The Canadian Convertible Debentures Project: October 2017

Saturday, October 21, 2017

October 20, 2017, Quick Update: Peanut Convertible Debentures Power Rankings

This is the 18th update of the Peanut Convertible Debentures Power Rankings. This update is current to October 20, 2017. This is one of our quick updates, with abbreviated commentary.

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The Top-5 picks in the Power Rankings are also described with a little more detail in the corresponding section below.

For background information on the Peanut Power Rankings, please see our FAQs by clicking here.

Important: the Peanut Power Rankings are provided as information and opinions only and are not intended to be a provision of investment advice or a recommendation of any investment action in any form. As with all information concerning investments, it is highly recommended that an individual consult with a qualified investment professional before making any investment decisions.

Market Commentary - Quick Points (October 20, 2017)

Alert! The next Bank of Canada rate announcement is scheduled for Wednesday. As we've mentioned the last couple of updates, our guess is that the Bank will hold off on raising rates for now, given the uncertainty around the NAFTA trade negotiations, strength of the Canadian dollar (which is oscillating back and forth around 80 US cents), and worries about what rising rates might do heavily indebted Canadian homeowners.
Looks like the bond markets seem to be of the same mind as we are? For the week, interest rates are down across the yield curve.
For the week, the S&P/TSX was up 0.32%, the S&P 500 up 0.86%, and the NASDAQ up 0.34%. Damn the torpedoes, the equity markets keep steaming ahead in the is long-running bull market.
In the convertible debentures market, two new issues of interest - a whopping $260 million offering (including both private and public portions of the offering) from Osisko Gold Royalties, and a $50 million offering from Diversified Royalty Corporation, were announced during the week. Both made our Top-5 ... let's get to the details on these below.

Peanut Power Rankings Top-5 Convertible Debentures (October 20, 2017)

American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' Convertible Debentures. (Ticker: HOT.DB.U), (Last update's ranking: #1). Not much new to report here that we haven't already covered in the last couple of weeks. After selling off somewhat earlier in the summer, the underlying REIT units have stabilized and seem to be on the comeback trail. Acquisitive in the last couple of years, the hotel REIT's revenue mix is now approximately two-thirds from ownership of branded midmarket hotels (e.g., think brands like Hilton Garden Inn, Courtyard by Marriott, Holiday Inn, Windgate by Wyndham) in secondary US markets, and one-third from so-called rail hotels, where revenue is generated via long-term contracts with rail companies. The accommodations sector is among the most volatile of the investable real estate sectors, sensitive to economic and interest rate risks. That said, we think the REIT and this convertible debenture are good value at current trading values and management is experienced and well-regarded. Insiders are aligned with shareholders and recently bought over 225,000 units of the REIT - see press release here. The bottom line: HOT.DB.U has traded below par in the months since it hit the market. With a yield-to-hard-call-date of 5.54% and almost four years to the hard call date, we think it's great value here and the potential is there for future gains. It closed Friday at US$98.20 and we're long HOT.DB.U at US$98.00.

Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last update's ranking: #2). As above, not much new to report here either. Cargojet just keeps going about its business, doing its job (well). The air cargo carrier is estimated to have a +90% share in the overnight air cargo market, and with the secular movement towards e-commerce and online retail, the future looks outstanding. Cargojet has long-term contracts with Canada Post (Purolator Courier) and UPS, and also has a developing relationship with Amazon in Canada. The bottom line: Cargojet continues to have a dominant market position in an area of long-term, secular growth, and even at current prices, it's decent entry point for CJT.DB.C. There are still 3+ years to the hard call date and based on Friday's close of $109.02, the yield-to-hard-call-date is a positive 1.73%. We continue to really like it. We've been long CJT.DB.C since it debuted at $100.00.

