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).

Administrative Note on Comments on site

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Sorry for any inconvenience. While we are on the topic, the “email on new postings” function has also been a little wonky – there have been enough subscriptions on this site that I’ve actually had to throttle down the rate of emails going out since Google mail servers were rejecting the automated mails. Website management is a lot more difficult these days than when things were starting up 25 years ago!

Lending Loop – Why even bother?

Lending Loop is one of those peer-to-peer financing companies where you can allow yourself to be the recipient of future defaulted loans in the name of some business cause or another spending it without any real accountability. When you sign up, on top it states “Start investing today and earn a projected return of 5-8% per year*”

The “*” leads to a link with a model that uses words like “projected”, “estimated”, and other such mumbo-jumbo that is nearly as good as a COVID-19 mortality prediction.

Why the heck would anybody want to lend some random small business money at 5% when you can pick a brain-dead debenture (e.g. Rogers Sugar RSI.DB.F, 6.25% YTM) of a publicly traded company that has a billion more layers of accountability, and actual consequences (i.e. owners lose equity) if there is a default?

Finally, during this COVID-19 crisis, we have the following:

We have implemented a temporary hardship program for borrowers that are currently distressed as a result of impacts of COVID-19. This program will allow Lending Loop clients that meet certain criteria to make interest-only payments on their loans for a period of 3 months to accommodate this unexpected event.

I am guessing they are not doing this with the consent of the lenders. If the terms and conditions of the loans are so malleable, why would anybody ever bother putting their money in Lending Loop or other peer-to-peer lending services? This never made sense to me.

This is also why companies like Alaris (TSX: AD) never made sense to me. Companies have to be pretty desperate to lend money at double-digit coupons, and if you’re willing to sell royalties on revenues, you’re likely to destroy the margins that are required to keep your business competitive. It might make sense in specific scenarios (e.g. gold mining streams can make economic sense at times, e.g. “some percent of something versus 100% of nothing”) but gold miners are not like widget manufacturing where you have to squeeze out 200 basis points of margin in order to make a living. (Very abstractly, the less competitive the industry is, the more possibility that royalty selling makes sense).

And finally, if you want your double digit yields on questionable debt of corporations, there’s always gems like Bombardier unsecured, which when I last checked would net you 20% YTM if you feel brave. Less riskier than most stuff on Lending Loop and higher potential return, in addition with the likely possibility of getting a few morsels of recovery if they defaulted!

The future of monetary policy

We are all forced to be closet macroeconomists and for that, I’d suggest reading Ray Dalio’s primer on money, credit and debt:

More specifically, the ability of central banks to be stimulative ends when the central bank loses its ability to produce money and credit growth that pass through the economic system to produce real economic growth. That lost ability of central bankers typically takes place when debt levels are high, interest rates can’t be adequately lowered, and the creation of money and credit increases financial asset prices more than it increases actual economic activity. At such times those who are holding the debt (which is someone else’s promise to give them currency) typically want to exchange the currency debt they are holding for other storeholds of wealth. When it is widely perceived that the money and the debt assets that are promises to receive money are not good storeholds of wealth, the long-term debt cycle is at its end, and a restructuring of the monetary system has to occur. In other words the long-term debt cycle runs from 1) low debt and debt burdens (which gives those who control money and credit growth plenty of capacity to create debt and with it to create buying power for borrowers and a high likelihood that the lender who is holding debt assets will get repaid with good real returns) to 2) high debt and debt burdens with little capacity to create buying power for borrowers and a low likelihood that the lender will be repaid with good returns. At the end of the long-term debt cycle there is essentially no more stimulant in the bottle (i.e., no more ability of central bankers to extend the debt cycle) so there needs to be a debt restructuring or debt devaluation to reduce the debt burdens and start this cycle over again.

Does this remind you of anything that is going on right now?

With monetary policy at an effective zero bound (I don’t really care whether the interest rate is 0.25%, 0.75% or -0.5%, it is effectively zero and the negative bound is the ability to store paper currency underneath the mattress), the ability for central banks to stimulate the economy (without causing reams of economic damage with massive inflation) is effectively toast. The large recent failure was to not attempt a better normalization after it was perfectly evident the 2008-2009 economic crisis was passing, coupled with the US government not being fiscally responsible. In Canada, Harper was on the right track (he got the budget balanced and the Bank of Canada was able to escape the economic crisis with far less intervention than the US Federal Reserve), but Trudeau and the Liberals have done an exceedingly fine job of reversing this, and now Canada is basically in the same boat as the USA – central banks are employing quantitative easing as a last resort to stimulate economic activity.

The big difference this time is that when the government also mandates a shutdown of the economy, it doesn’t matter how much stimulus you put out there, the real economy is not going to respond. Why would a restaurant owner at this point in time make any investment at all when you have talks of COVID-19’s “second wave” and this can just start all over again?

The real interesting implications occur after one asks what the new currency will look like when it goes from fiat back to something that the public has confidence in. Will that be gold, or bitcoin (or some other crypto)? My big problem with bitcoin, and most cryptocurrencies in terms of them providing a “hard asset” is the dominance of the hash – most of the power in the network has been increasingly centralized to miner pools and it is getting to the point where the possibility and allure of collusion is effectively the equivalent of 51% of people deciding to steal the 49%’s capital.

I would deem it more likely that central banks will try to introduce a parallel currency.