PrefBlog

Barry Critchley was kind enough to quote me in his piece TransAlta cancels a planned preferred share swap because of investor push back:

“It is a good day for shareholders. We don’t always do what the banks tell us to do,” said James Hymas, portfolio manager at Hymas Investment Management and the publisher of the PrefBlog. CIBC World Markets was TransAlta’s financial adviser while PWC provided a fairness opinion.

When TransAlta announced the plan in late December, Hymas said on the blog: “This is a rotten deal for the preferred shareholders, so rotten that we may call it a sleazy attempt by the company to pull the wool over the eyes of unsophisticated retail investors.”

Reached Friday, Hymas reiterated that it “was a bad deal. I suspect the early returns by shareholders combined with comments made to their investor relations department convinced them that it was not going to pass. Rather than be embarrassed, my guess is that they decided to cancel the deal.”

Hymas offered TransAlta, whose common share holders received a major dividend cut one year back, some advice: Get to work on improving the credit rating and spend less time on financial engineering. Last March DBRS changed the trends of all TransAlta’s long-term debt ratings – as well as on its preferred share ratings – to negative from stable.

There are also some amusing quotes from a portfolio manager who liked the deal so much, he’s willing to hide under his bed with the light turned off and say so anonymously:

The manager had little time for the view that holders were being “compromised” because they were not being offered full value, or $25 per share.

“That’s a fiction. They are perpetual securities and worth what they are worth. It’s not like a piece of debt where eventually they owe you the principal,” he added.

I hadn’t actually heard anybody say the holders were being compromised because they were not being offered full value. Perhaps the fact that all this guy has is a straw-man argument explains his anonymity..

This follows previous posts on this topic:

• TA Proposes Sleazy Exchange Offer
• TransAlta plays the Grinch with its preferred share holders
• TransAlta Nudges TA.PR.D Offer; Hopes To Pay Sleaze Fees To Banks
• TransAlta pref shareholders not happy with consolidation plan
• TransAlta Corp takes to the airwaves to spread the advantages of its pref share consolidation
• TA Withdraws Plan of Arrangement

Affected issues are TA.PR.D, TA.PR.E, TA.PR.F, TA.PR.H and TA.PR.J.

This note is a little stale by now, but Barry Critchley was kind enough to quote me in his piece TransAlta Corp takes to the airwaves to spread the advantages of its pref share consolidation, published on January 24:

Some financial advisers, and at least one portfolio manager, argue the higher yield and better terms aren’t enough to make up for the potential capital loss investors are being asked to take.

James Hymas, portfolio manager at Hymas Investment Counsel said, “that’s the crux of the issue. The reduction in the effective redemption price (from $25), is an incredibly major change, an incredibly valuable feature to be given up, and TransAlta is not even close to matching that value on the income side.”

It was also interesting to read:

[TransAlta CFO Donald] Tremblay noted that the preferreds par value of $25 “is theoretical in the sense that prior to the announcement of the transaction these shares were trading at or below $0.50 on the dollar; Management would never have utilized the call option on the Preferred Shares,” he said.

This is disingenuous: it is remoteness of the potential call that makes the extant preferreds so valuable. Potential calls are always harmful to the investor!

This follows previous posts on this topic:

• TA Proposes Sleazy Exchange Offer
• TransAlta plays the Grinch with its preferred share holders
• TransAlta Nudges TA.PR.D Offer; Hopes To Pay Sleaze Fees To Banks
• TransAlta pref shareholders not happy with consolidation plan

Affected issues are TA.PR.D, TA.PR.E, TA.PR.F, TA.PR.H and TA.PR.J.

Barry Critchley was kind enough to quote me in his piece TransAlta pref shareholders not happy with consolidation plan:

Others disagree. For instance, James Hymas, a portfolio manager at Hymas Investment Counsel and the publisher of Prefblog, called it “an appalling, abusive offer. TransAlta’s extant preferred shares are trading well below their call price, which gives them a lot of room to make impressive capital gains should market conditions improve.” In Hymas’s view, the plan “effectively lowers the redemption price of the preferred shares outstanding, which will allow any such gains to be scooped up by the company instead of its preferred shareholders.”

This week, Hymas weighed in again. In an interview he said the “amount of extra income being offered is not just minimal but will disappear completely on reset with only a modest rise in government of Canada five year rates.” Accordingly if five year Canada bonds rise “significantly, the extant issues will pay more than the (proposed) new issue.”

Hymas also was critical of the process that will see those members of the soliciting group collect $0.13 per share per favorable vote — but nothing in the event the vote is unfavorable. The large difference in payments, “really makes me think they understand very well how cruddy their offer is.”