Osisko Gold Royalties, 4.00% 31-December-2022, Convertible Debentures. (Presumed ticker: OR.DB), (Last update's ranking: unranked). Note: this issue is not yet trading. This whopper of a $260 million deal ($160 million offered to the public, $100 million privately placed with PSP Investments) was announced on Monday, and adds a relatively high credit quality, growth precious metals royalty company to the Canadian convertible debentures universe. This, of course, is very welcome and word on the street is that demand for the issue was at pound-the-table levels. This isn't surprising as there's lots to be positive on here. For those unfamiliar, Osisko Gold Royalties is essentially an intermediate-sized precious metals royalties and streaming company. Its impressive portfolio is anchored by a 5% net smelter return (NSR) royalty on the Canadian Malartic mine (this is the largest gold mine in Canada, and is operated by Agnico-Eagle Gold and Yamana Gold), as well as a 2.0% to 3.5% NSR royalty on the Éléonore mine (a rich Quebec mine operated by Goldcorp). In fact, the company holds, in total, over 130 royalties, streams, and precious metal offtakes, most of which are in stable North American jurisdictions. In our view, when investing in resource companies, one of our risk management prerequisites is to minimize country risk by focusing on companies (like Osisko Gold Royalties) which focus on stable jurisdictions. Finally, it's worth mentioning that the company has a superior cash flow growth profile to like precious metals royalty and streaming companies, and also holds material equity interests in other publicly traded junior resource companies under its "incubator" program. As for the convertible debenture itself, it sports a relatively low coupon rate of 4.00% (which, in our view, speaks to the credit quality of the company), a conversion price of $22.89 per share, cannot be soft called unless the underlying shares of OR are trading at 130% above the conversion price and, unlike most Canadian convertible debentures that we follow, has no hard call provision at all. The latter is of course, an advantage for investors. The bottom line: this high-quality, gold-focused convertible debentures issue is a blue-chipper convertible in our eyes, and we subscribed to the issue at $100.00. We only received a partial fill, and we will be looking to expand our position once the issue hits the market on or around November 3. We also have a position in OR common shares.

Diversified Royalty Corp, 5.25% 31-December-2022, Convertible Debentures. (Presumed ticker: DIV.DB), (Last update's ranking: unranked). Note: this issue is not yet trading. This is a fascinating little company whose stock has been on fire (i.e., up almost 50%) for the past two months. The company bills itself as "a multi-royalty corporation, engaged in the business of acquiring top-line royalties (author's note: this is the best kind, a royalty that's simply a percentage of sales) from well-managed businesses and franchisors in North America." Currently, DIV owns the Sutton Realty, Mr. Lube, and AIR MILES® trademarks in Canada. Previously, the company also owned the trademarks for the Franworks group of restaurants (which included fast casual dining chains such as Original Joe's, State & Main, and Elephant & Castle), but this was previously sold to reduce exposure to the struggling Alberta economy. The current momentum in the underlying stock price was attributable to an August 25 announcement of DIV's acquisition of the AIR MILES® royalty stream, which appears to be accretive. Furthermore, in the associated press release, it was hinted that another royalty acquisition by the end of 2017 was the company's objective. The announcement of this $50 million convertible debentures offering on Tuesday only reinforced this market view, and the stock actually rallied after the announcement. So, on the convertible debenture: it offers an attractive coupon rate of 5.25%, and the conversion price of $4.55 is about 33% above where DIV closed on Friday. The bottom line: this is an interesting royalty company which, after a long lull following its Mr. Lube acquisition and Franworks divestment, is starting to gain momentum once more. It is also noteworthy that management is highly regarded, and are aligned with shareholders through their own shareholdings. Finally, the terms of the convertible debenture seem positive and this is a decent credit risk, in our view. We did not successfully subscribe to the issue, but we are interested in acquiring one once the issue hits the market on or around November 7. We also have a position in DIV common shares.

Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #3). Not a whole lot to report on this mainstay of our Top-5. Higher interest rates, the stronger Canadian dollar and the fact that REITs and real estate operating companies have been somewhat out of favour on the TSX haven't helped Tricon in the last few months. This said, there is organic growth in the company, scale in its US single family rental portfolio, good management, a decent US-dollar denominated coupon, and a reasonable company valuation. The bottom line: there's still plenty to like here, and quite frankly, we think this current sale makes for a nice opportunity to get in if you're looking for USD-denominated convertible debenture exposure with possibility of future upside. At Friday's close of US$105.98, the yield-to-hard-call date is 3.88% and there are about 3.5 years left until the hard call date. We've been long TCN.DB.U since it debuted at US$100.00.

DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #4). Bonus coverage! Well, disappointingly, DHX has been a roller-coaster ride in the worst way, and this week was the kind of week that, um, builds character. DHX stock plumbed new lows and the bottom fell out Friday morning, prompting the market regulator to seek a statement from DHX, which in turn commented that it was not aware of any material undisclosed information relating to the company. The market seemed to be comforted by that news, and DHX's Series 'B' shares actually closed Friday at $4.52, after hitting a harrowing low of $3.81 just that morning. Hard to believe that just a month ago, this company was trading with a 7-handle at 52-week highs. Yikes. Well, as those of us who follow and invest in DHX are all too aware, this has not been a name for the meek. As the market action on DHX securities continues to gyrate, as long-term investors we choose to stick to the fundamental story: DHX has attractive media content assets, its Peanuts IP assets (Charlie Brown and Snoopy!) have cash cow characteristics, and the company is currently undergoing a strategic review and could be sold at a premium (see our update last week on our theory as to why it could sell for $9.32 a share). Yes, we will reiterate that the company is highly levered (outstanding net debt of just over $1 billion) and there are risks. However, we think its assets and potentially are worth the risk. The convertible debenture (DHX.DB) closed Friday at $96.00. At this price, DHX.DB has a yield-to-maturity of 6.60% (note: there is no hard call provision for DHX.B, which is good for investors), but the struggling underlying common shares closed Friday 77.0% away from DHX.DB's conversion price of $8.00. Recovery will probably take patience and a strong stomach, but if it happens, investors could be very handsomely rewarded. We added to our position this week, and sit with an average acquisition cost of $99.22. We also have a position in DHX's Series B common shares (ticker: DHX.B).

Picture of the Day

Like a DHX Media investor, this Madagascar Day Gecko (Phelsuma madagascariensis madagascariensis) is holding on for dear life. Botaniska Trädgården, Lund, Sweden. Copyright © 2009 Felix Choo / dingobear photography. Picture is available for licensing at Alamy Images. Photo may not be reproduced without permission.

Drop Us a Line

Thank you for reading this blog. As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com.

In addition, for media, sponsoring and/or financial institution inquiries, please email us at convertibledebs@gmail.com. Thank you for your interest!

***

Saturday, October 14, 2017

October 13, 2017, Quick Update: Peanut Convertible Debentures Power Rankings

This is the 17th update of the Peanut Convertible Debentures Power Rankings. This update is current to October 13, 2017. This is one of our quick updates, with abbreviated commentary.

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The next Bank of Canada rate announcement is scheduled for October 25. Our guess is that the Bank will hold off on raising rates for now, given the uncertainty around the NAFTA trade negotiations, strength of the Canadian dollar (now back above 80 US cents), and worries about what rising rates might do heavily indebted Canadian homeowners.
Since our last update a week ago, interest rates on the short end of the curve have increased a few basis points, while rates on the long end have decreased about a corresponding amount. All-in-all, not a whole lot of change.
For the week, the S&P/TSX was up 0.49%, the S&P 500 up 0.17%, and the NASDAQ up 0.24%. As the US markets start to slow, will Canadian markets take the baton and lead us into winter?
We have one new re-entry into our Top-5 convertible debentures in this week's update. More on the Top-5 below.

