at a discount to par, and this is likely due to scarcity of shares – shares outstanding have decreased from 4.87 million at the end of 2015 to 4.01 million at the end of 2016, and this trend is likely to continue. Holders are probably waiting for the inevitable call by the company to redeem the preferred shares. But until this happens, holders receive an eligible dividend of 7% on their preferred shares.

Likewise with Birchcliff, liquidity with DREAM preferred shares is not good. However, there is usually daily activity on the shares and the spreads are typically within pennies. In a financial panic, however, that liquidity might fade and in a quick trading situation you might get a price a percent or two below par value.

There is conversion risk – the company can choose to redeem the preferred shares in DREAM equity, to a minimum of $2/share or 95% of the market price (which is the standard 20 business day VWAP, 4 days before the conversion provision, as defined in section 4.09 on page 68 of this horrible document). With the common shares trading at $6.60 and the business fundamental not being terrible, the risk seems to be quite low that preferred shareholders will leave this situation with anything less than par value.

I have some idle cash parked in both instruments. I consider them a tax-advantaged cash-like instrument and do like the fact that they are margin-able at IB (Birchcliff at 50% and DREAM at 33%!). This is much better than putting the money in a Home Capital Group GIC (earn 2% fully-taxable interest income AND have the privilege of losing principal when they go insolvent)!

Does anybody out there know of any similar situations that relate to US-denominated preferred share securities that are “cash-like” in nature?