Category: Debt

Just Energy – Unjust Recapitalization

I wrote about Just Energy (TSX: JE) last December after they suspended their preferred share dividends and were obviously awaiting a recapitalization.

A memory refresher on their debt structure:

A couple days ago the proposal came out.

Given all of the classes of debt, this is a messy proposal to read through all the relevant terms. It involves a debt/preferred share conversion, a 33:1 reverse split, and then a follow-on offering of equity.

* Exchange of C$100 million 6.75% subordinated convertible debentures due March 31, 2023 (TSX: JE.DB.D) and C$160 million 6.75% subordinated convertible debentures due December 31, 2021 (TSX: JE.DB.C) (the “Subordinated Convertible Debentures”) for new common equity;
* Extension of C$335 million credit facilities by three years to December 2023, with revised covenants and a schedule of commitment reductions throughout the term;
* Existing senior unsecured term loan due September 12, 2023 (the “Existing Term Loan”) and the remaining convertible bonds due December 31, 2020 (the “Eurobond”) shall be exchanged for a New Term Loan due March 2024 with initial interest to be paid-in-kind and new common equity;
* Exchange of all 8.50%, fixed-to-floating rate, cumulative, redeemable, perpetual preferred shares (JE.PR.U) (the “Preferred Shares) into new common equity;
* New cash equity investment commitment of C$100 million;
* Initial reduction of annual cash interest expense by approximately C$45 million; and
* Business as usual for employees, customers and suppliers enhanced by the relationship with a financially stronger Just Energy – they will not be affected by the Recapitalization.

In total, the Recapitalization will result in a reduction of approximately C$535 million in net debt and preferred shares.

Translated:

1. Convert C$260 million of convertible debt into equity
2. Convert US$117 million par of preferred shares = ~CAD$160 million in equity
3. Add CAD$100 million in equity financing
4. Convert ~CAD$15 million in the “Eurobond” to equity

This is where they get the bulk of the CAD$535 million figure from – from the publicly traded JE.DB.C/D and JE.PR.U securities.

None of the other tranches of debt receive a haircut – instead, they get extended. I will note that the holders of debt is that is the (unlisted) US$207 million unsecured term loan receives relatively preferential treatment in this recapitalization. The likely reasons for this: “The US$14 million draws were secured by a personal guarantee from a director of the
Company.”, and the fact that this tranche of debt was loaned from Sagard Credit, who is backstopping the equity offering.

The CAD$260 convertible debentures will be converted into 56.7% of the equity of the company, prior to the CAD$100 million equity financing.

JE this second is trading at 49 cents per share. At their existing market cap, JE equity is valued at $74.3 million. Convertible debt holders are being asked to convert CAD$260 million into $42 million of pre-diluted equity. This would also explain why the debentures presently are trading at about 18 cents on the dollar.

Preferred shareholders receive 9.5%, and this works out to 4.4 cents on the dollar. This class of shareholder is lucky to get anything.

The common shareholders will retain 28.8% of the company, and they should be even luckier to hold onto anything.

The convertible debentures are subordinated unsecured obligations of the company, which means that they are the lowest tranche of debt in the pecking order. However, the convertible debentures upon maturity can be converted into shares of JE with a standard VWAP clause:

The Corporation may, at its option, on not more than 60 days and not less than 30 days prior notice, subject to applicable regulatory approval and provided no Event of Default has occurred and is continuing, elect to satisfy its obligation to repay all or any portion of the principal amount of the Debentures that are to be redeemed or that are to mature, by issuing and delivering to the holders thereof that number of freely tradeable Common Shares determined by dividing the principal amount of the Debentures being repaid by 95% of the Current Market Price on the date of redemption or maturity, as applicable.

Presumably, if the convertible debentures were allowed to be exchanged for shares under this formula they would be receiving more than 56.7% of the pre-diluted equity. This is not allowed to happen because the senior creditors (the facility due on September 1, 2020) want to squeeze them out for a lot less.