This follows previous posts on this topic:

• TA Proposes Sleazy Exchange Offer
• TransAlta plays the Grinch with its preferred share holders
• TransAlta Nudges TA.PR.D Offer; Hopes To Pay Sleaze Fees To Banks

Affected issues are TA.PR.D, TA.PR.E, TA.PR.F, TA.PR.H and TA.PR.J.

Barry Critchley was kind enough to quote me in his piece titled The not-so-pleasant choices faced by RONA’s preferred shareholders. First he gives some space to an argument I don’t understand:

According to some holders, agreeing to that low price would set a bad precedent given that there are a slew of rate-reset prefs which are trading at a substantial discount to their purchase price. If one issuer gets away with such a deal, others will follow suit.

Accordingly, it is not in the interests of pref share holders, who put up $25 when the issue came to market in the expectation they would get $25 of value when the time rolled around for the rates to be reset, to encourage such behaviour. So Lowe’s bid $20 – which represented a premium to the recent trading price but a total acquisition savings of $34.5 million – knowing that if it’s rejected it will be required to remain a reporting issuer.

I don’t get it. It’s a vote. You can vote yes or you can vote no. One likes to imagine that good proposals will succeed and bad proposals will fail. The above argument is equivalent to saying that you have to vote Conservative in the Federal election, because if you vote Liberal this time you’ll have to vote Liberal every time. It makes no sense.

But after that, it’s my turn:

James Hymas, of Hymas Investment Management, has a different take, arguing RONA pref shareholders could tender and redeploy the proceeds in other rate reset prefs that generate about the same cash flow.

Hymas, who does not own RONA preferreds either personally or through the funds he manages, argues that if the $20 a share offer is turned down, the price of the RONA prefs will fall below $20. In other words: make the trade.

For more detail regarding my views, see RON.PR.A Vote: Yes or No?.

Mr. Critchley also commented on the Stirling Funds joke:

Numerous attempts have been made to reach Stirling and its Swedish-based advisor ÖstVäst Advisory to find out its next steps. The first call elicited the response that it had received numerous responses from holders. Since then nothing.

He also pointed out one little nugget of information:

But there may be another twist given that as of the end of 2015, Fidelity Investments owned more than 10 per cent of the issue — more than three times what it owned at the end of the first quarter of 2015. We couldn’t reach Fidelity for a comment.

Well done Fidelity! That’s a trade that has worked out very nicely indeed!

Lowe’s Companies, Inc. and RONA Inc. have announced:

that they have entered into a definitive agreement under which Lowe’s is expected to acquire all of the issued and outstanding common shares of RONA for C$24 per share in cash, and all of the issued and outstanding preferred shares of RONA for C$20 per share in cash. The total transaction value is C$3.2 billion (US$2.3 billion) (the “Transaction”). The offer represents a premium of 104 percent to RONA’s closing common share price on February 2, 2016 and a 38 percent premium to RONA’s 52-week high of C$17.36. Together, Lowe’s Canada and RONA stores will create Canada’s leading home improvement retailer with 2015 pro forma revenues from Canadian operations of approximately C$5.6 billion. Excluding transaction and integration costs, we anticipate the Transaction will be accretive to Lowe’s earnings in the first year following the close of the acquisition.

The Transaction has been unanimously approved by the Boards of Directors of Lowe’s and RONA and is supported by the management teams of both companies. The Transaction is expected to proceed by way of a plan of arrangement by which Lowe’s would acquire all of the outstanding shares of RONA, subject to RONA common shareholder approval and satisfaction of customary conditions, including the receipt of all necessary regulatory approvals. The RONA Board has received an opinion from Scotia Capital Inc. that the consideration to be received by RONA’s common and preferred shareholders pursuant to the Transaction is fair, from a financial point of view.

The RONA Board will recommend that RONA shareholders vote in favor of the plan of arrangement at a special meeting of shareholders expected to be held before the end of the first quarter of 2016. Further information regarding the Transaction will be included in RONA’s information circular to be mailed to RONA shareholders in advance of the special meeting. The arrangement agreement provides that RONA is subject to customary non-solicitation provisions.

$20 is quite the premium over yesterday’s closing quote of 12.41-05!

The consensus is that the deal will succeed – f’rinstance, Frederic Tomesco of Bloomberg:

The fact both boards agreed to the C$3.2 billion ($2.3 billion) offer, along with Lowe’s commitment to preserve head-office jobs and maintain supply agreements, will likely seal the deal. Political conditions in Canada’s second-most populous province also favor the acquisition after helping to scupper a hostile offer in 2012.

