Debt – Page 3 – Divestor

How much to pay for yield?

Some near-guarantees of interest income, how much will people pay for it? This is typically represented in a “yield to maturity” calculation but here is another way of looking at things which may be a little more intuitive – it involves capitalizing the cash stream to be received to the present, with a zero discount rate. It is a fun exercise:

* Bombardier 8.75% December 1, 2021 unsecured debt, not callable: Trading at bid/ask 104.35 / 105.65. Bombardier has completed their disposition of their transportation division with Alstrom, and has indicated they are exploring how to manage their debt. This one is the nearest term maturity and is a lock to mature. As there is 10 months left to maturity, the remaining coupon is worth 7.3% of par, so at the midpoint, an investor would be paying 105% to receive 107.3% over 10 months.

* Yellow Pages (TSX: YPG.DB) 8%, stated maturity November 30, 2022 but callable at par, May 31, 2021. Trading at bid/ask 101.2 / 102.4. Management has stated for the past few quarters they will be redeeming this debt as soon as they can. With 4 months of interest remaining, that is 2.7%. There is a tiny, tiny amount of optionality in the potential conversion (they can be converted into stock at $19.04/share but that is 55% above the current trading price and not too probable, although one quarterly report showing revenue stabilization would alter that conclusion).

We also have some “zero-coupon” equivalents in the form of merger arbitrage.

* Atlantic Power (TSX: ATP) will be bought out for at least US$3.03 in the second quarter. Right now, trading at US$2.96, that is +2.4% over an estimated 3-5 months (more attractive than the bonds presented above, in addition to the gain being on capital and not income account!). The risk of merger arbitrage, of course, is that the deal will fall through.

The baseline for cash is the high interest savings ETF (TSX: PSA) which gives out a yield of about 50 basis points at present. There’s almost no point in investing in this ETF at present, but they have a whopping 2.4 billion in AUM, skimming off 15bps of MER, so good for them.

The above are examples that will yield superior returns than the risk-free option. Indeed, there are plenty of options to skim a few hundred basis points of yield for very little risk, but it involves work and paying attention. It does come at the cost, however, of liquidity.

Canaccord Genuity Debenture amendment

A general cliche to remember in finance is that when things are complicated, they usually advantage the proposer of the complex terms.

Canaccord has an issue of convertible debentures outstanding (TSX: CF.DB.A) which are fairly typical: Unsecured debt, 6.25% coupon, matures December 31, 2023, convertible (by the holder) at $10/share at any time; it can be redeemed by the company after December 31, 2021.

Canaccord is reasonably solvent and payment of the debt is not an issue at present.

The stock (TSX: CF) is at $11.69/share, which means the debentures are in the money.

Canaccord proposed an amendment today with some terms I have not seen before. I have reformatted the below to make it easier to read:

The proposed amendments (the “Proposed Amendments”) are as follows:

The addition of a right of the Company to redeem, at its option and from time to time, between April 1, 2021 and October 31, 2021, any or all of the outstanding Debentures (the Amended Redemption Right”), for consideration of (for each $1,000 principal amount of Debentures held) cash equal to

(i) the greater of:
(a) 125% of the principal amount, being $1,250, and
(b) the sum of:
x) the amount calculated by multiplying 100 by the volume weighted average price of the common shares of the Company (the “Common Shares”) for the 20 trading day period ending two trading days prior to the date upon which the Company issues a press release announcing its intention to exercise the Amended Redemption Right; and
y) $40.00;

plus:
(ii) accrued and unpaid interest up to, but excluding, the date of redemption.

The Debentureholders’ right to convert their Debentures into Common Shares, at the current exercise price of $10.00, will be suspended until November 1, 2021.

The analysis of this offering took me a little bit of time to work out, but just like most complex transactions does not work well for the recipient.

The terms on initial glance seem attractive: Right now the debentures have an “intrinsic” value of $1,169 per $1,000 par (the assumption of a conversion and then a frictionless disposition on the open market). In scenario (a), you have $1,250, which is a higher amount, and in scenario (b), you have what you would have received otherwise in a conversion-and-sell scenario, plus an extra $40 for your efforts. Win-win, right?

No, for two reasons.

One is that the debenture holder is surrendering some time value of their equity call option (in the worst case scenario this would be eliminated by a December 31, 2021 redemption).

The second, and in my opinion, more valuable feature is that this amendment proposal is asking the holder to sell an information call option on the effective equity that their debentures have, for a very cheap price.

Specifically, the amendment proposal term of “for the 20 trading day period ending two trading days prior to the date upon which the Company issues a press release” is the offending term which gives away a lot of value to the holder, in this case, Canaccord.

The company controls the degree of information flow on its stock and to that extent, has some ability to talk up or down the stock price. The ability to issue a press release and retroactively determine a redemption price is a very powerful option given to the company. It’s like buying and selling a stock using historical data.

If the company wants to get rid of the debentures without conversion dilution, it could launch a substantial issuer bid, but retiring the convertibles would likely involved a price higher than $1,250 per $1,000 par. Hence, this convoluted scheme to amend the debentures should be voted against.

The proposal requires 2/3rds of the debentures to be in support to pass the amendment.

A large Canadian asset manager, on behalf of certain of its managed accounts, has agreed to support the Proposed Amendments and has entered into an agreement with the Company to consent and vote in favour of the Proposed Amendments. These accounts hold approximately 55.4% of the outstanding Debentures.

What do I know? Nothing, it seems.

