CJR – Divestor

Corus Entertainment

Corus Entertainment (TSX: CJR.B) has been a slow melting cube business case, dealing with the woes of competing against Netflix and streaming media, and the internet in general. Despite these competitive factors, they have still been able to generate a prodigious amount of cash flows.

They released their fiscal quarter results on January 12, 2024 and the following was their quarterly cash flow statement:

I’ve circled some relevant numbers. The key parts are that they have huge capital requirements to acquire program rights (this part makes the EBITDA look very attractive!) but these costs are necessary and increasing; they also have non-controlling interests which get claims to dividends that ordinary shareholders do not receive.

When netting this out, you have about $15 million in effective cash to work with. Management has a very strange interpretation of “free cash flow” which I won’t get into here.

This effective cash is contrasted to the $1.08 billion debt they have. Management is very fortunate to have $750 million of this at much lower fixed rates (5% and 6%) due 2028 and 2030 (the rest of it is in a credit facility) but needless to say, this leverage coupled with non-controlling interests do not leave the prospect of equity returns to be very good given the melting ice cube. The fixed rate debt is traded on the open market at a 13% yield to maturity at present.

There is some residual clout in ‘traditional media’ and Corus does still reach a lot of television sets and radios across the country. Perhaps some deep-pocketed individual will want to take control for strategic/political and not necessarily financial reasons.

The entity does appear to be more viable if they got rid of about half their debt.

Losers of the TSX, year to date

Rank ordering year-to-date, losers on the TSX, with a minimum market cap of $50 million:

What strikes out at me?

Canfor Pulp (CFX) – What a miserable industry pulp and paper has been over the past four years. Their profitability last decade has been quite good, and then 2019 hit and that was it. Now they are closing down core assets in British Columbia (their Prince George mill is a considerable producer). Most of their production is destined for export to Asia and the USA, and if there is ever a poster child for how BC is a high-cost jurisdiction to conduct forestry, this one is it. CFP owns 55% of CFX. Contrast this with Cascades (TSX: CAS) which the common stock continues its usual range-bound meandering (remember – they were one of the prime recipients of demand for toilet paper during the onset of Covid-19!). If there is any sense of regression to the mean on CFX, however, it would be a multi-bagger stock. The question would be – when? Solvency is not too particular a concern – they’ve got their lines of credit extended out sufficiently.

Verde Agritech (NPK) – A foreign fertilizer firm, notably one of their board members got cleared out of half of his position in the company on April 24th on a margin call. I have no other comments on this other than my professed non-knowledge about Potash and the fertilizer industry. I note that Nutrien (NTR) has been trending down for over a year.

Corus Entertainment (CJR.b) – They cut their dividend, and are realizing that their degree of financial leverage is really going to hurt their cash generation, especially in an industry that is becoming more and more questionable for advertising revenues (broadcast television). The risk here is obvious.

VerticalScope (FORA) – How they managed to get over a half-billion valuation when they went public is beyond me. Rode the 2021 “web 3.0” bubble for the maximum (right there with Farmer’s Edge and the like). Given the organic business is marginally profitable and unscalable at best, and given their existing debt-load, good luck!

Vintage Wine (VWE) – This is a US/Nasdaq entity, I don’t know why this went on the TSX screen, but I checked it out anyway. Sales issues (declining), cost containment, and a large amount of debt plague this company. However, if you shop around any of their wineries, they do offer a “Platinum Shareholder Passport“, where if you own 1000 shares (which is now US$1.08/share, not too steep), you qualify for “25% discount on any wine purchase made at Vintage wineries and web stores.”, which quite possibly might be even larger than a $1,080 investment, depending on how much wine you end up buying. Now that’s a non-taxable dividend you can drink to!