Rona’s biggest shareholder, the provincial pension fund manager Caisse de Dépôt et Placement du Québec, said Wednesday it would tender its shares to the offer. Quebec’s new economy minister indicated the government probably wouldn’t stand in the way of a deal.

“If three of the groups that were against Lowe’s last time — the board, the government and the Caisse — are saying it’s a good idea, it would be hard to see it not get the green light,” Karl Moore, a management professor at McGill University’s Desautels Faculty of Management in Montreal, said in a telephone interview. “There’ll be some squawking for sure, but that’s predictable. The opposition has to be against this deal in principle.”

Matthew Townsend and Scott Deveau of Bloomberg point out that the plunging loonie helped a lot:

The Canadian dollar’s loss is Lowe’s gain.

After being rebuffed in its attempt to buy Quebec-based retailer Rona Inc. in 2012, Lowe’s Cos. reached agreement on Wednesday to buy it for C$3.2 billion ($2.3 billion). Two big changes in the past four years made the transaction possible: The Parti Quebecois, which opposed the original deal, is out of power, and the loonie fell to its lowest level against the dollar in more than a decade.
…
Lowe’s withdrew the $1.8 billion unsolicited bid for Rona in 2012 after the board and some Quebec politicians opposed the offer, concerned about a loss of jobs and local control in the French-speaking province. The withdrawal came just 12 days after the separatist Parti Quebecois won elections.

Since then, the Liberals have taken power in Quebec, and the loonie has dropped to 72 cents versus the U.S. dollar, compared with parity when Lowe’s pulled its bid, making it cheaper for Lowe’s to offer a richer premium. So while the C$24 a share bid in Canadian dollar terms is about 65 percent higher than the C$14.50 a share bid that was rejected, in U.S. dollar terms the offer is just 16 percent higher.

Click for Big

… and Bloomberg’s Brooke Sutherland suggests it’s all about footprint:

Focusing on Canada may be a distraction, but it’s a distraction that could pay off for Lowe’s. While the home-improvement company has benefited from a rebounding real estate market, the maturing U.S. retail landscape and the rise of online shopping puts a cap on the growth opportunities for big-box vendors. Many are shuttering stores, or at least slowing down expansion.

Lowe’s, for example, had 1,793 U.S. locations as of January 2015 — a gain of about 76 from a year earlier, much of which could be explained by the acquisition of Orchard Supply Hardware. The way to keep growing its store base is to make more acquisitions and push harder into adjacent markets such as Canada, where Home Depot currently has almost five times as many locations as Lowe’s. With Canada’s home improvement industry valued at C$45 billion, Lowe’s can’t really afford to sit on the sidelines.

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John Heinzl was kind enough to quote me when discussing the preferred share part of the deal:

Rona Inc.’s battered preferred-share investors may not be getting as fat a premium as common shareholders in the $3.2-billion takeover by Lowe’s Cos. Inc., but they should be thrilled with what they’re being offered, money managers say.

As part of the deal, the U.S. home-improvements chain is offering $20 for each Class A rate-reset preferred share of Quebec-based Rona. The offer, which is based on a fairness opinion from Scotia Capital, represents a 59-per-cent premium to the closing price of Rona’s preferred shares before the deal was announced.
…
Some Rona preferred shareholders said it’s possible Lowe’s might make a higher offer for the preferreds. “Perhaps they could be persuaded to offer more money. Perhaps. I’m not banking on it but not discounting it either,” said Benj Gallander, co-editor of Contra the Heard Investment Letter. “These are early days.”

Don’t hold your breath, said preferred-share fund manager James Hymas, president of Hymas Investment Management. Rona’s preferred shareholders don’t have the leverage to squeeze more money out of Lowe’s, he said.

“They can always try, but I don’t know how far they’ll get,” said Mr. Hymas, who does not own Rona’s preferred shares.
…
After all the suffering Rona’s preferred investors have endured, they should be happy that Lowe’s is willing to take them out at $20, Mr. Hymas said.

“You don’t want to kill the goose that lays the golden egg,” he said. “They’re not going to sweeten that deal. There is no reason to.”

I base this view on the fact that during the conference call the following statements were made:

what’s important to understand that a positive vote from the pref holders is not a condition precedent to the closing of the transaction.
…
If you don’t have a majority acceptance from the prefs, does RONA continue to report its financial results? … Yes. So the entity would need to continue to report as a public listed entity. Yes.

