Category: Equity

Buffett on his AGM

He sold out his airlines. Not a surprise since the Form 4 of him dumping Delta and Southwest Airlines. He’ll be able to apply the capital losses to previous capital gains and do okay. He’s correct in saying that aviation will not be the same as it is today for a long time. Just looking at YVR inbound traffic, it is a dim shadow of its former self – apparently passenger flow is down about 90%. This is going to take a very long time to recover (indeed, if at all). You want to go to another country? Most of them will require you to spend 14 days in a virtual prison – in Canada, you get less of a jail sentence for most petty crimes!

We learn that Berkshire’s still sitting on over $130 billion in cash and equivalents, and there are a few ways to spin this:

1) “He’s holding onto so much cash, so the markets are still expensive!”
2) “He’s holding onto so much cash that will have to find its way into the market!”
3) “Buffett’s totally lost it, he missed out on the investing opportunity of the decade!”

Personally I think he’s at the point where if he isn’t going to be investing $50 to $100 billion into something, why bother? I would think that taking over Boeing would be in his ballpark, especially after his comments on the airlines… I will point out that Boeing’s market cap is $75 billion and needless to say, would be Buffet going out with a huge bang (one would have thought Burlington Northern was the crowning achievement, but I always remember the phrase “Planes, Trains and Automobiles”, and how would you get closer than by buying out Boeing?).

Either that, or he could pay a few bucks and put Bombardier out of its misery!

Birchcliff Energy preferred shares

The market is starting to normalize again. We’re about half-way done on the up-side, and I estimate while there will be some minor panics here and there that will bring things down 3-5%, in balance you’re going to see things get back to at least where they were before the end of the year.

I’ve taken my fair share of these shares (earlier in the month), so I’ll post it to the public since there is plenty of upside. I’ve written about them before, so this is going to be somewhat redundant.

Birchcliff Energy (TSX: BIR) is a natural gas heavy producer. They are a low cost producer, refine their own gas, and they will survive. They are primarily financed by a low cost line of credit which is not in any danger of having the plug pulled. While their equity remains undervalued (and insiders also believe the same, especially those that were buying when the stock was under a dollar), the even better risk/reward are the preferred shares.

There are two series. BIR.PR.A is a standard fixed-reset perpetual preferred share, currently 8.374% coupon with a +6.83% reset rate, resetting September 2022. Even at the present Government of Canada’s 5 year bond yield of 0.41%, at current market rates it will reset at a 10.5% yield. It is conceivable that they will trade up to par again, just as they were for most of 2017 to 2019. A ‘quick’ capital gain of roughly 50%, plus you’re given a very healthy 12% eligible dividend. Even with the Bank of Canada turning our currency into toilet paper, your real return will be positive.

BIR.PR.C is a straight perpetual share with a coupon of 7%. After June 30, holders can put their preferred shares back to Birchcliff at par, which BIR has the option of paying cash, or giving stock at the 20 day VWAP or $2 minimum per share. Considering BIR is trading at $1.57/share, this works out to a discount to the current preferred share value ($17 for the preferred shares vs. $19.60 in BIR stock). I don’t know what the term is in finance, but it creates a “Mexican standoff” situation where if this continues past June 30th, I don’t think holders will be too eager to redeem, nor will Birchcliff be too eager to redeem either. In the meantime, you can collect a 10.3% yield (assuming a $17 purchase price) for waiting. The obvious price target is par, although if you get fancy you might be able to get a mild premium.

I generally believe the worst is over for oil and gas, and as a result, all of this is going to be a moot point when BIR goes higher later this year. Why not buy the equity? There are worse things you can do, but the preferred shares are pretty much a lock for appreciation on a risk/reward spectrum. For every 1% the equity goes up, the preferreds will probably get around 75% of it until they get closer to par.

Of course there aren’t any guarantees of 50% gains in a few months’ time, but this one seems feasible. The risk scenario is that the common stock meanders about and you collect an ultra-high coupon while waiting for natural gas demand to rise. In the case of BIR.PR.C you end up with 12.5 shares of BIR.

