Category: Debt

Learning to read statements faster than others

First Uranium posted a production report for their last quarter. In the Thursday morning very long release contained the words that all equity investors dread:

The Company’s current cash resources may be insufficient to address its medium-term working capital needs. Accordingly, the Company has retained RBC Capital Markets as its financial advisor to review all funding alternatives.

Nobody appeared to read this paragraph until the opening of trading on Friday when presumably all the analysts released negative reports on the company.

The company’s common stock declined significantly Friday – from about $1.17/share to about $1.05/share presently. What is interesting is that this is purely from the news contained in the Thursday release – so institutional investors and analysts could not interpret the statement until given an evening to doing so.

I sold all the debentures (TSX: FIU.DB) out of my TFSA on Thursday for 80 cents on the dollar, but this was strongly instigated by the report. Most people on Thursday mis-interpreted the report as “steady as she goes” for the company operationally when they likely missed the critical part concerning the future capital requirements.

I also had some debentures in my non-registered account that I jettisoned, but still have some position.

First Uranium will likely have to raise further equity or debt capital to bridge their capital expenditure requirements. After that, presumably their existing Ezulwini mining operation could be cash flow positive. The equity is a high risk, high reward situation that I have not invested in. Depending on how such financing is structured it could be positive for debenture holders (e.g. a straight equity raise), but the company is otherwise restricted in terms of raising secured debt because of an existing agreement with noteholders (of which I own some as well).

Priszm Income Fund – Specified Defaults

Priszm (TSX: QSR.UN) filed in the documentation pertaining to their bridge loan, and when going through it, came up with the following summary as to what conditions the business defaulted on their senior loan obligation:

I notice that the senior noteholders are three related companies – The Prudential Insurance Company of America, Pruco Life Insurance Company and the Prudential Retirement Insurance and Annuity company. Whoever was the investment manager that picked Priszm for investment isn’t feeling too good right now – and presumably forced to sinking in $4M more into this train wreck in order to salvage the remainder of their investment.

The subordinated debentures (TSX: QSR.DB) traded down today to about 20 cents on the dollar as investors question their sanity for putting money into this venture. To figure out if there is any value left, one has to figure out whether management’s motivation is to eventually resurrect the company, or to generate a tax-loss write-off that works in their own favour (and not necessarily investors). One thing that I believe is virtually guaranteed is that the units are nearly worthless.

Disclosure: I own $200 market value of debentures, which I still believe offers a better payoff ratio than the upcoming Lotto MAX.

Equal Energy debentures – a lock at par

When a company rolls over its debt and extends the maturity, a call on the previous debt is not too far away. Equal Energy (TSX: EQU.TO) announced a bought deal for $45 million in face value of debentures, with a 6.75% coupon, maturing in just over five years (March 31, 2016) and a conversion premium of approximately 40% over common share price ($9/share).

They have two debenture issues on the marketplace, $80M maturing December 31, 2011 (TSX: EQU.DB) and $40M maturing June 30, 2012 (TSX: EQU.DB.A). Both of these have a conversion price well over the price of the common shares.

Most importantly for existing holders is the current phrase in the press release:

Proceeds from the offering will be used to retire a portion of the 8.00% convertible unsecured subordinated debentures due December 31, 2011 (the “8.00% Debentures”). Equal intends to call the 8.00% Debentures for redemption as soon as practical. The Company intends to fund the balance of the redemption cost of the 8.00% Debentures from its operating bank line.

…

Closing of the offering is expected to occur on or about February 9, 2011. The offering is subject to receipt of normal regulatory approvals, including approval of the TSX.

The company has been clearing away its debt at a fairly rapid pace over the past couple years and has sufficient room in its line of credit to pay off the debentures (currently $115M of room at a relatively low rate of interest). It is likely to assume that December 2011 debenture holders can expect a call by around mid February of the year. They will receive 102.5 for the debt. Investors paying this amount would receive interest at a minimum or about a 5% YTM, while investors paying less than 102.5 will receive a higher short term reward assuming a call. There would be a minimum of 30 days notice for a call and a maximum of 60 days.

The June 2012 debentures are a little more complicated – on July 1, 2011 they can be redeemed for 102.5 cents on the dollar, and 105 cents on the dollar before. So management will likely redeem these on July 1, 2011.

