Equity – Page 8

Office REITs

Those of you that tuned into the last episode of Late Night Finance will know that I took tiny positions in a couple office REITs, which I took the liberty to dump out subsequent to that zoom-cast (no, not a pump-and-dump, I promise).

Traditional valuation methods of real estate can use cash flow methods, capitalized costs of land/building, and gut instinct on where future market demand lies, but there is one universal truth and that is when vacancy rates are high, it is not a good sign of how much cash flow you can dredge out of a property.

We are starting to see downward pressure on various office properties (WSJ article), at least in San Francisco.

While the specific example in this article may be an extreme case (a mark-down of 80% or so from pre-Covid pricing), because mortgage and other secured financing is collateralized by real estate asset values, it stands to reason that many other office REITs are going to face issues with trust covenants of specific debt-to-asset ratios going forward.

Since real estate loans are a slow-moving process, it will take a sustained credit-tight environment to trigger more and more financial stress on these entities, but just like how Silicon Valley Bank and Signature Bank New York were the first canaries in the coal mine, it will be inevitable that we will see the first office REITs start to fall – the trigger will be forced liquidations of office properties.

Crown Capital Partners debenture refinancing proposal

A hat-tip to Frank L. for pointing out that Crown Capital Partners (TSX: CRWN), a little-known microcap financing company, on April 11, 2023 issued a proposal to refinance their $20 million face value of convertible debentures trading as (TSX: CRWN.DB).

The salient features they are offering are:

* Extending the maturity date of the Debentures from June 30, 2023 to December 31, 2024;
* Amending the interest rate on the Debentures from 6% to 10% effective July 1, 2023;
* Removing the conversion right of the Debentureholders; and
* Removing the right of the Corporation to repay the principal amount of the Debentures in common shares of the Corporation (“Common Shares”) on the new maturity date or any redemption date.

This company wasn’t on my radar but I gave it a closer look and glossed through their annual financial statement.

First, I noticed that there is quite a bit of consolidation going on in their entity (which means it takes a lot of time to dig through – time I, quite frankly, did not want to spend). A material amount of their assets are in the non-current category consisting of their investments (Crown Partners Fund, leased distributed power equipment, and other property and equipment). Needless to say it isn’t exactly of the variety that you can put it up on Ebay and dump for some quick cash.

The other thing that struck out at me is that they had $7.2 million cash on their balance sheet, and $11.9 million in mortgages payable (November 2023), $18 million in credit facilities (long-dated), and of course the $20 million in convertible debentures.

The credit facility’s fine print, is the following:

Effective February 7, 2023, the Corporation entered into a new senior secured corporate credit facility with Canadian Western Bank of up to $43,500 to be used to fund a full repayment and cancellation of lender commitments in respect of the Crown Credit Facility, support working capital and growth capital requirements of the Corporation and its operating businesses, and to fund the Corporation’s remaining capital commitment in respect of Crown Power Fund. The new senior secured corporate credit facility replaced the Crown Credit Facility and includes an amortizing term loan of up to $30,000 with a maturity date of February 7, 2028, an operating loan of up to $10,000 with availability subject to margin condition restrictions, and a letter of credit facility of up to $3,500. The term loan is comprised of an initial advance of $25,000 plus $5,000 to be advanced upon request by the Corporation prior to June 30, 2023. The term loan and the operating loan provide financing at variable interest rates based on Prime Rate plus 165 bps to 265 bps and 200 bps to 300 bps, respectively, and feature a customary set of covenants.

(You want to know why Canadian Western Bank (TSX: CWB) is trading like it will go First Republic Bank (NYSE: FRC) any moment?)

Pay attention to the rate paid. Prime is 670bps at the moment, so the term loan is 8.35% to 9.35% and the operating loan is 8.7% to 9.7%, floating.

In addition, you have the mortgage payable which has the following fine print:

Effective May 27, 2022, the Corporation entered into an agreement for a mortgage payable of $11,900 that is secured by the value of property under development, has a maturity date of November 30, 2023, and bears interest based on Prime Rate plus 570 bps (with a floor of 8.40%) per annum.

Prime plus 570bps is a 12.4% mortgage! Holy moly!

So why on planet earth would the convertible debenture holders agree to an unsecured 10% coupon when clearly the cost of capital for the other secured lending the corporation is taking is at much higher rates and you lose the (nearer) maturity date advantage? They generously offer a 1% consent fee for a yes vote!

The last thing I’ll point out is that they spent $24.8 million on share repurchases over the past two calendar years. Money that could have been better spent on… perhaps redeeming this debt?

The debentures are really illiquid, the stock is unshortable, and I have no positions in this company, nor do I intend on taking any.