Peanut Power Rankings Top-5 Convertible Debentures (October 13, 2017)

American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' Convertible Debentures. (Ticker: HOT.DB.U), (Last update's ranking: #1). On trend, this issue has continued to slowly inch higher in recent weeks. Acquisitive in the last couple of years, the hotel REIT's revenue mix is now approximately two-thirds from ownership of branded midmarket hotels (e.g., think brands like Hilton Garden Inn, Courtyard by Marriott, Holiday Inn, Windgate by Wyndham) in secondary US markets, and one-third from so-called rail hotels, where revenue is generated via long-term contracts with rail companies. The accommodations sector is among the most volatile of the investable real estate sectors, sensitive to economic and interest rate risks. That said, we think the REIT and this convertible debenture are good value at current trading values and management is experienced and well-regarded. Insiders are aligned with shareholders and recently bought over 225,000 units of the REIT - see press release here. The bottom line: HOT.DB.U has traded below par in the months since it hit the market. With a yield-to-hard-call-date of 5.60% and almost four years to the hard call date, we think it's great value here and has good potential for future gains. It closed Friday at US$98.00 and we're long HOT.DB.U at US$98.00.

Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last update's ranking: #2). Cargojet just keeps going about its business, doing its job. The air cargo carrier is estimated to have a +90% share in the overnight air cargo market, and with the secular movement towards e-commerce and online retail, the future looks outstanding for the company. Cargojet has long-term contracts with Canada Post (Purolator Courier) and UPS, and also has a developing relationship with Amazon in Canada. The bottom line: Cargojet continues to have a dominant market position in an area of long-term, secular growth, and even at current prices, it's not a bad entry point for CJT.DB.C. There are still 3+ years to the hard call date and based on Friday's close of $110.10, the yield-to-hard-call-date is a positive 1.42%. We continue to really like this one. We've been long CJT.DB.C since it debuted at $100.00.

Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #3). Higher interest rates, the stronger Canadian dollar and the fact that REITs and real estate operating companies have been somewhat out of favour on the TSX haven't helped Tricon in the last few months. This said, there is organic growth in the company, scale in its US single family rental portfolio, good management, a decent US-dollar denominated coupon, and a reasonable company valuation. The bottom line: there's still lots to like here, and quite frankly, we think this current sale makes for a nice opportunity to get in if you're looking for USD-denominated convertible debenture exposure with possibility of future upside. At Friday's close of US$106.10, the yield-to-hard-call date is 3.85% and there are about 3.5 years left until the hard call date. We've been long TCN.DB.U since it debuted at US$100.00.

DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Ticker: DHX.DB), (Previous ranking: #5). The news flow just keeps coming with this one; whether you're hot or cold on the name, I think we all agree this has been the most exciting convertible debenture on our board as of late. On Thursday, DHX announced through a press release that the company had signed a large-volume content deal for 13 DHX Media kids’ shows (including Bob the Builder, Fireman Sam, Caillou, Johnny Test, Yo Gabba Gabba!, classic Inspector Gadget and In the Night Garden) with Amazon Prime Video for its global subscription-video-on-demand (SVOD) service. Financial terms were not disclosed, but it was noted that the agreement was the the largest between the two companies to date, covering more than 200 countries and territories and 15 languages. The market reacted moderately positively on the news, while also balancing out the disappointment of a terrible fiscal Q4 and the ongoing strategic review of the company, which could result in an outright sale. On the latter, we had mentioned in an October 5 special update that we thought that a sale could fetch between $8 and $10 per share, and we've gotten questions as to how we came to that conclusion. In short, management guided fiscal 2018 EBITDA to a range of $125 to $155 million (see DHX's quarterly earnings presentation slides for this information). Notwithstanding whether you believe in management after its last quarterly miss, if you assign a 10x EBITDA multiple on $125 million (the low end of the guided range), you get a valuation of $9.32 per share. Yes, it's true that the DHX had levered up to buy Peanuts and Strawberry Shortcake (outstanding net debt is just over $1 billion), but we don't expect debt service to be a problem. Peanuts has cash cow attributes, and management guided fiscal 2018 free cash flow to a range of $50 million to $70 million, which should provide opportunities to de-lever (though granted, maybe not as quickly as the market would prefer). The bottom line: certainly there are a lot of moving parts, and there's risk. That said, DHX's media content assets have value, as Thursday's Amazon deal demonstrates. The company just needs to execute, and it's our feeling that the market isn't yet taking into account the prospects of Peanuts and Strawberry Shortcake. At Friday's close of $98.63, DHX.DB has a yield-to-maturity of 6.12% (note: there is no hard call provision for DHX.B, which is a bonus for investors) and the underlying common shares closed Friday 63.6% away from DHX.DB's conversion price of $8.00. Recovery will probably take patience and a strong stomach, but if it happens, investors could be very handsomely rewarded. We're long DHX.DB at $101.00 and are looking to add more at these levels. We also have a position in DHX's Series B common shares (ticker: DHX.B).

