Holloway Lodging REIT

Forgive my sarcasm, but my favourite nearly insolvent REIT, Holloway Lodging REIT (TSX: HLR.UN) announced their latest quarterly results. They weren’t that bad relative to the previous year, but the company has a huge debt anchor around its throat while it is being asked to swim across the Pacific Ocean.

More specifically, in order to pay off an earlier debenture, the company through a related entity, borrowed money at double-digit rates of interest and continues to have about $12M outstanding at this time through that loan. There is another debenture maturing in less than 8 months worth approximately $50M face value that they admitted they won’t be able to pay off when it becomes due.

The likely scenario is that they will be doing a debt-for-equity swap. However, there is a game of “chicken” being played – there could also be a chance that the controlling shareholder would float another bridge loan to the company and pay off the debenture to avoid massive dilution – similar to what happened with the first debenture.

This is the only reason why I can think that the debenture has a bid at 50 cents on the dollar. Even with this debt anchor removed, the underlying operations are not all that profitable – most of the profit is being sucked off by the controlling shareholder through related entities.

Yellow divests a business

I don’t have enough time to fully write about it, but here are some low quality notes for Yellow Media (TSX: YLO).

Yellow Media announced they are divesting their LesPAC Inc. business unit for $72.5 million in cash. The company basically operated a craigslist-type pour les Quebecois, pardon my mauvais Français! The company generated $12.7M in revenues for the 2010 fiscal year, so on first glance, a sale at 5.71 times revenues seems good. It would probably be a more depressing figure how much they spent to build the service, so it wouldn’t surprise me in the least that with the disposition of that business there would be another chunk of goodwill and intangibles off the balance sheet if they did have to purchase some technology in order to build the site.

Now if they can just sell the rest of their business at 5.71 times revenues, then they won’t have much of a debt problem anymore. Equity holders will get $15/share and everybody will be happy. Don’t hold your breath.

That said, $72.5 million is not an inconsiderable chunk of change and increase the chances the company will be able to chip away at its credit facility due February 2013. Preferred shares C and D are trading a shade lower, yielding 38% at the bid, while debentures are trading a shade higher on reaction to this news at roughly 29 cents on the dollar. The market continues to be deeply skeptical on the ability of YLO to pay back its debt and obviously this depends on whether the “transformation to digital” will be a profitable one or not.

Slight tightening of mortgage credit

I notice that the local credit union, which used to offer prime minus 0.9% (equating to 2.1%) floating rate is now at prime minus 0.3% (2.7%).

The only conclusion that one can make is that retail credit is somewhat tightening and/or banks are getting concerned about their leverage linked to the real estate market. You wouldn’t see this in government debt rates – 1 year treasuries in Canada yield 0.90%. Five-year government bonds yield 1.35% and the best five-year mortgage rate you can find in Canada is about 3.19%.

Given the difference between the two (prime minus 0.3% versus 3.19% fixed), combined with the (albeit unlikely) potential for an interest rate spike would suggest that paying the half-percent spread for a five-year lock would be well-spent insurance money.

That said, anything around the 3% range is historically very, very, very low and would explain the high prices in the real estate market.

Petrobakken Q3-2011: Still burning cash

One anonymous bullish person on Petrobakken (TSX: PBN) posted the following comment upon the release of PBN’s third quarter report:

The only thing you can say about PBN’s results is: outstanding.

This was a big time turn-around from 2Q spring breakup.

They are already at 47,500 per day and expect to exit 2011 at over 49,000 per day (49k was their previous year end exit number, so this is a production beat and raise). BMO’s analyst was at 39k. How wrong he is.

Assuming a go-forward production rate of approximately 49,000 boepd (87% oil weighted), the estimated discretionary cash flow would be approximately $905 million in 2012, assuming US$90 WTI, foreign exchange of 0.975, AECO CDN$3.50 and a 5% differential. A $10 change in oil = $100MM change in cash flow.

Analysts are expecting this year’s $900MM capital program to be repeated next year… Management gave hints it might be much less (perhaps ~$500MM). This which would mean FCF could be $400MM or more. So much for their balance sheet problems.

Their covenants are easily being met.

Looks like the cross-over point when cash flow will meet spending needs + dividends will be sometime in 2012 (based on $90 oil and reasonable production growth).

Three wells have been drilled in the new plays and they aren’t saying much. That is a good sign.

@Kevin @Sacha – you still have time to reverse course. I would suggest it’s much better to focus on this deep value opportunity than Yellow Media or BAC. Poor souls.

