The power of Berkshire is strong – why would shares of (TSX: HCG) go up when the acquisition price is so dilutive to existing shareholders (selling 19.9% of the company for CAD$9.55 and another substantial chunk of equity at CAD$10.30 to a 38% ownership interest) and the company cannot even obtain a better rate on a secured line of credit than 9%?
They managed to sell $1.2 billion dollars of commercial mortgages between 97 to 99.61 cents on the dollar, which leaves the question of how much their residential portfolio is worth. How can this investment by Berkshire and the line of credit be good for anybody but Berkshire, or more specifically anybody but common shareholders?
Now that short sellers have been crushed to death, I’m going to guess the next month or so will likely represent the “top” of their stock price. Borrow rates are 75% right now so I’m not touching it.
Book value with this stock purchase, FYI, goes down to under CAD$20/share. So even on a price-to-book metric, HCG is almost trading like a regular mortgage provider – except with the very relevant fact that their cost of capital is well above what they can receive in mortgage interest! How they plan on making money by issuing 5% mortgages and loaning money from the credit facility at 9% or 10% is beyond me. Maybe they’ll make it up on volume!
There is absolutely no reason why Genworth MI should be trading up 10% on this news either. They are in much, much, much better financial shape than HCG, and shouldn’t be trading at less of a discount to book value than HCG is!
Reuters rumor is that HCG is near some type of arrangement similar to EQB has with Canadian banks. Today’s announcement still mention securing cheaper funding is on going (will actually be extremely terrible news if it is just equity investment by Buffet and no longer pursing cheaper funding). I think with such a strong backer, they maybe able to come to terms with banks. In addition, their ability to sell the portfolio at 97 – 99.61 on the dollar means maybe in the worse case of a liquidation / run-off scenario, the firm can still realize something close enough to book value. That’s why there was the run up prior to the Buffet news. Lastly, they still may have one potential big catalyst in the stock price on the funding end. Now with the dilution, while the immediate existential threat is gone, the upside is capped for now. Looks like you are tempted to short it. This one may top out afterward and meander along for a while.
Retracting on that – “The Company expects to have sufficient liquidity over the coming months to repay all amounts outstanding under the New Credit Agreement through other sources of liquidity currently under consideration.”
Maybe a EQB like arrangement – but potentially more asset sale. Upside is really capped on this one.
I can see two reasons why MIC is going up
1- Some who were short on HCG were also short on MIC and are now facing margin calls
2- Some see this Buffet investment in HCG as a vote of confidence in the sustainability of the canadian mortgage market.
All this being said there were no reason in MIC’s share drop in sympathy to HCG issues in the first place. We are now back to more reasonable valuations. The real question is whatshould be a fair price for MIC on its own merits?
Entirely off-topic but I wonder whether you’ve looked at TBL again. Notes are back around par, same issues persist. It’s a foot race with many different stations: to positive equity, to a Canadian housing crash, to refinancing at a less ruinous rate (or the opposite), to a pivot to export/US markets that will insulate them from a Canadian crash, etc., etc. A few things going right could be very favorable for the common, but any one thing going wrong could impair the notes. It strikes me (from afar) as an acceptably-run business with a balance sheet problem it may or may not cure.
@Will: An interesting theory that I read is that this is Buffet’s relatively low-priced admission ticket into the Canadian banking sector (http://www.osfi-bsif.gc.ca/Eng/wt-ow/Pages/wwr-er.aspx?sc=1&gc=1&ic=1#WWRLink111). Since our banking system is functionally an oligopoly, it leads one to believe that if he parks capital in Canada it may be relatively worthwhile in the future and using HCG’s banking unit could be a vehicle. Or maybe not.
But I agree with the comment that the upside is capped. It’s like the crisis is over, they’re trading at a reasonable function of book value and life continues. Until the Canadian real estate market blows up, or doesn’t.
@Chessman: MIC is squarely in my “can’t buy, can’t sell” range right now.
@Aharon: Not really interested in them. I remember the last time their notes were trading well below par and their ownership bailed them out. I still don’t know what’s going on there even though they’re located in my backyard.
Thanks, Sacha. Our views are basically the same in very different geographies. Seems to me it’s fairly easy to describe their circumstances but impossible to handicap them, so impossible to have any rational conviction.