Liquor Stores, 4.70% 31-January-2022, Series 'B' Convertible Debentures. (Ticker: LIQ.DB.B), (Last week's ranking: #6). And this issue is back in our Top-5. After dissidents won a proxy fight with the previous board of directors back in June, the new board and management have been pretty quiet. That is, up until Friday, when it was announced that the embattled Alberta-based liquor retailer was considering the sale of its Kentucky-based liquor stores. If the sale goes through, it's probably a good move. The Kentucky stores never really performed to expectations, and I always thought it was a bit of a curious strategic fit. The shares of LIQ spiked briefly on Friday on the news, before settling back down. The bottom line: under previous management, the company had been kind of wandering the desert for a long time, not really creating shareholder value. The jury is still out on the new board and management, but there is potential for a rebound, and LIQ.DB.B is a way to play this. At Friday's close of $100.50, the yield-to-hard call is 4.53% and there's still 3+ years out to the hard call date. The underlying common shares closed Friday 49.4% away from LIQ.DB.B's conversion price of $14.60. In time, it may get back to those lofty levels if the company regains its focus and the Alberta economy recovers. We had sold our previous position in LIQ.DB.B and do not currently have a position at this time.

Picture of the Day

This is what an American red squirrel (Tamiasciurus hudsonicus) looks like when he sneezes! Whitemud Nature Reserve, Edmonton, Alberta. Copyright © 2014 Felix Choo / dingobear photography. Photo may not be reproduced without permission.

Drop Us a Line

Thank you for reading this blog. As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com.

In addition, for media, sponsoring and/or financial institution inquiries, please email us at convertibledebs@gmail.com. Thank you for your interest!

***

Monday, October 9, 2017

October 6, 2017, Update: Peanut Convertible Debentures Power Rankings

Happy Canadian Thanksgiving! This is the 16th update of the Peanut Convertible Debentures Power Rankings. This update is current to October 6, 2017.

For a summary of the rankings of our entire convertible debenture coverage universe including the quantitative model prices of, and notes on each issue we follow, click on the table below to view it larger.

The Bank of Canada has raised its benchmark target overnight rate twice in 2017, and the market is closely watching whether a third is on the way during the Bank's next rate announcement, currently scheduled for October 25.
Our guess is that the Bank will hold off this time around. The Canadian dollar remains elevated (just below 80 US cents as at the time of writing), the future of trade with our biggest trading partner remains an open question given the policy positions of the new US administration, and we suspect there are worries what a third rate increase in rapid succession might do to heavily-indebted Canadian homeowners on variable-rate mortgages.
Since our last update, North American equity markets have continued to move higher, with the S&P/TSX up 1.77%, S&P 500 up 1.87%, and NASDAQ up 2.52%. In Canada, the trusty big banks have led the rally.
The Canadian convertible debentures market continue to truck along. Big news for us here at the Canadian Convertible Debentures Project, the DHX Media 5.875% Convertible Debentures (ticker: DHX.DB) we've had ranked in the Top-5 all summer (finally) hit the market October 2, unfortunately on the heels of some pretty poor earnings. We wrote up a special update on October 5; DHX.DB remains in our Top-5 at #5. More on the Top-5 below.