This is what I’d call a fairly “unjust” recapitalization of Just. Caveat Emptor for those that were holding onto any of these securities! In particular, the purchasers of the February 22, 2018 offering of the 6.75% convertible debentures have realized an approximate 70% loss in their investment over the 2 years they’ve been holding it, which is fairly impressive.

No positions, never had any, do not intend on taking any either, and also commend management for ruthlessly taking out more retail capital – this is a textbook case.

Cineplex raises a quarter billion

(Thanks to Marc for commenting on this offering in the Debentures comments section)

Cineplex (TSX: CGX) was about to exit the escape room for CAD$34/share. Their timing was nearly perfect (December 16, 2019 announcement), but COVID-19 struck during the closing process. Now they’re a $8.40 stock and their business has been decimated due to the reaction over COVID-19 – movie theaters were right up there with cruise ships as being COVID disaster zones.

However, yesterday they raised $275 million in unsecured convertible debt financing! 5.75%, convertible at $10.94/share.

Quite frankly I was surprised. Maybe it is a sign of how frothy the market environment is. Their last published financial statements were from March 31, 2020 and I will dissect them:

Balance sheet, assets:

The highlights here are little cash, coupled with a large amount of right-of-use assets (leases) which are worthless if you can’t perform business in them, and about $820 million in intangibles and goodwill. In relation to their $412 million of equity (below), this pulls them very deeply into a negative book value, which is generally my metric to value companies as a cash flow vehicle.

Balance sheet, liabilities plus equity:

There’s a few adjustments to be made here. One is that the “deferred revenues” is mostly unused gift cards, which means if you haven’t used them yet, this is where they are represented on the books. If the business isn’t operating, this “liability” virtually amounts to a zero cost equity injection by hapless consumers.

We see the discounted cost of lease obligations, for the first year it represents a $115 million outflow. This is a large number but it isn’t crushing. These leases are long-term in nature, which is the “WOW” $1.23 billion figure. Most of this is property and a tiny bit is equipment.

Finally, they do already have $665 million of debt on the books.

Income statement:

Note the industry is seasonal in nature, so taking one quarter and extrapolating it to the full year is not appropriate.

I work through the line items and I do not see much in the way of revenues when the business is closed due to COVID-19. I then try matching up the costs that would be reduced as a result of COVID, and most of this is the “Note 12”, and lease (depreciation of right-of-use assets) costs, coupled with depreciation of film rights, and financing expenses.

We look at this “Note 12” which represents a large expense:

Presumably the executives and administrative staff of the corporation are still employed, but the various people involved in box office operations (e.g. retail cashiers, cleaners, film technicians, etc.) are off on CERB. I don’t know what fraction of the $53 million are ‘baseline’ employment expenses. I’d guess they’d be able to shed about 80% of their employment expenses?

They will still have to pay realty fees, occupancy taxes, and so on.

Just as a very broad proxy, let’s say that Note 12 expenses can be reduced to $50 million a quarter.

So just as a ballpark figure, when incorporating lease expenses and financing expenses, the entity is burning about $100 million a quarter, very roughly, when it has zero revenues. They might have given some guidance in their last quarterly conference call (I have not paid attention).

The fact that they can raise $275 million, unsecured, and at such a low rate of interest I find amazing. Am I that seriously out to lunch on the valuation of Cineplex?

I haven’t even evaluated the question of whether people actually want to go back to movie theatres, but this is an age-old question that has predated COVID-19. I recall a posting back in August 2014 where I was wondering how the heck they were doing so well despite the internet age.

Delphi Energy – proposed recapitalization

Delphi Energy (formerly trading as DEE, and with a second-lien secured note trading as DEE.NT) went belly-up into CCAA on April 14, 2020.

The last trade on DEE.NT was at 55 cents on the dollar before the company was delisted.

