Category: Debt

Market timing is half luck, half skill

Less than 12 hours after I published my rationalization of purchasing First Uranium debentures in my TFSA, they released an adverse piece of news stating that their environmental permit for their tailings mine (which they subsequent reprocess for gold and uranium because prices have made it economical) was revoked.

The equity is down 23% as I write this; it brings their market capitalization down to $344M, which means that if shareholders wanted to capitalize the debentures, it would cost them 30% of the company instead of 25% the day before.

The debentures, however, remained within the bid-ask spread. Currently they are quoted as 75 cents bid, and 78 cents ask. I tend to trust the debt markets more than the equity markets in terms of true valuations.

It might actually be a good time to look at the equity as a more serious investment candidate if I was a little more risk-taking, but I will be continue to be happy with the debt. The foreign country operational risk is something I find very difficult to quantify and measure beyond a “gut feel” and this is the overriding factor in my decision. I believe something “political” is going on with this news release, but I have no way to judge whether it is a genuine operational aspect, or whether some politician is trying to wring a campaign donation out of the company or its management.

Peer to peer lending is quite risky

I find the fellow that writes Bad Money Advice to be quite entertaining. His latest article is written about his experience with Prosper.com, which is the foremost in peer-to-peer lending. He put $1,000 into it three years ago and managed to transform it into $1,029 – which apparently is an above-average performance on the site. At least it was better than the S&P 500, but certainly less than what a risk-free GIC would have yielded.

If you are Joe Consumer and need a loan for whatever reason, you can request a loan and have people bid rates on your loan. Prosper makes money by taking a slice of both the lender and the lendee.

Putting $1,000 into Prosper and attempting to transform it into a market-beating rate is actually money well spent even if you have your entire portfolio default – the reason being that it is a first-hand experience why banks and credit card companies charge such high rates for (relatively) unsecured consumer loans. In effect, it is an educational expense. It might not even be a bad idea to give younger people an account with a modest amount and get them to “invest” the money in an attempt to educate them why making money through banking is not as easy as it seems.

The only debt investing I do is through publicly traded companies and there is some legal protection because such companies have to file a prospectus and report quarterly – when dealing with consumers, you have no such protection other than the good faith of the person behind the internet wire. In most cases, if they have to borrow money through a place like Prosper, chances are they are in bad shape to begin with and your only proper compensation for this risk are rates that would otherwise be considered usury – around 30%.

This is why “payday loan” companies charge relatively high rates – they experience the same kind of default rates as people on Prosper. Payday loan companies are vilified for charging these high rates, but without doing so, they would go bankrupt.

I love the idea of Prosper.com – I just wouldn’t invest there unless if I knew I had some form of collection that was a little more powerful than the (expensive to implement) threat of a collection agency.

Harvest Energy offers debenture repurchase

As the Harvest Energy debenture agreement requires them to repurchase them at 101 cents on the dollar within 30 days of a change of control, Harvest Energy has made the offer today. The expiration of the offer is as follows:

Series                          Trading Symbol                  Expiry Date
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6.50% Debentures due 2010       TSX: HTE.DB.B                 March 4, 2010
6.40% Debentures due 2012       TSX: HTE.DB.D             February 11, 2010
7.25% Debentures due 2013       TSX: HTE.DB.E                 March 4, 2010
7.25% Debentures due 2014       TSX: HTE.DB.F             February 25, 2010
7.50% Debentures due 2015       TSX: HTE.DB.G             February 25, 2010
7 7/8% Senior Notes due 2011    N/A                       February 16, 2010

An investor should look at the market price of the debentures before considering to tender and also look at the yield they would get by holding onto the debentures vs. the risk they would have to take until they mature. Right now all of the debentures are trading above 101, which likely means they will not be tendered by investors – they can be dumped on the open market for a higher price. I dumped my “D” debentures at 101.5 and my “E” debentures at 102.0 in January in a lucky feat of trading execution.

Next TFSA investment – First Uranium

Following the success of getting out of Harvest Energy debentures, I had a lot of cash in my TFSA, especially after the January 2010 contribution of $5,000. There was only one debenture candidate left on my radar that appeared to have a good risk/reward characteristic. Although it wasn’t great, it was good enough and I executed a trade on it.

Continuing with my less than diversified strategy, I have placed the sum of the TFSA into the debentures of First Uranium (FIU.DB). The debentures give a 4.25% coupon, maturing in June 2012. They are convertible into equity at $16.42/share, but this is unlikely to be a factor in the valuation. The total issue was for CAD$150M. They went as low as 41 cents in the debenture crash of early 2009.

The price I received was 74.5 cents on January 11, which is a 5.7% current yield and an implied annualized capital gain of 13.0%. Assuming a 1.2% (short term interest rate) reinvestment of coupon, this is a realized return of about 16.8%, which is (barely) above my investment threshold. The previous Harvest Energy investment was above 30% at the time and price I made it, but the spring of 2009 was a very special investment climate where buying anything would give you massive returns. Today, things are much different and you really have to pull out a high powered microscope since anything with a high return has a lot of baggage you have to sift through. First Uranium is no exception.

First Uranium is a Toronto corporation, but with operations primarily in a South African mine with uranium and gold reserves. The name is misleading in that the bulk (~85%) of the company’s revenues are expected to be from gold sales. The foreign nature of their operations introduces a risk, but South African mining operations have been able to operate sustainably in other circumstances. Although I have my geopolitical concerns about South Africa in the medium term (10 years out), I have discounted such concerns in the 2.4 year timeframe of this present investment. It is also likely that coming closer to maturity that the investment may be liquidated sooner than later, or when the yield shrinks to my sell target (around 95 cents presently).