Peanut Power Rankings Top-5 Convertible Debentures (October 6, 2017)

American Hotel Income Properties REIT LP, 5.00% 30-June-2022, Series 'U' Convertible Debentures. (Ticker: HOT.DB.U), (Last update's ranking: #1). This issue has been trading stronger in recent weeks, no doubt helped by the slowing surge of a previously runaway Canadian dollar. Acquisitive in the last couple of years, the hotel REIT's revenue mix is now approximately two-thirds from branded midmarket hotels in secondary US markets, and one-third from so-called rail hotels, where revenue is generated via long-term contracts with rail companies. The accommodations sector is among the most volatile of the investable real estate sectors, with economic and interest rate risks. That said, we think the REIT and this convertible debenture are trading rather cheaply, and management is considered top-notch. Insiders have also put their money where their mouth is and have recently bought units of the REIT. (See September press release here). The bottom line: HOT.DB.U has traded below par in the months since it debuted. With a yield-to-hard-call-date of 5.75% and almost four years to hard call date, we think it's a bargain and it's at #1 for the second update in a row. It closed Friday at US$97.50 and we're long HOT.DB.U at US$98.00.

Cargojet, 4.65% 31-December-2021, Series 'C' Convertible Debentures. (Ticker: CJT.DB.C), (Last update's ranking: #4). Cargojet just keeps quietly executing. The air cargo carrier is estimated to have a +90% share in the overnight air cargo market, and with growing movement towards e-commerce and online retail, the future looks friendly. Cargojet has long-term contracts with Canada Post (Purolator Courier) and UPS, and also has a developing relationship with Amazon in Canada. The bottom line: Cargojet continues to have a superb market position in an area of long-term, secular growth, and even at current prices, it's not a bad entry point for CJT.DB.C. There are still 3+ years to the hard call date and based on Friday's close of $111.25, the yield-to-hard-call-date is 1.10%. We really like this one. We've been long CJT.DB.C since it debuted at $100.00.

Tricon Capital, 5.75% 31-March-2022, Series 'U' Extendible US Dollar Convertible Debentures. (Ticker: TCN.DB.U), (Previous ranking: #2). Higher interest rates, the stronger Canadian dollar and the fact that REITs and real estate operating companies have been somewhat out of favour on the TSX haven't helped Tricon in the last few months. This said, there is organic growth in the company, scale in its US single family rental portfolio, good management, a decent US-dollar denominated coupon, and a reasonable company valuation. The bottom line: there's still lots to like here, and quite frankly, we think this current sale is nice opportunity to get in if you're looking for USD-denominated convertible debenture exposure with possibility of future upside. At Friday's close of US$106.51, the yield-to-hard-call date is 3.74% and there is about 3.5 years left until the hard call date. We've been long TCN.DB.U since it debuted at US$100.00.

Innergex Renewable Energy, 4.25% 15-August-2020, Series 'A' Convertible Debentures. (Ticker: INE.DB.A), (Last week's ranking: #5). Innergex isn't necessarily a fast grower, but as a renewable energy producer, it is a solid company in an industry that has good prospects for the future. The bottom line: at Friday's close of $108.00, INE.DB.A has a yield-to-hard-call date of 0.04% and is just under 2 years to hard call. Importantly, INE is trading only 2.2% away from INE.DB.A being in the money. We're long INE.DB.A at $102.75.