Cheapest TSX Debenture right now – Surge Energy

Just looking at the list of TSX-traded debentures (100 issues from 63 companies), price-wise, the company trading at the lowest price is Surge Energy (TSX: SGY). Their debentures (a total of $79 million, about half of which matures in the end of December 2022) are trading just a shade above 30 cents on the dollar.

Usually when a company’s debt is trading that low, a recapitalization is looming. Indeed, for Surge, it is a likely scenario, if not an outright CCAA proceeding. Q2-2020 was very rough for all oil producers, with WTIC going negative and all the Covid fallout. For Surge, the last corporate snapshot on July 30, 2020 showed a fairly dire financial picture, specifically the $307 million in senior bank debt. This credit facility goes to a redetermination on December 2020, and is otherwise payable on March 2021.

Although in a ‘normal’ environment, the corporation is cash flow positive (even after the capex), it isn’t going to be nearly enough to address the bank debt, let alone when the convertible debentures are due. The absolute amount of product being produced (17k boe equivalent with 80% crude) is well below what it needs to be to support the amount of financial leverage. Hence, the convertible debentures, being very low on the pecking order, are going to be incredibly disadvantaged if it comes to a recapitalization proposal, and are sure to be wiped clean in a CCAA arrangement. Hence, this is why they are trading in the low 30’s.

There is a winning scenario, and that involves a surge (pun intended) in oil prices. Right now the corporation is hoping they get bailed out by the commodity market before the banks close in for the kill.

I took a small loss in September bailing out what was a very small position in the debentures I took post-COVID. Sometimes debt is cheap for a reason! Or another way – just because it’s cheap doesn’t necessarily mean it’s a good value!

The next companies in line in terms of having the lowest trading prices: Supreme Cannabis (FIRE.DB), Invesque (IVQ.DB.U/.V), and Chorus Aviation (CJR.DB.A), all roughly in the upper 40’s or 50’s, and all for fairly obvious reasons when examining the businesses in question.

Gran Colombia Gold notes

A minor update on (TSX: GCM.NT.U), they will amortize another 8% of their notes effective October 31. (Press release)

They also received a credit rating increase from B to B+ on their senior secured notes. Considering that after the quarterly amortization that they will have US$35.5 million outstanding, coupled with a positive net cash balance, this isn’t surprising. However, Fitch is very correct in identifying that the life of the Segovia mine (which is substantially most of their cash flow) is quite limited and they will need to find additional reserves, and that ore grade levels are depleting. Even if the mine were to shut down tomorrow, the remaining cash balances will be sufficient to pay off the debt (albeit the equity holders will suffer greatly).

They’ll call off the notes on April 30th. In the meantime, holders continue to enjoy a disproportionately large coupon. The notes are trading in a tight bid-ask where it doesn’t make sense to either buy or sell them. I really wish somebody would bid them up into the one hundred plus teens. It hasn’t been the case – lately the bid/ask has been 108/109. So I’ll continue holding until maturity.

Just Energy – the conclusion to the recapitalization

In regards to Just Energy (TSX: JE), after a suspenseful suspension of the recapitalization proposal meeting, a couple days later an agreement with substantially most of the shareholders and debtholders was struck.

On August 26, there was agreement to amend the following:

* pay accrued and unpaid interest in cash on the Subordinated Convertible Debentures until closing of the Recapitalization,
* issue C$15 million principal amount of new subordinated notes (the “New Subordinated Notes”) to holders of the Subordinated Convertible Debentures, which New Subordinated Notes will have a six-year maturity and will bear an annual interest rate of 7% (which shall only be payable in kind semi-annually),
* pay certain expenses of the ad hoc group of convertible debenture holders, and
* issue approximately C$3.67 million of common shares by way of an additional private placement to the Company’s term loan lenders at the same subscription price available to all securityholders pursuant to the New Equity Subscription Offering, proceeds of which will partially offset the incremental cash costs noted above.

All other terms of the Recapitalization remain unchanged.

The cash interest payment will save the debentureholders about (JE.DB.C) 1% and (JE.DB.D) 3% of par, and the $15 million debt issuance, assuming par, will be another 6 cents on the dollar. Debentures did jump up by a factor of 2 upon the recapitalization, and so did the preferred shares – clearly both classes were anticipating a CCAA proceeding.

The common shares also jumped upon the news, but traded lower from the morning spike throughout the day after approval.

Now, what is odd is that the news of the amended terms of recapitalization, coupled with the voting support agreements came by way of press release on August 26, at 8:27am, eastern time. The actual approval came on August 27, 5:32pm (after market close). On the morning of August 28, trading spiked up. There was a full two trading days where if one was alert, you could have sucked up a few bits of liquidity on the common shares and debentures:

Volume, August 26:
JE: 505,700 shares, VWAP 0.4315
JE.PR.U: 41,000 shares, VWAP 0.9997 (note: par value $25)
JE.DB.C: 113,000 par, VWAP 16.687
JE.DB.D: 139,000 par, VWAP 16.22

Volume, August 27:
JE: 349,850 shares, VWAP 0.4023
JE.PR.U: 100 shares @ 1.16
JE.DB.C: 93,000 par, VWAP 17.442
JE.DB.D: 18,000 par, VWAP 16.914

Dollar-wise, while we’re not talking about gigantic amounts of money, but for the small guppies out there, you could have made quite a few sushi dinners out of the gains from sucking up 5-10% of the average volume. Sadly I was asleep at the switch as well.

No positions, but this was rather fascinating to watch.