Today, we have the following proposed recapitalization plan:

The claims of creditors in respect of:

approximately $13.5 million outstanding under the Company’s debtor-in-possession interim loan financing secured by a Court-ordered priority security interest,

approximately $13.0 million outstanding under the Company’s senior credit facility secured by a first lien security interest, and

approximately $119.7 million outstanding under the Second Lien Notes secured by a second lien security interest,

will be settled in exchange for approximately 14.7%, 14.2% and 36.5% of the issued and outstanding voting common shares of a newly created class of shares of the Company (the “New Shares”), respectively, subject, in the case of the Second Lien Notes, to the Second Lien Opt-Out Election (as defined below);

Assuming a 100% recovery on the DIP financing, this works out to an equity valuation of $92 million. The second lien notes thus are looking at 28 cents on the dollar in the proposal, with the following alternate option:

Subject to the terms and limits set out in the Plan, beneficial holders of Second Lien Notes holding an aggregate principal amount of Second Lien Notes equal to or less than $200,000 will have the opportunity to elect (the “Second Lien Opt-Out Election”) to receive cash in the amount of $0.25 per dollar of outstanding principal amount of Second Lien Notes in lieu of the New Shares that they would otherwise be entitled to receive pursuant to the Plan; provided that, in the event that the aggregate of all payments pursuant to the Second Lien Opt-Out Election would exceed the aggregate amount of $1 million, such payment will be reduced on a pro rata basis so that total payments pursuant to the Second Lien Opt-Out Election do not exceed $1 million;

So their options are either 28 cents on the dollar (implied value) of equity, or a 25 cent on the dollar cash-out, or roughly half of the last trading price of the notes. It doesn’t look like there will be a Twin Butte Energy here!

Owners of Hertz stock should be aware that in the instance of Delphi Energy the proposal, if agreed upon, will rendered the common shares worthless.

Mogo Inc. Debentures Extension Proposal

(Hat tip to a comment that Will wrote)

It is really rare when I see a debt extension proposal that is so one-sided that it makes me speculate about the ulterior motives.

You can at least excuse entities like Lanesborough REIT (TSXV: LRT.UN) which was all but insolvent when they asked their debentureholders to take a haircut – it was a case of “if you don’t, we’re going to pull the plug and leave you with nothing”. At least the company had a hammer to pound on the hands of the creditors.

The proposal to extend the unsecured convertible debentures of Mogo (TSX: MOGO.DB) is even more absurd. Management Information Circular here.

Mogo is one of those millennial fintech-type companies that offers a mish-mash of financial products (credit card, mortgage, small loan, crypto, etc.). The loan portfolio is extremely risky, as judged by their charge-off rate in 2019 – 17%, which puts them at payday loan levels. The entire operation is still losing money, but this is accelerated by a considerable cost of capital – they are paying double-digit rates of interest on their credit facility.

They merged with Difference Capital (formerly TSX: DCF) which enabled them to raise enough cash to survive another year or so. But they’re still running out of cash – down to about $10 million at the end of 2019. They inherited a (less than liquid) private equity portfolio from Difference Capital worth $20.8 million on the books, but who knows how much it is actually worth (given COVID-19, I’d wager it would be worth less than the stated book value).

One headache to MOGO is their convertible debentures. There is $12.7 million outstanding and it is due to mature on June 6, 2020. As MOGO clearly doesn’t want to pay for it with cash, they can convert it into shares of MOGO at the 20-day VWAP ended May 26, 2020. MOGO currently has a market cap of $34.5 million, and triggering this option would likely cause the market capitalization to drop further and heavily dilute existing equity holders. While it is difficult to predict the magnitude (this depends on how heavily the convertible debenture holders can short sell MOGO stock to drive the price down to receive more shares upon conversion), I would guess there would be at least 50% dilution.

So to preemptively arrest the short-sellers, they float a proposal to extend the debentures on a vote to be held on May 22, 2020. I believe this is the ultimate motive of management’s proposal.

