Tag: GFL

Featured on the Globe and Mail – reflections on dealing with short selling reports

I’d like to thank Larry MacDonald for mentioning me on his regular article on the Globe and Mail about short selling on the TSX.

A hedge-fund analyst once sold short a company in which Sacha Peter had invested. Then he published a critique on it.

Did Mr. Peter, author of the Divestor blog, rush to his keyboard to click on the sell button, or log into online forums to urge a squeeze on the short seller? Not at all.

Instead, he rolled up his sleeves and dived into the critique. After reading it, the shares remained in his portfolio and were later unloaded at a profit.

It may not always turn out as well as it did for Mr. Peter, but there is something to be said for monitoring the trades of short sellers to see if any are targeting a stock you hold. As Mr. Peter says, “I very much like reading the short-sale cases of anything I hold. It forces me to check my analysis.”

Larry was referencing my post back in April 2018, The case to short Genworth MI, where a very intelligent young analyst won an accolade for writing a fairly comprehensive short report on Genworth MI.

Keep in mind there is no “one size fits all” strategy concerning how one deals with new information that comes with people or institutions issuing short selling reports on your holdings. Everything depends on your ability to perceive fact from fiction, and perhaps more maddeningly, perceive the market’s sense of reality versus fiction that they bake into the stock price.

I’ll also talk about a time where I got things less correct.

Go read my August 2020 post on what happened when a short selling firm released a report on GFL Environmental. I had taken a small position on one of their hybrid securities (effectively yield-bearing preferred equity with equity price exposure above and below a certain GFL price range) and then a short sale report came out. I bailed very quickly. Retrospect has shown that wasn’t a good decision financially (right now GFLU is about 70% above what I sold it for including dividends), but one of the reasons for bailing was because I was not nearly as comfortable with my level of knowledge about the company than I was about Genworth MI. Another reason is that there were still very active market reverberations going on during COVID-19 so there were plenty of alternate investment candidates for my capital. I’d also like to give a hat tip to Jason Senensky of Chapter 12 Capital for his comment that has stuck in my mind ever since, which is his insightful analysis that my “return on brain damage is too low” – which indeed is an accurate reflection that my mental bandwidth on such cases is better spent elsewhere.

And while I’m on this topic, Jason also wrote a fantastic article on the near-demise of Home Capital Group, instigated by a high profile short seller. Hindsight is 20/20, but I feel like there was a missed opportunity on that one – I should have taken the cue after they announced they obtained their ultra-expensive secured line of credit facility (it marked the bottom of their share price).

GFL Environmental year-end

No positions after the Spruce Point debacle, but reviewing the year-end GFL Environmental (TSX: GFL) statements, they are still a huge train wreck.

Income statement, with some colour commentary:

The gross margins are exceedingly thin (and indeed in the last quarter, negative). We can’t make money per unit of revenue, so we’ll make it up on volume!

The balance sheet tells more of a story:

From the end of 2019 to 2020, the company:

Raised $4.1 billion in equity financing (and another slab of money in “Tangible Equity Units” which trade as GFLU; these will be converted to equity).
They also were able to pay down a net of $1.46 billion in debt with the above line.

However, on the outflows we have the following:

Cash: negative $550 million
PP&E, intangibles, goodwill: $3.8 billion net

So about $4.3-$4.4 billion out the windows in a year. These were to complete the WMI acquisitions. This is a lot of money out the door. I’m also ignoring the $1 billion or so in the increase of the deficit, which I’ll very generously dismiss and chalk up to one-time contract adjustments, foreign currency translation, and operational issues. Presumably the prior expenditures went for the purpose of building a return on equity it would be a good expenditure of capital.

Management claims guidance for an “Adjusted Free Cash Flow $465 million to $495 million” for 2021 and an “Adjusted EBITDA $1,340 million to $1,380 million”.

The question for an investor is whether they can produce an un-adjusted free cash flow, full stop. The historical financial statements are at complete odds with what management is saying. It doesn’t mean they won’t be able to produce positive financial results in 2021 and beyond.

I truly don’t know.

They still appear to have a very good ability to raise capital. On December 2020, they closed another US$750 million financing of senior secured notes at a 3.5% coupon, good until 2028, and also sliced another 50bps off their $1.3 billion credit facility. Their common stock is also near their all-time highs, about CAD$38/share.

Again, I’ll just leave this one up to smarter people than myself to evaluate, but this is one fascinating case study.

GFL Financial Scandal – or what to do if a short selling firm reports on one of your holdings

Thanks to Etienne and another that was kind enough to email me, Spruce Point Capital wrote a hit piece against GFL Environmental (TSX: GFL / NYSE: GFL, GFLU).

The allegations can be summarized as shady people, shady accounting, shady history, shady operations and shady associations. Apparently being associated with the late Toronto Mayor Rob Ford (infamous for being busted in his term in office for doing cocaine) is also is grounds for financial excommunication.

Do I believe the report? Not in its entirety. Do I dismiss the report? Not in its entirety.

The investment thesis for GFL has always been on whether they possess an ability to process acquisitions and make them more profitable. Even at the IPO their financials were a train wreck to go through, although you could see how it could be done to yield a decent amount of free cash flow, in line with major competitors (Waste Management / Waste Connections / Republic / etc.).