The Teck Sweepstakes, Round 2

In the second round of the Teck and Glencore corporate soap opera, Glencore responds to Teck’s rejection with the following:

Glencore continues to believe that CoalCo’s combined thermal and coking coal assets would position it as a leading, highly cash-generative bulk commodity company which would attract strong investor demand given its yield potential. However, Glencore acknowledges that certain Teck investors may prefer a full coal exit and others may not desire thermal coal exposure.

Accordingly, Glencore has proposed to the Teck Board to introduce a cash element to the Proposed Merger Demerger to effectively buy Teck shareholders out of their coal exposure such that Teck shareholders would receive 24% of MetalsCo and US$8.2 billion in cash. This valuation is in line with both (i) the implied enterprise value of Elk Valley Resources (“EVR”) and the Transitional Capital Structure owned by Teck shareholders based on the Nippon Steel investment under the proposed standalone separation into Teck Metals and EVR (the “Proposed Teck Separation”), and (ii) the upper end of the valuation ranges of EVR provided by Origin Merchant Partners, in its fairness opinion to the Special Committee of the Teck Board.

Glencore clearly knows that Teck is going to reject this proposal, but they still want to keep in the limelight for the next couple rounds of this drama. There’s more action to come before the April 26, 2023 meeting to confirm (or reject) Teck’s proposal to its shareholders.

My guess is that Glencore will be offering around CAD$70/share for Teck in some very strange contingently valued offer (least of which is that the April 26 meeting no longer take place). Money speaks, and this situation is certainly no exception. It’ll probably be a good time to punch out the clock at that point – this is faintly reminding me of what happened to Potash Corp (now Nutrien) roughly a decade back.

The corporate soap opera at Aimia

I last covered Aimia (TSX: AIM) last September and things have progressed from bad to just outright hilarious (unless if you’re a shareholder).

Aimia had raised nearly half a billion in cash from the disposition of one of their legacy business units, leaving their balance sheet relatively open for investment. The company’s stated objective was to invest such proceeds in such a manner that could utilize their extensive tax losses, neatly summarized by this page on their last annual report:

What does the corporation do instead?

Two headlines:
a) January 31, 2023: AIMIA TO ACQUIRE TUFROPES FOR $249.6 MILLION

Aimia Inc. (TSX: AIM), a holding company focused on long-term global investments, has announced today that it has signed definitive agreements to acquire all of the issued and outstanding shares of Tufropes Pvt Ltd. as well as certain business undertakings of India Nets (together referred to as “Tufropes” or the “Company”). Aimia will pay a purchase price of $249.6 million (1) on a cash-free and debt-free basis

…

A family-owned business founded in 1992, Tufropes is expected to achieve annual revenue of approximately $130 million (1) for the fiscal year ending March 31, 2023 , and industry-leading EBITDA margins of 18%.

b) March 6, 2023: AIMIA ANNOUNCES ACQUISITION OF BOZZETTO GROUP FOR $328 MILLION

The purchase price will be based on an enterprise value of approximately $328 million (1) . It is anticipated that the acquisition will be financed with a combination of cash and debt, with an expected level of debt of around 3x Adjusted EBITDA, or approximately $135 million . Bozzetto achieved annual revenue of approximately $326 million (1)(2) and Adjusted EBITDA of $47 million (1)(2) with an Adjusted EBITDA margin of 14.5% (2) for the fiscal year ended December 31, 2022 , with higher than 80% free-cash flow conversion (3).

Quick analysis

Acquisition (a) invests $250 million for [$130*18%?] $23.4 EBITDA margins. Assume no “I” and a combined TDA of 40% and that leaves $14 million net income. Tufropes is an Indian corporation.

Acquisition (b) invests $193 million cash ($328-$135) for an “adjusted” EBITDA of $47 million. Let’s ignore “adjustments”, and apply an “I” of $135*7%, and according to the press release, claims a “free cash flow conversion of 80%” which miraculously assumes that a multi-country specialty chemical business has little in the way of capital investment requirements. Somehow, I don’t think so. Looking at Chemtrade, for example, we have 43% of their 2022 EBITDA going to capital and lease and cash taxes. But they are a trust structure, so I would suspect that Bozzetto would be paying more than 50% of adjusted EBITDA on this, but let’s round to half and you get $23 million. Bozzetto is an Italian company.

Add these up, you get about $37 million on a $443 million cash investment or an 8.3% leveraged return. Not only that, but it is an incredibly tax inefficient way of utilizing the tax losses.

These guys could have bought CNQ and would likely do a lot better and gone through less headaches than dealing with jurisdictional headaches like the ones they’re entering in now!