The terms and conditions is that if 2/3rds agree, the major changes are that MOGO debentures will be extended 2 years, the conversion (at the demand of the holder) will lower from $5 to $3.50, the floor conversion price on maturity (on the option of the company) will be at $1.50/share, altering the change of control provisions, in exchange for a 1% consent fee for those that vote in favour. In particular, the $1.50/share floor conversion price is highly unfavourable to existing debentureholders.

If the vote fails, MOGO.DB holders will be converted into a lot of MOGO shares. By having this vote, management is hoping that the VWAP for conversion will be higher than what it would be if they didn’t float this proposal – and if MOGO.DB holders actually agree to this, it would be a huge coup for them since the debentures are most likely to be converted into stock at $1.50/share in a couple years – representing much less dilution than in the current scenario.

I do not have any position in any of this, I do not intend to take a position. I am curious, however, to see how it will turn out.

Counting on the Federal government to do exactly the wrong thing, Part 2

The amount of incompetence exhibited by the current federal government is mind-blowing, but that’s what you get when political correctness is a dominant social consideration than taking proactive action. However, our incompetent government does have the legislative authority to blow over a hundred billion in borrowed money on their supporting constituencies, in addition to the levers of the Bank of Canada and others that tilt monetary policy and loan guarantees towards favoured sectors.

So let’s start with Bombardier, the poster child for government handouts. They will get a loan guarantee to ensure continuity of their operations as corporate business jets is an essential service (can’t catch Covid-19 when you’re in a private jet 35,000 feet above the skies).

Bombardier debt was selling at nearly 25% YTM, and unlike their common shares and preferred shares (where there is a good chance they will suspend dividends), they can’t suspend interest payments on their senior debt. They’ll find a way to kick the can ahead in time, even if their proposed sale of the Transportation division with Alstom fails. Alstom is still trading at 37 Euro per share and part of the BBD sale valued $550 million of Alstom stock at 47.50 Euro, so it’ll be interesting to see how this goes.

Needless to say, the Caa1 rating by Moody’s is well warranted and it is trading like a default is imminent.

Their floating rate preferred shares (BBD.PR.B) give out a yield that is the equivalent of prime, and at their current trading price, that equates to a 13% eligible dividend. So this is a rare situation where the lower risk asset, the debt, is yielding more than and is ultimately cheaper than the preferred shares. Go figure.

I’ll point out that the super-voting shares (BBD.A) are trading exceptionally higher than the small-vote (BBD.B) shares, which should be an indication that there is some sort of value in controlling the corporation. If everything was going to crap, I’d expect the A’s to trade much closer to the B’s.

I got some of Bombardier’s unsecured senior debt at nearly 25% YTM. Not a huge position, but enough of a position where when I start hearing about the inevitable bailout via loan guarantees, I can at least feel I didn’t get robbed, because the rest of the Canadian taxpayers certainly are. Keeping to my short duration policy (regarding inflation), it was the March 2022s that caught my attention. In my nominal scenario, Bombardier will put out a tender offer to repurchase these at some modest premium sometime in 2021.

I know this makes me a hypocrite since I generally suggest not having to do anything with aviation during this CoronaPanic. However, this is more of a political call than a financial one (although financially, Bombardier is not in catastrophic shape).

Since I’m talking about bonds, I’ll throw out another idea I’ve looked at but declined simply because it was beyond my horizon to evaluate but others out there might have some perspective. Taseko Mines (TSX: TKO) is financed mostly by a senior secured bond that matures on June 15, 2022. Taseko’s main producing operation is a copper mine (75% ownership) and the commodity is currently trading ever so slightly above their all-in cost to produce it (about US$2/pound while copper is hovering around US$2.20 post Covid-19). If you anticipate spot copper improving, TKO is well leveraged and they would be able to renew the debt which is secured by their operating mine. The last trade on the June 2022 debt (8.5% coupon) was 45 cents on the dollar, which needless to say is a 55% YTM. High risk, very high return. Even in the event of a CCAA or recapitalization process, I’d suspect you’d get some sort of recovery in line with the price. I don’t know much about copper, so I’m throwing this out here for you.