DHX Media, 5.875% 30-September-2024, Convertible Debentures. (Presumed ticker: DHX.DB), (Previous ranking: #3). Ok, lots has happened with this one in the last little while. Please read our special update on DHX Media, which was published on this blog on October 5. Given the poor price action of DHX's common shares since its disastrous Q4 earnings, it's likely a bit controversial we still have DHX.DB in our top-5, but we continue to believe the IP assets are unique and hold considerable revenue-generating potential, and that the company remains an acquisition target for a larger media company hungry for DHX's content portfolio. Quite frankly, this is a tricky company to value, and the market doesn't quite seem know how to do it. If the strategic review nets a buyer, we're guessing that the company gets sold in the $8 to $10 range. Just a wild guess. The bottom line: it's not without risk, but DHX.DB is an alternative way to play DHX's unique media content proposition. At Friday's close of $99.25, DHX.DB has a yield-to-maturity of 6.01% (note: there is no hard call provision for DHX.B) and the underlying common shares closed Friday 65.6% away from DHX.DB's conversion price. Recovery may take awhile, but if it happens, investors may be handsomely rewarded. This said, there are risks and this doesn't appear to be a play for the meek. We've initiated a position in DHX.DB at $101.00, and we also have a position (ouch) in DHX's Series B common shares (ticker: DHX.B).

Picture of the Day

Peafowl in fall. Beacon Hill Park, Victoria, British Columbia. Copyright © 2015 Felix Choo / dingobear photography. Photo is available for licensing at Alamy Images. All rights reserved. Photo may not be reproduced without permission.

Drop Us a Line

Thank you for reading this blog. As always, if you have any comments or questions about convertible debentures or this blog, please leave us a comment at the bottom of the page or email us at convertibledebs@gmail.com.

In addition, for media, sponsoring and / or financial institution inquiries, please email us at convertibledebs@gmail.com.

***

Thursday, October 5, 2017

Special Update: DHX Media 5.875% Convertible Debentures (DHX.DB)

Here at the Canadian Convertible Debentures Project, we've been writing about DHX Media's 5.875% convertible debentures since May 19. This was about a week after the Halifax-based children's media content and brands company announced the US$345 million acquisition of the entertainment division of Iconix Brand Group Inc., which effectively brought an 80% interest in Peanuts (i.e. Charlie Brown and Snoopy) and 100% of Strawberry Shortcake under DHX's control.

From the beginning, we thought the deal was transformative. As such, the 5.875% convertible debenture issue associated with the acquisition has been highly anticipated, and if you've been a regular reader of this blog (sidebar: we thank you for your loyalty!), you know that the issue has been consistently featured in the Top-5 of our Peanut Convertible Debenture Power Rankings throughout the summer. Well, it's been a long wait, but the issue has finally started trading on the TSX, hitting the market on October 2 with the ticker of DHX.DB.

In our last update, which was current to September 22, we ranked the DHX 5.875% convertible debenture at #3 in our coverage universe. However, in the relatively short period of time between the the update and today, a surprising amount has happened with DHX, all of which has an impact on the convertible debenture issue. Consider:

First, on September 19, DHX's common voting shares (ticker: DHX.B) hit a 52-week high of $7.33. Presumably, shares of DHX.B had been trading higher in anticipation of good earnings and lofty expectations for Peanuts and Strawberry Shortcake.
Unfortunately, on September 27, DHX released its financial results for their 2017 fiscal fourth quarter and year and, to be blunt, the results were terrible. Full-year revenue declined slightly from $304.8 million in FY2016 to $298.7 million in FY2017, and EBITDA missed expectations by a country mile, tumbling from $103.7 million to $87.3 million. However, the company did increase its dividend to 2 cents per quarter.
On September 28, analyst downgrades and price target slashes ensued. DHX.B got crushed in trading, and at one point the shares traded at a 52-week low price of $4.75. DHX.B had essentially taken a complete 180-degree turn from the week prior.
At market open on October 2, the 5.875% convertible debenture (DHX.DB) was made available for trading on the TSX. So far, liquidity for the issue has been quite decent, which is allays our previous fears that liquidity for the issue might be limited.
At 2:18pm (EST) on October 2, all exchange-listed securities of DHX were halted from trading. At 2:45pm, it was announced via press release that the company had initiated a strategic review to "evaluate potential strategic alternatives focused on maximizing shareholder value. These alternatives could include, among other things, the sale of part or all of [DHX], a sale of some of the assets of [DHX], a merger or other business combination with another party, or other strategic transactions."