Autocanada (ACQ) – How the mighty have fallen. After blowing a considerable amount of capital on share buybacks (the latest substantial issuer bid at $28 – stock is now $16) in 2022, they are finally feeling the pinch of margin erosion, especially from their last quarterly report. There are macroeconomic headwinds in place here, in addition to a not inconsiderable amount of debt. On their balance sheet, they did something smart by financing a $350 million senior unsecured note financing in early 2022 at 5.75% at a 7-year maturity, but there is still $1.2 billion in other floating rate debt on the books, which needless to say is getting very expensive. Even worse yet is the impact when you have to pass these costs onto your customers in financing charges, so suddenly your Land Rover that was a low $799 per two week payment is now $999! At some point, customers walk away and then decide they want a Toyota Corolla, which is also inconveniently unavailable everywhere. See: Gibson’s Paradox.

… a bunch of Oil and Gas drilling companies are on the list. No comment – it is pretty obvious why.

Brookfield (BN) – A surprising name to see on the list. I have a “no investment in entities named Brookfield” policy simply because of complexity. There are so many interrelationships between the various Brookfield entities that I do not want to make it my full-time life to keep appraised with it all.

51 on the list was Aritzia (ATZ) – I have long since given up on predicting women’s retail fashion trends. I note that Lululemon (LULU) is still sky-high in valuation (forward P/E of roughly 30). Victoria’s Secret (VSCO) is trading at a projected P/E of 5. Aritzia has kept a relatively decent balance sheet (only material liabilities is the retail leases they have committed to) and the projected multiple is 20. If you can get into the minds of the clientele, you would probably get more visibility on the future sales of this company. How do institutions do it? Should I go stick out like a sore thumb and go outlet mall shopping?

Anything else strike out at you?

Cheapest TSX Debenture right now – Surge Energy

Just looking at the list of TSX-traded debentures (100 issues from 63 companies), price-wise, the company trading at the lowest price is Surge Energy (TSX: SGY). Their debentures (a total of $79 million, about half of which matures in the end of December 2022) are trading just a shade above 30 cents on the dollar.

Usually when a company’s debt is trading that low, a recapitalization is looming. Indeed, for Surge, it is a likely scenario, if not an outright CCAA proceeding. Q2-2020 was very rough for all oil producers, with WTIC going negative and all the Covid fallout. For Surge, the last corporate snapshot on July 30, 2020 showed a fairly dire financial picture, specifically the $307 million in senior bank debt. This credit facility goes to a redetermination on December 2020, and is otherwise payable on March 2021.

Although in a ‘normal’ environment, the corporation is cash flow positive (even after the capex), it isn’t going to be nearly enough to address the bank debt, let alone when the convertible debentures are due. The absolute amount of product being produced (17k boe equivalent with 80% crude) is well below what it needs to be to support the amount of financial leverage. Hence, the convertible debentures, being very low on the pecking order, are going to be incredibly disadvantaged if it comes to a recapitalization proposal, and are sure to be wiped clean in a CCAA arrangement. Hence, this is why they are trading in the low 30’s.

There is a winning scenario, and that involves a surge (pun intended) in oil prices. Right now the corporation is hoping they get bailed out by the commodity market before the banks close in for the kill.

I took a small loss in September bailing out what was a very small position in the debentures I took post-COVID. Sometimes debt is cheap for a reason! Or another way – just because it’s cheap doesn’t necessarily mean it’s a good value!

The next companies in line in terms of having the lowest trading prices: Supreme Cannabis (FIRE.DB), Invesque (IVQ.DB.U/.V), and Chorus Aviation (CJR.DB.A), all roughly in the upper 40’s or 50’s, and all for fairly obvious reasons when examining the businesses in question.

Corus Entertainment – quick look

Corus Entertainment (TSX: CJR.B) is a well known company. They have various media assets in Canada on television and radio. At one point I was considering a purchase, but held back because they are highly leveraged and I didn’t have a solid grasp on the risk/reward profile – I suspect they do have competitive advantages but the broadcasting industry is shifting so much (“cord-cutting”, Netflix, etc.) it is difficult to tell whether it is sustainable.

