There is a reason why Yellow Media (TSX: YLO) is trading at 30-some odd cents per share, and the preferred shares are trading at 40% yields: it isn’t entirely clear whether the company will make it out of the doldrums or not.
The last quarterly report was not a home run, nor was it a strike-out; instead, it is a continuation of the fine line between the company going broke or the company making it.
Cash flow continues to be relatively poor, especially with the addition of income taxes after the trust conversion. The only solace there is that the federal corporate rate drops from 16.5% to 15% in 2012. Normally companies trading this low usually don’t have taxes as a problem (since they are typically not making money) but in this case, the federal-provincial tax bite becomes material since debt has to be paid off with after-tax dollars.
The tax tidbit that are sending analysts into negative mode again is that their estimate is their tax cash outflow of $250M in 2012 based off of a 27% tax rate; 2012 is a double taxation year because they will have to pay in installments for two years worth of taxes; if you do the simple division by two and divide by 0.27, that gives you an estimated pre-tax income of about $463M. At a 27% rate, that is about $338M after tax.
The company has the following debt maturity schedule:
February 18, 2013: $266M + $35M Credit Facility / CP
July 10, 2013: $130M MTN maturity
December 3, 2013: $125M MTN maturity
April 21, 2014: $254.7M MTN maturity
Feburary 2, 2015: $138M MTN maturity
February 15, 2016: $319.9M MTN maturity
The company has $52M cash currently. Assuming they have zero access to the credit market for the next couple years, they will need to generate roughly $50M in free cash flow each quarter, which is a tall order given their declining revenue base. That said, if they can actually stabilize their cash situation, they will likely be able to get an extension to their facility and figure out a way how to re-finance their MTN maturities. It will not be an easy climb up from the abyss, however.
My quick guess is that an easy $10.7M annual after-tax cash flow will be saved by converting the Series 1 preferred shares (TSX: YLO.PR.A) into equity as soon as possible. My other guess, and this one is not a guarantee by any stretch, is that they will opt to convert their Series 2 (TSX: YLO.PR.B) preferred share series as quickly as possible to save another $7.6M/year of after-tax cash flow. This then leaves the question whether the company is going to suspend preferred dividends entirely, and if they do, then Series 2 will not be converted, at least not until 2017. This is why the preferred shares are trading as low as they are – the company can pull the plug on the dividends. They will likely make this decision after the first quarter of 2012, depending on results. Series 3 and 5 of the preferred shares (TSX: YLO.PR.C and YLO.PR.D) both add up to about $22.2M/year in dividends.
Yellow Media should survive operationally, but the question at this point is whether they will survive financially. Who will reap the rewards of the cash flow of this over-leveraged entity? Certainly not common shareholders at this point, but right now the marginal question is whether the preferred shareholders will come out of this looking like geniuses or will they be burnt as well? This is increasingly looking like a binary situation, with either the preferred shareholders going to zero (in a recapitalization), or seeing the company slowly trudge their way back up to credit-worthy status over the process of a few years. The big hurdle is 2013.
I’m thinking it’s not quite binary when it comes to bankruptcy protection. YLO would still be worth something because of it’s cash flow. Bond holder’s will likely see the largest payback if they help the company get over it’s 2013 hump. Thus, it would make sense for the company to try to strike a deal with the bond holders under CCAA. If such a deal were to affect shareholders than shareholders would get to vote. If a deal can’t be struck then YLO get’s sold off, and shareholders get wiped out.
At least that’s my understanding of CCAA, anyone with more insight into what might happen?
Correct, my binary statement mainly applied to preferred shareholders. Holders of the Medium Term Notes will still get something out of CCAA (likely equity and/or warrants in a deleveraged entity), while the debenture holders *may* get something – they are subordinated to the MTNs.
My point was that I think the company would try and strike a deal and avoid bankruptcy. Such a deal would require shareholder approval, and thus would only be approved if the shareholder got something. This would be in the bond holder’s interest as they would get higher returns. That is to say the prefs would have some value after such a deal.
The only deal would be with the bondholders, and the only thing they would accept is some sort of pre-packaged bankruptcy where shareholders (common and preferred) would get zip.
Recapitalization of a debt-heavy company is always a messy business. Just ask Greece and the EU.
For what it’s worth I don’t agree, based on my limited understanding of CCAA legislation. But yes it would be messy.
Let me be more specific. If YLO goes into CCAA, there is no shareholder vote for anything. Bondholders will get a committee together and work with the other senior unsecured creditors. The subordinated debentureholders might get a bone or two thrown at them, but they will be under the banks and the MTN holders. This is why the MTNs are roughly at 50 cents compared to 30 cents for the debentures. At the end of it all, preferred and common shareholders will get wiped.
Now, the company outside the confines of CCAA could cut a deal with bondholders, something like “We’ll convert half your debt into equity, diluting current shareholders 95%, but it requires shareholder approval” – that type of deal would have to go to a vote at a special meeting. If that’s the type of deal you were talking about then you’re right. But that would be out of CCAA.
http://www.fasken.com/files/Publication/b67d44b2-6625-4e55-a9b3-113ee303d883/Presentation/PublicationAttachment/ec8fe2c5-a502-4fe0-ae7f-060edbf461e1/Shareholders_and_corporate_insolvency.pdf
Did some more digging … you are right no vote to the shareholders under CCAA, however if shareholders can demonstrate there is still value in the company and hence their shares then they have some standing under CCAA.
I agree with your comments regarding an out of court solution.