So a negative vote from RONA preferred shareholders will mean just that the shares will continue to be outstanding. Since RON.PR.A is a FixedReset, 5.25%+265, that commenced trading 2011-2-22 after being announced 2011-2-1, it has a relatively low reset. Absurdly low for junk, albeit more reasonable for investment grade. Investment-grade issues with comparable resets are:

• MFC.PR.J, +261, bid at 17.89
• RY.PR.M, +262, bid at 18.45
• TD.PF.D, +279, bid at 19.00
• SLF.PR.I, +273, bid at 17.45
• BAM.PF.B, +263, bid at 16.46
• BMO.PR.Y, +271, bid at 19.35

So it’s a decent premium over fair value even given an upgrade in credit quality. I’ll suggest that Lowe’s takes the view that they’re willing to give that premium to the preferred shareholders if they’re co-operative, or give it to the lawyers, bookkeepers, auditors and accountants if that’s what the preferred shareholders decide they want. Since the takeover deal is not conditional on preferred shareholder approval they’ve got no reason to pay an extortionate premium for the prefs.

And yes, the credit quality will almost certainly go up if the deal is approved. DBRS confirmed Lowe’s at A(low):

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Debt rating of Lowe’s Companies, Inc. (Lowe’s or the Company) at A (low) as well as its Short-Term Rating at R-1 (low), all with Stable trends. This action follows the Company’s announcement that it has entered into a definitive agreement under which Lowe’s is expected to acquire all issued and outstanding common shares of RONA inc. (RONA) for CAD 24 per share in cash and all issued and outstanding preferred shares of RONA for CAD 20 per share in cash. The total transaction value including the assumption of RONA’s debt is CAD 3.2 billion ($2.3 billion; the Transaction or Acquisition).
…
Despite the risks associated with the effective integration of RONA, DBRS believes that the relatively modest magnitude of the Transaction and the temporary increase in financial leverage keep Lowe’s credit risk profile in a range acceptable for the current rating category. Should Lowe’s be challenged to maintain credit metrics in a range acceptable for the current A (low) rating because of weaker-than-expected consolidated operating performance or more aggressive-than-expected financial management (i.e., slower deleveraging), the current ratings could be pressured.

…. while putting RONA on Review-Positive:

DBRS Limited (DBRS) has today placed the ratings of RONA inc. (RONA or the Company) Under Review with Positive Implications following the Company’s announcement that it has entered into a definitive agreement under which RONA will be acquired by Lowe’s Companies, Inc. (Lowe’s; please see separate DBRS press release) for a total transaction value of $3.2 billion (the Transaction). The total transaction value comprises Lowe’s offer to acquire RONA’s issued and outstanding common shares for $24 per share in cash as well as its issued and outstanding preferred shares for $20 per share, plus RONA’s outstanding debt.
…
Rona’s Under Review – Positive Implications status reflects Lowe’s current ratings (A (low) and R-1 (low) as rated by DBRS), the intention to purchase RONA’s outstanding preferred shares and the assumption of RONA’s outstanding senior unsecured debt. As of September 27, 2015, RONA had approximately $313 million of senior unsecured debt outstanding, consisting of $116 million of senior unsecured debentures and $197 million drawn on its revolving credit facility (maximum limit of $700 million). DBRS notes that the Company’s senior unsecured debentures will mature in October 2016.

S&P has also taken a positive view regarding RONA’s ratings:

• •Home improvement retailers Lowe’s Cos. Inc. and RONA Inc. announced today that they have entered into a definitive agreement under which Lowe’s is expected to acquire RONA for about C$3.2 billion
• •As a result, we are placing our ratings on RONA Inc., including our ‘BB+ long-term corporate credit rating on the company, on CreditWatch with positive implications.
• •We intend to resolve the CreditWatch placement on the acquisition’s closing, which we expect by the third quarter of 2016. At that time, we would likely equalize our long-term corporate credit rating on RONA with that on Lowe’s.

…
The CreditWatch placement follows Lowe’s Cos. Inc.’s and RONA Inc.’s announcement that they have entered into a definitive agreement under which Lowe’s is expected to acquire RONA for about C$3.2 billion. As part of the transaction, we expect Lowe’s to purchase all of the issued and outstanding preferred shares of RONA for C$20 per share in cash and assume its C$116.6 million of unsecured notes that mature in 2016.

“The positive CreditWatch placement reflects our view of the potential uplift for RONA creditors from the possible acquisition of the company by the higher-rated Lowe’s,” said Standard & Poor’s credit analyst Alessio Di Francesco.

So, assuming the common shareholders vote in favour of the deal, holders of RON.PR.A will wind up in one of two positions:

• Owning a perfectly normal investment-grade preferred share trading somewhere around $17-$19, or
• Getting $20 cash.

I’d rather take the cash and deploy it into something else! However, a formal recommendation will have to await receipt of the management information circular.

At today’s closing bid of 19.95, RON.PR.A yields 4.22% to perpetuity.