Reading their year-end financial statements, there are a few interesting wrinkles which caught my attention.

0. Fiscal year ends August.

1. They historically have generated a lot of cash. FCF in FY2018 was $344 million, and $307 million in 2019. In 2019, they chipped away $250 million on their debt (which stood at a FY year end balance $1,732 million). Most of this debt was issued to facilitate the acquisition of Shaw Media. $258 million is due November 2021, $869 million on May 2023 and $639 million on May 2024. Clearly they won’t stand much of a chance of paying back the 2023 and 2024 tranches, but one would presume if they rake in $300 million a year in free cash, this won’t be a problem to refinance. The effective rate on the debt is 4.3%.

If for whatever reason this future operating cash flow were to drop at a more accelerated pace, however, the equity is going to suffer badly.

But needless to say if one believes that $300 million is the norm, $1.42/share in cash means the Class B shares trade at a 3.5x multiple…

2. The amount of dividends issued is structured in a peculiar manner:

Corus slashed their dividend 80% last year so they can concentrate their capital on deleveraging. However, the amount of dividends going to non-controlling interests is quite high.

The concept of non-controlling interests is not easy to explain in accounting terms, so I will try here.

Let’s pretend you own a holding company, but this company’s only asset is the ownership of 70% of voting and common shares of an operating entity. If the operating entity makes $100 of income, you consolidate the operating company’s financial statements into your own, but $30 of that income is attributable to non-controlling interests. Shareholders of the holding company effectively only “see” 70% of the operating company’s income.

This is most prominent in a case like Interactive Brokers (Nasdaq: IBKR) where a shareholder of IBKR (76.7 million shares outstanding) owns 18.5% of IBG LLC, which is the entity that actually owns most of the assets. In the 3 months ended June 2019, for example, IBG LLC reported $210 million in net income, but $178 million goes to non-controlling interests (the 81.5% that owns IBG LLC, mainly Thomas Petterfy) while IBKR holders effectively see $32 million. Indeed, IBKR holders will only be able to “cash in” if IBG LLC is generous enough to distribute earnings to it (which they do through a nominal dividend, and control is not an issue because the entity has the same controlling shareholders).

Indeed, when we look at Corus’ income statement, we see that various entities contribute a 13.6% slice on net income:

So one obvious question is the following: what is the agreement governing the non-controlling interest and Corus? It appears that the non-controlling interest has favourable agreements with respect to cash distribution than common shareholders. What entitles these non-controlling interests a $30 million slice of income each year when common shareholders get 56% of the dividends paid by Corus?

I haven’t been able to figure this out.

However, on page 51 of their financial statements, we have the list of subsidiaries, and the non-controlling interest must come from these entities:

I never knew the Food Network and HGTV was so profitable!

What sort of agreements are stripping so much value away from common shareholders? I tried looking into the MD&A and AIF, but couldn’t find any relevant answers.

3. Here is the biggest issue I have with Corus – alignment of interests.

Shaw used to own 38% of the non-voting Class B shares of the company (the only shares which are publicly traded). They dumped this stake for CAD$6.80/share on May 31, 2019. However, the Shaw family trust still owns 85% of the Class A voting shares (3,412,392 shares outstanding) which means they have an economic stake in the company of 1.6% but still total control. Now that Shaw is virtually out of Corus, the incentive structure is completely mis-aligned with common shareholders. Right now the 24 cent/year dividend is the only thing they have going for it. One wonders what sort of value-stripping agreements might take place in the future (similar to my suspicions on the relatively high cash drain coming from non-controlling interests – where is this value going?).

It is one thing if the controlling shareholder has a significant economic interest in the firm they are leading (e.g. one would suspect that Genworth Financial is not going to take actions that will hurt the economics of the underlying Genworth MI entity). It is completely another thing if somebody has control but no economic interest – this sort of alignment asks for common shareholders to get the short end of the stick.

If anybody has answers on this one, or if I’m completely out to lunch, I’d like to know.