I own the December 2011 debentures, purchased during the economic crisis in 2009 at a price that made me wish I bought more of them compared to alternatives at the time. I am also finding it difficult to reinvest this capital in other ventures with similar risk-reward profiles.

For risk-takers only: Priszm Income Fund

The most troubled (but not formally bankrupt… yet!) company trading on the TSX is the Priszm Income Fund (TSX: QSR.UN), which operates fast food franchises. The fund owns 60% of a limited partnership that operates 432 restaurants (KFC, Taco Bell and Pizza Hut) across seven Canadian provinces. The other 40% is owned by a corporation controlled by the fund manager.

Unfortunately for the fund, they have substantial balance sheet issues. As of September 5, 2010, they have a $66 million loan that is secured by substantively all assets of the company, and this loan is due at December 31, 2010 (which was not paid). The company had $13.4 million in cash in early September, and cash through operations in the first 9 months of 2010 generated approximately $3.4 million. It should be noted the business is seasonal, with most of the revenues obtained in the third quarter (summer) season.

The company is trying to liquidate over half (232) of their restaurants, all located in BC and Ontario, for $46 million (link) but this deal has not closed yet. Even then, the company is not quite out of the woods in terms of their balance sheet situation.

Notably, the company has $30 million in unsecured convertible debentures outstanding that are due on June 30, 2012. The company has not paid interest on them at the end of December 31, 2010.

The debentures are trading at around 20 cents on the dollar, and have tanked over the past month as the solvency issue became very apparent:

This is a lesson for debenture investors that market valuations can be considerably divergent from the underlying truth – as early as the beginning of December, debentures were worth about 70 cents on the dollar – any investors at that point would have received a 70% haircut in valuation AND also the ignominy of paying the sellers 5 months of accrued interest!

It is also not quite clear even if the fund can realize $46 million in value out of the 232 franchises whether they will be able to avoid bankruptcy – they still have a considerable amount payable after this liquidation. Such a liquidation would occur on January 15, 2011 if approved by the buyer after they do their due diligence.

That said, it makes one wonder whether there is still value in the convertible debentures of Priszm. They are very cheap, but very cheap for a reason – even if the company can liquidate their franchises for an acceptable price, there is a stack of other payables that are due, possibly before or possibly jointly with unsecured debenture holders. Study up on your knowledge of the Bankruptcy and Insolvency Act! Suffice to say, this one would be for extreme risk-takers only.

Disclosure – No positions.

Corporate Debenture Screen for TFSA

Since a good deal of investors put their federally mandated $5,000 into the Tax Free Savings Account at the beginning of the year, the next logical question is what to invest it in.

A 1-year GIC, at best, can yield you about 1.75%. Other banks give you teaser rates, roughly around 2% for a floating rate. So naturally the eyes waver to more riskier options, mainly the corporate debt market.

The following is an exhaustive list of TSX-traded debentures that are scheduled to mature by December 31, 2011:

Maturity Ticker Coupon Price Conv. Price Share Price ITM
1-Jan-2011 NPF.DB.A 7.00% 75 6.9 0.39 5.7%
30-Apr-2011 PVE.DB.D 6.50% 101.01 14.75 8 54.2%
31-May-2011 PWT.DB.E 7.20% 101.8 75 24.5 32.7%
30-Jun-2011 KEY.DB 6.75% 302 12 34.96 291.3%
30-Jun-2011 NPI.DB 6.50% 126.04 12.5 15.79 126.3%
31-Jul-2011 AG.DB 6.50% 84.5 12.6 1.12 8.9%
15-Aug-2011 WEQ.DB 9.00% 105 4.2 4.5 107.1%
16-Aug-2011 WEQ.DB.B 8.50% 101 5.25 4.5 85.7%
30-Sep-2011 PRQ.DB.A 6.25% 102.01 24 12.5 52.1%
1-Dec-2011 AAV.DB.D 7.75% 102 21 6.81 32.4%
31-Dec-2011 GCL.DB 7.00% 121.6 10.25 12.06 117.7%
31-Dec-2011 EQU.DB 8.00% 102.5 27.75 6 21.6%
31-Dec-2011 FEL.DB 6.50% 102.5 13.5 4.34 32.1%
31-Dec-2011 FBK.DB 7.00% 100.2 4.32 1.15 26.6%
31-Dec-2011 IRG.DB 7.75% 100.1 10 2.4 24.0%
31-Dec-2011 LRT.DB.G 7.50% 77 7 0.4 5.7%
31-Dec-2011 PWT.DB.F 6.50% 102.75 51.55 24.5 47.5%
31-Dec-2011 UUU.DB 4.25% 98.75 15.76 4.77 30.3%
31-Dec-2011 WRK.DB.E 6.30% 102 20.63 20.17 97.8%

