Canadian Life Companies Split Corp. has finally announced the details of its reorganization:
The purpose of the meeting is to consider and vote upon a special resolution to reorganize the Company, including a capital reorganization of the Preferred Shares of the Company and an extension of the termination date of the Company as described in the Management Information Circular. Extending the life of the Company would allow Shareholders to participate in any strengthening in the Canadian life insurance sector:
• Preferred Shareholders will receive an increased dividend and the opportunity to participate in increases in the net asset value as a result of the issuance of two classes of warrants; and
• Class A Shareholders could benefit from any market appreciation or dividend increase over the extended time period;
If the capital reorganization is approved Preferred Shareholders would receive an increased dividend payment of 6.25% per annum and the following securities for each Preferred share held on or about June 28, 2012 (the “Conversion Date”):
- One 2012 Preferred Share – paying fixed cumulative preferential monthly dividends to yield 6.25% per annum on the $10.00 nominal issue price and having a repayment objective on the termination date of $10.00;
- One 2013 Warrant – each 2013 Warrant can be exercised to purchase one 2012 Preferred Share and one Class A Share (together a “Unit”) for an exercise price of the lesser of $13.25 and 103% of the net asset value of the Company on the Conversion Date (the “2013 Warrant Subscription Price”) on any business day during the period commencing at market open (Eastern time) on the day following the Conversion Date and ending at 5:00 p.m. (Eastern time) on June 3, 2013; and
- One 2014 Warrant – each 2014 Warrant can be exercised to purchase one Unit for an exercise price of 105% of the 2013 Warrant Subscription Price on any business day during the period commencing at market open (Eastern time) on the day following the Conversion Date and ending at 5:00 p.m. (Eastern time) on June 2, 2014.
In addition, if the capital reorganization is approved, Class A Shareholders and Preferred Shareholders will be provided with a Special Retraction Right as described in the Management Information Circular which is designed to provide Shareholders with an opportunity to retract their Shares, if they so wish, and receive a retraction price that is calculated in the same way that such price would be calculated if the Company were to terminate on December 1, 2012 as originally contemplated.
A look at the Information Circular shows the motion has an excellent chance of passing:
The Company will also pay dealers whose clients hold Shares of the Company a fee of $0.05 in respect of each Preferred Share and $0.03 in respect of each Class A Share voted in favour of the matters to be considered at the Meeting, such payments to be due and owing only if the special resolution in respect of such matters is approved and implemented, and provided the Shareholder does not exercise the 2012 Special Retraction Right discussed below.
The warrants are interesting:
amend the Articles of the Company to permit the Company to create warrants (the “Warrants”) of two series, one series designated as the “2013 Warrants” and providing the holders thereof with the right to acquire one 2012 Preferred Share and one Class A Share on any business day during the period commencing at market open (Eastern time) on the day following the Conversion Date (as defined below) and ending at 5:00 p.m. (Eastern time) on June 3, 2013, for an exercise price of the lesser of $13.25 and 103% of the net asset value of the Company on the Conversion Date (the “2013 Warrant Subscription Price”), and one series designated as the “2014 Warrants” and providing the holders thereof with the right to acquire one 2012 Preferred Share and one Class A Share on any business day during the period commencing at market open (Eastern time) on the day following the Conversion Date and ending at 5:00 p.m. (Eastern time) on June 2, 2014, for an exercise price of 105% of 2013 Warrant Subscription Price, all as more particularly described herein;
The definition of the Conversion Date should be noted carefully:
On the date the capital reorganization is implemented, which if the special resolution is approved is expected to be on or about June 28, 2012 (the “Conversion Date”),
So the exercise price of the warrants will be set sometime around the end of June and will not be more than 13.25.
However, before you whip out your financial calculator and start plugging in Black-Scholes, remember that there are income effects involved. The underlying portfolio yield is about 4.50%, which currently covers only 76% of the preferred share distribution. Once the preferred dividend has been hiked, the coverage will be more like 64% of the distribution. So the drag on the NAV for the first year will be a little over twenty cents, so the exercise price should be adjusted to more like 13.45. You can put your own price on the value of that option.