Update, 2016-3-3: RONA has filed the Management Proxy Circular with respect to the two offers.

Niall McGee of the Globe was kind enough to quote me in his piece Daily Deals: Dundee sweetens preferreds offer and Canaccord hires bankers:

“Since launching our initial proposal, we have learned who our larger holders are and have sought input from a broader group in coming to our revised proposal,” David Goodman, chief executive officer of Dundee, said in an e-mail.

“We listened to the position of others and responded with a proposal that we believe is in everyone’s best interest.”
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Preferred share fund manager James Hymas, president of Hymas Investment Management Inc., who didn’t care for the original offer, doesn’t like the revised offer much either – calling it “abusive” in a published note on his website, partly because of the omission of a “special retraction right” that allows shareholders to cash out under the original terms.

“Virtually every preferred share term extension voted on by shareholders provides for a special retraction right,” Mr. Hymas wrote.

“No such provision implies that the company is afraid of a mass retraction, which indicates that the company knows its offer is no good.”

Barry Critchley of the Financial Post has declared victory:

The people have spoken and the people, in this case holders of Series 4 preferred shares issued by Dundee Corp. who responded negatively to an initial proposal, have emerged victorious.

But they only won because Dundee listened and changed a plan that seemed destined to be shot down at a meeting originally scheduled for Jan. 7. Put it down as a victory for shareholders and common sense, a victory reflected by the market’s reaction: the prefs shares closed at $16.60 Thursday, up 15 per cent on the news.

“We have consulted and we responded with what we think is a win-win solution,” said David Goodman, chief executive of Dundee.

And I’ll also quote Sacha Peter of the Divestor blog. I don’t normally quote blog posts by those who are not market professionals … but Mr. Peter uses his own name, is a professional in another field [and therefore has something to lose if he says something stupid] and, most importantly, says nice things about me, so why not? His post is titled Dundee Corporation – DC.PR.C – Series 4 Preferred Shares – Amended Exchange Offer:

My own quick summary is: the deal stinks less compared to the original offer, but it still stinks.
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By far and away the most important provision is the removal of the $0.223/share consent payment. This consent payment introduced the concept of a prisoner’s dilemma where if you believe the deal was going to pass, you would be incentivized to vote in favour of the deal despite how bad it was.

Without a prisoner’s dilemma, there is no incentive to voting yes for a marginal or mildly adverse offering (which was the only way the previous offering had any chance of passing).

This deal still stinks, but the removal of the $0.223/share carrot will remove votes in favour because (and this is my personal speculation) most of the shareholders are angling for the June 30, 2016 redemption.
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Using Black-Scholes valuation (which is not the best way to value long-dated options, but is good enough for paper napkin purposes such as this post) we get an option value of $1.84/share, or about 46 cents per preferred share (as each share would receive a quarter warrant).

Using some more formal methods involves different results – if you are that bullish on Dundee’s common stock, why bother playing around with the preferred shares when you can simply buy the common shares or even the other preferred shares?
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Preferred shareholders have an even easier decision this time around – vote against the offer. It is still terrible compared to the existing Series 4 preferred shares.

Today’s closing price of 16.60 allows us to estimate the packages total yield, ignoring the warrant value.

But, as stated in the title of the table, this analysis is wrong. Portfolio Yield is not the mean average of the yield of the individual securities, although it is usually presented this way as being close enough. In this particular case, the total portfolio cash flows are simple enough that we can calculate the Portfolio Yield from first principles, thus:

So that’s a bit of a difference, eh? An xlsx spreadsheet for the calculation is available: DCPRC_YieldAnalysis_160107 [Revised – see comments] and varying the price as it might be today allows us to construct the following chart:

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So, from looking at this, and making a ballpark allowance for the value of the warrants which I don’t want and are only offered to provide a little bit of flim-flam for advisors eager to collect their unconscionable proxy-solicitation fees, I’d say that the coupon needs to be 10% or so for the package to trade at par, based on today’s market reaction [in which 67,625 shares traded, mostly at a very steady price of 16.60 and a VWAP of 16.55. This was good volume and a steady price!].

So, I will reiterate my previous recommendation, with a slight alteration to the desired coupon:

I recommend holders of DC.PR.C vote No to the deal and, as before, seriously consider exercising right of dissent. What we want is:

• A Special Retraction Right allowing holders to cash out in June on the original terms [which may involve being paid in discounted DC.A shares]
• an offered dividend rate that allows a reasonable prospect of the issue trading near par; at the moment, I estimate this at about 13% 11% to 12%
• a commitment from the company to maintain a credit rating from two major agencies until the retraction date of the issue