The last column gives you an indication of how much the embedded call option is a factor in the underlying bond pricing – KEY.DB is well within the money, while NPI.DB, WEQ.DB, WEQ.B.DB, GCL.DB and WRK.E.DB are roughly at the money.  For all of these issues, the debenture then becomes a strong exercise in equity valuation rather than debt valuation, which involves a whole different type of analysis to properly perform.

The rest of the candidates leave a lot to be desired; the high yielding candidates appear to be Fibrek (FBK.DB) and Imvescor (IRG.DB) but both of these companies appear to have issues that would not exactly make them low risk candidates.  Fibrek used to be known as SFK Pulp, and people that remember SFK should know about their chronic debt problems – although they have made good strides since the beginning of the year in reducing their debt, there is still $85 million of first-order debt that is in front of the $50M convertible debentures.  It is likely they will be able to roll-over the debt, but not a slam dunk by any measure.

It should be pointed out that the pulp and paper industry has had a major cyclical turnaround and Fibrek appears to be greatly benefiting from it at present.  Contrarian investors made a killing if they invested in the middle of 2009; the equity is up from roughly 20 cents to $1.15 presently, but it should also be noted that in the middle of 2009, a bankruptcy liquidation was a very real possibility.

Imvescor is a restaurant and franchising company that can only be described as a mess – they also have $45M in other debt that ranks ahead of the $22M of convertible debentures.  I have not spent much time analyzing this company other than to briefly gloss over its financials.

If you split your money between both of them and were able to cash out at maturity, you’d be looking at around 7.2% yield to maturity, which doesn’t seem like a lot of compensation for a year’s worth of risk in these less than ideal investment candidates.  One has to dig deeper into the markets to find acceptable risk/reward in both the tax sheltered and non-registered accounts.

Maturity Ticker Coupon Price Conv. Price Share Price ITM
January 1, 2011 NPF.DB.A 7.00% 75 6.9 0.39 5.7%
April 30, 2011 PVE.DB.D 6.50% 101.01 14.75 8 54.2%
May 31, 2011 PWT.DB.E 7.20% 101.8 75 24.5 32.7%
June 30, 2011 KEY.DB 6.75% 302 12 34.96 291.3%
June 30, 2011 NPI.DB 6.50% 126.04 12.5 15.79 126.3%
July 31, 2011 AG.DB 6.50% 84.5 12.6 1.12 8.9%
August 15, 2011 WEQ.DB 9.00% 105 4.2 4.5 107.1%
August 16, 2011 WEQ.DB.B 8.50% 101 5.25 4.5 85.7%
September 30, 2011 PRQ.DB.A 6.25% 102.01 24 12.5 52.1%
December 1, 2011 AAV.DB.D 7.75% 102 21 6.81 32.4%
December 31, 2011 GCL.DB 7.00% 121.6 10.25 12.06 117.7%
December 31, 2011 EQU.DB 8.00% 102.5 27.75 6 21.6%
December 31, 2011 FEL.DB 6.50% 102.5 13.5 4.34 32.1%
December 31, 2011 FBK.DB 7.00% 100.2 4.32 1.15 26.6%
December 31, 2011 IRG.DB 7.75% 100.1 10 2.4 24.0%
December 31, 2011 LRT.DB.G 7.50% 77 7 0.4 5.7%
December 31, 2011 PWT.DB.F 6.50% 102.75 51.55 24.5 47.5%
December 31, 2011 UUU.DB 4.25% 98.75 15.76 4.77 30.3%
December 31, 2011 WRK.DB.E 6.30% 102 20.63 20.17 97.8%