If the extension of the termination date is approved, a Shareholder who retracts a Class A Share under the 2012 Special Retraction Right will receive a retraction price per Class A Share equal to the net asset value per Unit calculated on May 31, 2012, less $10.00. A Shareholder who retracts a Preferred Share under the 2012 Special Retraction Right will receive a retraction price per Preferred Share equal to the lesser of (i) $10.00 and (ii) the net asset value per Unit calculated on May 31, 2012. Shareholders wishing to take advantage of the 2012 Special Retraction Right must surrender their Shares for retraction no later than the close of business on May 17, 2012 (the “2012 Special Retraction Right Notice Date”). Payment for the Class A Shares or Preferred Shares so tendered for retraction pursuant to the 2012 Special Retraction Right will be made no later than June 19, 2012.
It’s an interesting attempt to transfer value from the Capital Unitholders to the preferred shareholders, but it should be remembered that there are a lot of warrants outstanding! Say, for instance, that the NAV in June 2013 is 14.25. The warrants are in the money, so they all get exercised. And hey, presto, that dilutes the NAV to 13.75! So the other thing option analysts should consider is that the warrants shouldn’t be treated as an entire option, but only half an option.
Credit Quality Analysis
LFE.PR.A Old and New |
| |
Extant |
Retract |
Keep |
| Template |
Start |
2002-12-8 |
| End |
2010-12-8 |
| Symbol |
xfn.to |
|
| Expected
Return |
7.00% |
Underlying
Dividend
Yield |
4.50% |
Issue
Data |
Initial NAV
2012-3-15 |
12.82 |
Pfd
Redemption
Value |
10.00 |
Pfd
Coupon |
0.525 |
0.525 |
0.625 |
| MER |
1.14% |
1.14% |
1.04% |
Cap Unit Div
Above Test |
1.20 |
Cap Unit Div
Below Test |
0.00 |
| NAV Test |
15.00 |
| Whole Unit Par Value |
25.00 |
| Months to Redemption |
8 |
2 |
80 |
| |
| Analysis |
Probability of Default |
3.33% |
0.18% |
27.85% |
| Loss Given Default |
6.55% |
2.38% |
21.93% |
| Expected Loss |
0.22% |
0.00% |
6.11% |
| |
Yields
Calculation |
Current Price |
9.77 |
| Maturity Date |
2012-12-1 |
2012-5-31 |
2018-12-1 |
| Yield to Maturity |
8.89% |
16.70% |
6.71% |
| Expected Price |
9.98 |
10.00 |
9.39 |
| Yield to Expectations |
8.60% |
16.70% |
5.95% |
All in all, this is a lot more interesting proposition than it would have appeared on the announcement date, when the most recent NAV was only 11.64 – the NAV is up more than $1 since then. There’s more asset coverage, and there’s transfer of more value from the Capital Unitholders than there was with the lower NAV, for the simple reason that they have more value to transfer. Naturally, this plan gets better and better as the NAV gets higher – but this also works in reverse!
Voting in favour of the plan is actually a way to reduce risk for preferred shareholders, since there is a Special Retraction Right:
If the extension of the termination date to December 1, 2018 is approved at the Meeting, the Company will also amend the Articles to provide Shareholders with a special retraction right (the “2012 Special Retraction Right”) which is designed to provide Shareholders with an opportunity to retract their Shares and receive a retraction price that is calculated in the same way that such price would be calculated if the Company were to terminate on December 1, 2012 as originally contemplated. Shareholders would be provided with notice of the 2012 Special Retraction Right, through the issuance of a press release and through the CDS Participant through which the Shares are held, and would have until the close of business on May 17, 2012 to provide the Company with notice if they wish to have their Shares redeemed pursuant to the 2012 Special Retraction Right.
If the extension of the termination date is approved, a Shareholder who retracts a Class A Share under the 2012 Special Retraction Right will receive a retraction price per Class A Share equal to the net asset value per Unit calculated on May 31, 2012, less $10.00.
This is a six-month shortening of term from the expected 2012-12-1 termination date.
Therefore, I recommend:
- Vote in favour of the reorganization
- Be prepared to tender for the Special Retraction in mid-May, effective May month-end, depending on the NAV in mid-May
LFE.PR.A was last mentioned on PrefBlog when I reviewed the 2011 Annual Report. LFE.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.