Most of the operations have been financed by equity – the last financing was done in June 1, 2009 at CAD$7/share. Today the common shares are at $2.66/share with 167M shares outstanding – a market capitalization of about $444M. Some portion of the gold reserves have been hedged off at below-market rates for up-front financing. In addition, the mining operations are still at the end of the initial capital injection phase before they can start producing sustainable positive cash flow, which is expected in the March 2010 to March 2011 fiscal year.

In terms of management and ownership risk, this is an interesting story. Simmer and Jack, another (larger than junior) South African mining company, owns 37% of the company as of September 2009. There has been a recent management and board struggle dealing with the Simmer and Jack management, who have moved over to First Uranium after they were kicked out of the Simmer and Jack board. The kicked-out CEO and Chairman, Gordon Miller, owns 1.66% of Simmer and Jack and roughly 0.1% of First Uranium. Although this struggle has an indirect impact on the value of the debentures (mainly that I am concerned about being paid off rather than owning the company), it is worthy to note that some deal must have been cut with the existing Simmer and Jack board such that he be allowed to run First Uranium since the 37% minority ownership of Simmer and Jack would likely be able to prevent him from doing so if they did so voluntarily.

There is a complex relationship here with respect to the debentures – Simmer and Jack is highly incentivized to make sure the debenture holders don’t take over the company so they can realize value of their equity stake. Gordon Miller likely wants to make a ton of money out of the deal and try to get some sort of revenge against Simmer and Jack and try to wrestle control away from the company. Either way, the debentures will have to be paid and it seems likely at this point it will be done by a simple equity swap – the current market capitalization is sufficient to pay off the debentures with about 25% dilution to existing shareholders.

On the balance sheet, First Uranium has US$60M in cash at the end of September and they have poured in about US$563M into their mining operations. Their only significant liabilities are a $22M loan from Simmer and Jack, and the CAD$150 of debentures. The income side is ugly when one looks back, but the corporation should start to generate cash through mining operations in the upcoming year and slow down capital expenditures – and perhaps even pay some common share dividends sometime in the second half of 2011 if things really go well and the refinancing of the debentures are in the bag.

The risks otherwise are typical of a mining firm – commodity pricing (gold and uranium) and realization of “proven” reserves into actual output. There is also some currency risk – they report in US dollars and their equity and debentures are denominated in Canadian dollars. Reading the technical report on the main mine and getting a feel for the operation is also essential (and rather dry) reading.

Although this investment is not the most ideal, I do believe that the company will be able to pay off the debentures, whether by refinancing, equitizing the debt or generating cash flow before the June 2012 maturity. There is enough of a margin of error to feel comfortable, but not “home free”, which is why the market value is trading significantly below at present. Assuming their story turns out, the equity side is also a compelling story, but it contains a high degree of risk that I am not willing to take – especially concerning the future of gold prices. That said, I expect these debentures will be made whole and will be a positive decision in terms of my risk-reward profile and being able to avoid income tax and capital gains tax by virtue of it being in the TFSA.

I also prefer short duration plays simply because when interest rates rise again, cash might be a more attractive option.

(Subsequent note: Operational risks include adverse news releases after hitting the “publish” button, although I do not think this one is too severe to my underlying investment thesis.)

Taiga Building Products resumes interest payments

Taiga Building Products has resumed paying interest on their notes. I have written about the notes earlier and pointed out the risks associated with the notes. At that time the notes were trading between 45 and 50 cents on the dollar.

After the closing of trading on January 13, 2010, Taiga announced the following:

BURNABY, BC, Jan. 13 /CNW/ – Taiga Building Products Ltd. (“Taiga” or the “Company”) is pleased to announce that due to strengthening cash flows, it will be resuming interest payments on its 14% subordinated notes, including monthly interest on deferred interest, as per Section 2.04 of the Note Indenture dated as of September 1, 2005. Interest deferred from March 1, 2009 through November 30, 2009, including interest on deferred interest, will be paid by September 1, 2010 as per Section 2.04 of the Note Indenture. The Board of Directors may choose to pay interest prior to September 1, 2010 subject to cash flow considerations.

The first reinstated interest payment date will be January 15, 2010, with respect to interest, and interest on deferred interest, accruing for the month of December 2009.

… and on the following day, announced:

BURNABY, BC, Jan. 14 /CNW/ – Taiga Building Products Ltd. (TSX: TBL & TBL.NT) announces that it will be paying the monthly interest payment of $11.6667 per $1,000 principal value subordinated Notes. Taiga will also be paying the interest on deferred interest, accruing for the month of December 2009, in the amount of $1.1233 per $1,000 principal value subordinated Notes. The payments will be made to shareholders and noteholders of record at the close of business on December 31, 2009 and will be payable on January 15, 2010.

The question for the noteholders will continue to be how the company will pay the deferred interest in light of the fact that their credit facility, as of September 30, 2009 was around $53 million and without any cash on the asset side of their balance sheet. The equity in the company is negative $82 million at this date. At the September 2010 date is the expiration of the bank credit facility, which would be senior to the notes and secured by most of the company’s remaining assets.

The market, however, didn’t seem to care. Taiga equity went up 15 cents to 60 cents a share (so its market capitalization is roughly $19.5 million) and for noteholders, the market value went from 60 cents to a high of 92 cents, closing at 91 cents.

It appears that the market is applying a very rich valuation to the notes in response to this news. If I held notes, I would be dumping them if the market rate was 91 cents.

I suspect within a year there will be some sort of recapitalization of the company’s debt balance, and the issue for the noteholders will be one of recovery, rather than yield.

Just an item of disclosure; I have never had a position (equity or debt) in Taiga Building Products. They are interesting to track, considering that they are a (relatively) local company to where I live and wish their business the best of luck in slaughtering their debt issues with a minimum of pain for everybody involved.