The report does present evidence that there have been exaggerations/creative interpretation by management, in addition to many acquisitions in the past that appeared to deliver sub-par results that were disappeared 1984-style.

One of the great things about being a small-time investor is that you can get in and out of positions (in most cases) by clicking a button. Shortly after the peak of the Covid crisis, I took a minuscule position in GFLU which I offloaded today.

Just imagine if you were an institution and have 50 million shares of this thing and the 180 day lock-up expiry doesn’t happen until August 31. Or if you were one of the purchasers of the US$750 secured bond financing, getting a paltry 3.75% for 5 years on an investment that doesn’t seem so secure anymore. Egg on your face as an institutional manager!

It actually doesn’t matter for me whether this report is true or not, simply because the thesis of any future investment in this company has changed. It is now a thesis on whether the evidence laid out in this report or not is factual enough to sink confidence in the company enough that it won’t be able to raise further financing. On balance, I deeply suspect it will survive and just like a lot of these short seller reports, they turn the most tenuous of connections into big news, just like a political “guilt by association” hit piece.

However, to deal with this in the future takes mental space that I can ill afford with a portfolio that is spread out with more individual holdings than I have ever had in my financial history. This quarterly cycle of 10-Qs and conference call transcripts just slammed me. I just do not have the mental capacity to follow the inevitable gyrations that will be occurring as institutional holders try to confirm or refute the GFL allegations in the upcoming weeks and months. Too many eyeballs are going to be looking at this, and my eyeballs aren’t going to have a competitive advantage of any worthy note. So I’m out, taken it off my watchlists, and focusing elsewhere.

This is also why I don’t get involved in any other financial scandal stocks (e.g. Herbalife), although I must say the Home Capital Group (TSX: HCG) fiasco in 2017 was most fascinating. There’s just too much attention and too many people, some a lot smarter and most of them better resourced than I, looking at these situations.

There is a valuation claim that I was suspecting from the very beginning that if GFL does have their crap together that they can head up to the CAD$50 range, but clearly that’s now going to turn into a “show me” with regards to their mammoth acquisitions they have recently made. This will take a lot of time (at least 18 months), and once the IPO lock-up period expires, there’s going to be a lot of gyration in the shareholder base. One tailwind for the company will be the inevitable inclusion in the TSX indexes (with a decent shot to get into the TSX 60 if it appreciates from here on in) which will cause its own momentum. We will see, and for those that are sticking around, I wish them the best of luck.

GFL Environmental Units

(Please note I wrote this a couple days ago when prices were different but didn’t get to hitting the ‘publish’ button until now)

GFL (TSX: GFL, also NYSE: GFL) is the fourth largest North American solid waste (garbage) collection companies, behind (Waste Management, WM; Republic Services, RSG; Waste Connections, WCN). GFL vomited out its IPO after a couple false starts in early March, just before the CoronaPanic really reared its ugliest days.

(GFL Prospectus from IPO)

If there is one guarantee on this planet, it is that waste collection will continue to be a viable business that can attract customers, and also be inflation-adjusted. There will be competitive cyclicalities that will cause margin compression, but the field also contains geographical barriers to entry that also will protect said margins, in addition to having captive customers (who the heck doesn’t produce waste?).

Financially, they have been operating as a roll-up operation; there is a lot of goodwill and intangibles on their balance sheet to reflect this history of acquisition (well beyond the equity line on the balance sheet). Patrick Dovigi is the founding CEO (from 2007) and retains a 3.7% economic stake and 27.7% voting stake in the company after the IPO – he’s also still very young – at the age of 40, he is still managing the empire.

At the beginning of March they went public at US$19/share, and the proceeds were primarily to reduce debt. They had a lot of it – about $7.7 billion, but this will be reduced to around $4.4 billion after the offering.

Financially, the operation makes money, especially when using the somewhat flawed EBITDA metric (approximately $800 million in 2019), but the “I” and “DA” amounts are significant – the company’s financial leverage was high, and garbage collection is intense on capital expenditures. They have been growing at such a large rate that they got overextended, and hence were forced to vomit this public offering out. They are going to enter a stage where they will become more efficient, and that should justify metrics that are closer to their counterparts (the companies listed in the first paragraph on this post).

(Prospectus for Tangible Equity Units)

They also sold “Tangible Equity Units” which trade as GFLU, which consist of 2.6316 shares of GFL plus US$8.5143 of a subordinated note. The units will be converted into shares on March 15, 2023 or earlier under some circumstances. The shares given will also be reduced to 2.193 if the shares of GFL trade above US$22.80, and it is a sliding scale between US$19 to US$22.80 (note that this represents US$50 of equity per unit). The subordinated note component has interest of 4%, and is amortized over a three year period with quarterly payments (consisting of roughly US$0.75/quarter per unit).

GFL currently trades at US$14/share and GFLU trades at US$41, or about a US$4.35/share above its immediate value and $17.51 if you assume full realization of US$50 of equity (which is currently worth US$36.84 at a US$14 equity price). Considering this as a hybrid instrument, you get a clean amount of upside for the first 36% of equity appreciation, and then this is effectively subject to a sold call option, until a further 20% appreciation from the US$19 par value.

An interesting hybrid instrument that I have taken a tiny stakes in, and no more.