I’m not sure whether we were reading the same quarterly report or not. Average bopde for the first 9 months of the fiscal year is down 8% from 2010 to 2011 (page 10); the emphasis on “estimated” or “current” production is relatively meaningless unless if such production can be sustained – and if so, at what capital cost? Reading the report, Q4’s capex is going to be yet again over operating cash flow.

Average WTIC in CDN$ was up 16% on average from 2010 to 2011, which is a boost to the company’s results – there is no doubt whatsoever that high oil prices will assist Petrobakken, along with any other crude production company. Despite the production drop, this price gain in WTIC increased the revenue intake. Indeed, crude price rises will be their only real way for salvation – if they experience drops in crude pricing, it will be financially very damaging below a certain point.

Now it could be the case that Israel does an air strike on Iran and crude oil spikes – getting lucky with Deus Ex Machina is one way of realizing investment gains.

Cash outflow (primarily through capital expenditures) was about $106M over operational cash flows – add another $45M in dividends out the door in the quarter means the company digs another $151M deeper into its bank facility – they will be forced to slow down capital expenditures as they are running up against their bank credit line and also have to face the issue with the put they sold on their US$750M debenture issue (February 2013). When the capital expenditure spigot stops – how quickly will that production fade? We’ll find out pretty soon.

No positions in PBN, nor will I be creating any.

Yellow Media – Q3-2011 Results

There is a reason why Yellow Media (TSX: YLO) is trading at 30-some odd cents per share, and the preferred shares are trading at 40% yields: it isn’t entirely clear whether the company will make it out of the doldrums or not.

The last quarterly report was not a home run, nor was it a strike-out; instead, it is a continuation of the fine line between the company going broke or the company making it.

Cash flow continues to be relatively poor, especially with the addition of income taxes after the trust conversion. The only solace there is that the federal corporate rate drops from 16.5% to 15% in 2012. Normally companies trading this low usually don’t have taxes as a problem (since they are typically not making money) but in this case, the federal-provincial tax bite becomes material since debt has to be paid off with after-tax dollars.

The tax tidbit that are sending analysts into negative mode again is that their estimate is their tax cash outflow of $250M in 2012 based off of a 27% tax rate; 2012 is a double taxation year because they will have to pay in installments for two years worth of taxes; if you do the simple division by two and divide by 0.27, that gives you an estimated pre-tax income of about $463M. At a 27% rate, that is about $338M after tax.

The company has the following debt maturity schedule:

February 18, 2013: $266M + $35M Credit Facility / CP
July 10, 2013: $130M MTN maturity
December 3, 2013: $125M MTN maturity
April 21, 2014: $254.7M MTN maturity
Feburary 2, 2015: $138M MTN maturity
February 15, 2016: $319.9M MTN maturity

The company has $52M cash currently. Assuming they have zero access to the credit market for the next couple years, they will need to generate roughly $50M in free cash flow each quarter, which is a tall order given their declining revenue base. That said, if they can actually stabilize their cash situation, they will likely be able to get an extension to their facility and figure out a way how to re-finance their MTN maturities. It will not be an easy climb up from the abyss, however.

My quick guess is that an easy $10.7M annual after-tax cash flow will be saved by converting the Series 1 preferred shares (TSX: YLO.PR.A) into equity as soon as possible. My other guess, and this one is not a guarantee by any stretch, is that they will opt to convert their Series 2 (TSX: YLO.PR.B) preferred share series as quickly as possible to save another $7.6M/year of after-tax cash flow. This then leaves the question whether the company is going to suspend preferred dividends entirely, and if they do, then Series 2 will not be converted, at least not until 2017. This is why the preferred shares are trading as low as they are – the company can pull the plug on the dividends. They will likely make this decision after the first quarter of 2012, depending on results. Series 3 and 5 of the preferred shares (TSX: YLO.PR.C and YLO.PR.D) both add up to about $22.2M/year in dividends.

Yellow Media should survive operationally, but the question at this point is whether they will survive financially. Who will reap the rewards of the cash flow of this over-leveraged entity? Certainly not common shareholders at this point, but right now the marginal question is whether the preferred shareholders will come out of this looking like geniuses or will they be burnt as well? This is increasingly looking like a binary situation, with either the preferred shareholders going to zero (in a recapitalization), or seeing the company slowly trudge their way back up to credit-worthy status over the process of a few years. The big hurdle is 2013.