Follow-through soap opera

Over the past half year, a Saudi-run capital corporation, Mithaq Capital, has acquired 19.9% of the common stock. Understandably they’re not happy with how present board management has handled the investment portfolio.

Aimia is holding their annual general meeting on April 18.

Mithaq released on April 6:

Mithaq is disappointed with recent events and has lost confidence in the Board and management. Mithaq believes that it would be in the best interests of Aimia to reconstitute the board and will vote against the re-election of David Rosenkrantz (Chair), Philip Mittleman , Michael Lehmann , Karen Basian , Kristen M. Dickey , Linda S. Habgood , Jon Mattson and Jordan G. Teramo to the Board at the Meeting.

The reasons underlying Mithaq’s decision to vote against the re-election of the Board include concerns previously raised with Aimia regarding capital allocation decisions relating to acquisitions.

Aimia management quickly rebuked and claimed it is taking action to “protect the integrity of the market”:

Over the past month, Aimia has been investigating the misuse of confidential information belonging to the Company and one of its affiliates. The misuse involved an insider who was a former member of the Company’s board of directors and a senior officer of the affiliate in breach of his legal obligations. The investigation also uncovered what Aimia believes to be undisclosed joint actor conduct relating to the acquisition and voting of Aimia securities.

Upon uncovering this misconduct, Aimia’s affiliate recently terminated the insider and Aimia reported its concerns about breaches of securities legislation to the relevant securities regulatory authority. The Company is considering all legal options available to it to protect shareholders and the integrity of the market.

Mithaq filed an official proxy statement on SEDAR (April 10, 2023) and there are many gems in there, but this one in particular was interesting:

Aimia’s current operating expense at the head office level is at an approximate C$15 million annual run rate, which is a grossly inappropriate set-up for an investment holding company of Aimia’s size. In addition to this, by bringing Paladin into the recently announced acquisitions, Aimia shareholders will be paying a 2% annual management fee and a 20% performance fee.

This makes the old corporate headquarters at the former Pinetree Capital (pre-2016, the current entity is parsimoniously run) look spartan by comparison.

Aimia on April 11:

Mithaq and its joint actors seek to control Aimia out of self interest

…

Aimia believes that these statements were made in furtherance of a self-interested attempt by Mithaq and its joint actors to acquire control of Aimia’s cash for the purpose of investing in the securities of poorly performing public companies held by Mithaq.

Of course there’s self-interest! They own 19.9% of the company. It indeed is quite ironic that one of the poorly performing public companies held by Mithaq is Aimia itself!

I am sure there will be more theatrics between now and the April 18th AGM. I do not expect a sane shareholder would vote in the incumbent board, but some shareholder votes in the past have surprised me!

In terms of how Aimia’s stock is doing, their preferred shares are trading at roughly a 9.5% reset yield. Definitely not enough compensation for risk in my books.

Also, if Mithaq is successful in taking over Aimia’s board, they have the unenviable task to undo the capital damage that has occurred. Basically they’d be taking over when the family silverware has already been ransacked.

The Teck Sweepstakes!

Glencore: Proposed Teck merger and coal demerger

What the heck is a “demerger”? Rhetorical question.

I see two events going on here. The very public event is the following slide on copper:

Glencore makes a case that there is a strategic synergy to utilizing QB2 facilities to improve efficiencies on its own project (Collahuasi), which you can see on a map are relatively close together:

It is a geographical advantage that the others (specifically BHP) does not have.

But really, this merger is all about coal.

With Teck, Glencore picks up 10 million tons a year of production and this will nearly double its Canadian production.

When working in its entire base of met and thermal operations, if you believe the slide deck, it will generate CAD$14 billion pre-tax cash. Needless to say, this would be a lot of money.

At Glencore’s stock price of about $7.60/share, it prices Teck (Class B) at around CAD$59/share. Notably this is below 10x analyst forward estimates, but given that most of the Capex has already been spent on QB2, Teck’s future free cash flows will be immensely higher in the future.

Thus, the price has to go higher. In addition, after the coal spinoff was announced, the market had Teck go up to around $62/share and I think that will be a psychological anchor point as a minimum.

Because Teck has a dual class structure, there is some inside baseball going on with the Class A shares. It could be possible they will be offered a sweetened deal, especially to the exclusion of Class B shareholders, and eventually agree to it.

There are cases where you hit the sell button after a proposed takeout offer. There are times where you hold on and wait for a better offer. The latter is likely the case.

I’m guessing a deal gets done in the mid to upper 60’s.

If not, there’s a ton of cash flow to be distributed in the future, especially with the Elk Valley spinout – will be interesting to see how much the market puts a price on political correctness.

After that, however, will be a regulatory nightmare that will make Shaw and Rogers look simple.