This is a lot to digest. Obviously, the market clearly views DHX as a "show me" story, and the market appears skeptical of the company as the common shares (DHX.B) closed today at $5.00 a share. Here are our thoughts on the situation and the 5.875% convertible debenture:

The earnings news had me feeling a little bit like Charlie Brown after Lucy pulled away the football. It was a big miss, and management copped to it. The company has been very acquisitive in recent years, and the results (which, importantly did not include Peanuts or Strawberry Shortcake, as that deal closed on June 30, the last day of DHX's fiscal year) raised questions on management's ability to execute on its suite of brands and assets.
This said, we maintain that Peanuts (and to a lesser extent, Strawberry Shortcake) are transformative assets, from which material licensing revenues and cash flow can be derived.
The open question is whether management can execute efficiently on the integration of Peanuts and Strawberry Shortcake. The market currently seems to lack confidence in management, and is also concerned about the amount of leverage in the company.
Notwithstanding the aforementioned strategic review, assuming the company continues with its business with current assets intact, it will need to wring out the synergies it previously promised in conjunction with the Peanuts acquisition and rapidly pay down debt. If it can succeed on doing this, the underlying common shares of DHX should rebound nicely.
Announcement of the strategic review this soon after the Peanuts acquisition was surprising. On the upside, a sale of the company could fetch a premium given the space the company operates in. There is a definite demand for the type of children's media content that DHX can deliver, and there should be several potential suitors (e.g., Bell, Rogers, Shaw, Disney, Netflix). DHX has significant institutional shareholder ownership, and may have been nudged into conducting this review.
There are varying estimates as to what DHX would fetch in sale if it were sold today. Canaccord Genuity indicated that a sale could be as high as $8.55 per share. A Globe and Mail article quoted figures between $5.50 and $8.50 a share. For what it's worth, we would ballpark a sale price in the $8 to $10 range given DHX's unique stable of assets, but this is just our (very) rough estimate.
The strategic review throws a bit of a monkey wrench for investors in the 5.875% convertible debenture. According to the indenture for the convertible debenture, in a change of control situation, the convertible debenture is redeemable at par ($100.00) plus accrued interest. As such, if DHX is sold for an amount that is less than the debenture conversion price of $8.00, there could be some downside risk for a debenture-holder that purchased his or her position at a premium to par.
We've run the numbers through our quantitative model for the convertible debenture and, current to today, October 5, we get a theoretical model price for DHX.DB of $110.18. In review, DHX.DB closed today at $100.00 even, the annual coupon is 5.875%, the issue has superior redemption options (from the perspective of an investor) when compared to the standard Canadian convertible debenture issue, the conversion price is $8.00 a share, and the DHX.B common shares closed at $5.00 a share. As such, DHX.B needs to move up 60% from current levels to hit the conversion price of the debentures.
In spite of DHX's difficult fiscal 2017, we still maintain that DHX has one-of-a-kind media content assets, and that Peanuts is a once-in-a-generation asset. As such, we think there is significant value to be unlocked in both the common shares and the convertible debentures despite the risks. In the past, after its acquisition of Cookie Jar Entertainment (i.e., Caillou), DHX management successfully de-levered the balance sheet so there is precedent for this type of execution in the company.

Bottom line: in crisis, there's opportunity. We've initiated a position in DHX.DB at $101.00, and also retain a long position in the common shares (DHX.B).

As always, remember this blog is for information only. Please remember to consult a professional investment advisor before making any investment decisions.

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