Impact of BNN (Mediagrif)

Mediagrif (TSX: MDF) is a small Quebec-based software company. It had a lot of turnover on its executive suite, and when it comes to software organizations, if they lose a lot of core intellectual knowledge, it can be very difficult for new offerings to come out. These sorts of changes are impossible to detect looking at financial statements (other than the losses that occur as a result of a loss of product agility), but you could infer this was going on in MDF. Perhaps the most well-known Canadian offering of MDF is Merx, where you can sell the Canadian government defective face masks and any other procurements they are interested in.

Today, MDF stock spiked up 40%:

I tried looking up what could possibly have caused the spike up. No news releases. Nothing on Twitter. Nothing on the usual message forums. But then I found it – some analyst on BNN made it his top pick and equated it to Shopify:

MEDIAGRIF INTERACTIVE TECHNOLOGIES (MDF TSX)
New position.

Mediagrif providea Shopify-like e-commerce solutions, but for much larger companies. They manage the online platform for Sobeys/IGA and also for Carrefour in Italy, the only company enabling online food orders during the peak the crisis. It also owns platforms that enable suppliers to bid on government contracts, allowing corporations to exchange data with their suppliers and customers. This is one of the rare companies doing well in this environment and benefitting from businesses going digital. Whereas Shopify trades at 35 times revenue, Mediagrif trades at just under one time. We have been accumulating shares and now own 5 per cent of the company.

Talk about bidding up his own book! MDF traded 186,000 shares today and typical volume is 10,000 shares. It took about 10,000 shares of trading after 9:00am (pacific) to get the stock up from about $3.80 to $4.80 (presumably after it was mentioned on television).

Who are these people that sit on television and pound the buy button on the words of BNN analysts? How long will be it before they get bored and start hitting the bid and reaching for the exits? (Answer: After 10:12am, 1,200 shares were traded at $6.25, and after that it was just the day-traders that got involved).

I don’t watch BNN, but if you ever have one of your smallcap stocks get mentioned on it in a positive light such as above, I’d pick a good point to dump it (especially as there is liquidity from the active daytraders) and you’ll very likely be able to reload later.

I don’t have much opinion on MDF. There aren’t a lot of software companies on the TSX (other than Shopify, the largest one is Constellation) so as a group they are not difficult to keep an eye on all of them. In general, the sector is more resilient to COVID-19 than others (especially Cineplex!).

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.

Offshore Drilling

Diamond Offshore (NYSE: DO) today went to Chapter 11 heaven. Offshore drilling is even more expensive than drilling for oil by digging into your backyard, and paying somebody US$40/barrel for your crude oil isn’t a very economical business model.

The demise in Diamond Offshore was generally projected by the stock market:

There was also a very explicit hint on April 16th, where they stated they were withholding interest payments on one of their senior notes – never a good sign!

Diamond Offshore Drilling, Inc. (the “Company”) elected not to make the semiannual interest payment due in respect of its 5.70% Senior Notes due 2039 (the “Notes”). Under the terms of the indenture governing the Notes, the interest payment was due on April 15, 2020, and the Company has a 30-day grace period to make the payment. Non-payment of the interest on the due date is not an event of default under the indenture governing the Notes but would become an event of default if the payment is not made within the 30-day grace period. During the grace period, the Company is not permitted to borrow additional amounts under the Credit Agreement (as defined below).

On December 31, 2019, the balance sheet had $2 billion in debt, entirely in four Senior notes and $5 billion in drilling assets. Subsequent to the 2019 year end, they drew some capital on a revolving credit facility before going to Chapter 11, but otherwise most of the debt is pari-passu, which means they will probably get a slab of equity in the restructured entity.

The senior debt has been very volatile in trading today, hovering around the 10 cent level. If I had deep enough pockets (it is nearly impossible and highly risky for retail players to get involved in outcomes of Chapter 11 proceedings) I’d consider buying a slab of the senior notes. They’ll probably wipe out 3/4 of the debt, give out a bunch of equity in compensation, extend the rest of the maturities out for five years, and then pray that there is a recovery in oil where everybody can be made whole.

Other related companies I keep an eye on: Transocean (NYSE: RIG), and Seadrill (NYSE: SDRL). Seadrill went through a recapitalization a couple years ago, and Transocean looks to be on the brink (although they are not in as bad a shape as Diamond was, they can probably find enough spare change in the couch to survive until around 2022).