Category Archives: Deeply discounted rights issues

Prime Office AG (DE000PRME020) – Strange rights issue

I have linked to the “special situation” stock Prime Office already in the past. The story in short:

Oaktree has effectively taken over a struggling German Office Reit by contributing a portfolio of office assets of their own. They then changed the status from REIT to “normal” company. In order to reduce the debt level, they started a rights issue a few days ago.

However this rights issue has a strange twist: Although the subscription rights are already traded (ISIN DE000PRME1B7), they did not publish the subscription price of the new shares yet.

Just as a reminder, let’s look how the value of a subscription right is calculated (from Stockopedia)

The calculated value of a subscription right. The theoretical value of a right during the cum rights period – which is the interval after the announcement of the rights offering but before the stock trades on an ex-rights basis – is calculated by the formula:

(Stock Price – Rights subscription price per share) / # of rights required to buy one share + 1

What we do know is that there will be 8 new shares for 23 old shares, that they are offering (up to) 46.58829 mn shares and that they want to raise 130 mn EUR. So one could calculate a theoretical subsrciption price of (130/46.59) = 2.70 and a value of the subscription right at the time of writing of (2.81-2.70)/(23/8+1)= 0.0283 EUR which is silghly lower than the traded prcie of 0.031 EUR per right.

But what I am asking myself is the following: Why did they do this in such a strange way ? Why didn’t they fix the price in the beginning as in very rights issue I have seen up to now ? I have no idea but I will watch that one closely.

Portugal Telecom & OI merger – another PIIGS stock transformation ?

It seems like that many PIIGS companies with significant international business operations try to transform their companies in some way or another in order to get rid of the “PIIGS” discount. Basically a first mover was Hellenic Botteling, which delisted in Greece and relisted as Swiss based company in the UK market in 2012. A second, very succesful attempt was made by Autogrill, spinning off the international business.

Now, a few days ago, Portugal Telecom (PTC), the Portuguese TelCo with a large Brazilian subsidiary, came up with a potential new way:

They want to merge with the Brazilian TelCo OI and effectively become a Brazilian Telecom company with a Portuguese subsidiary.

This alone is in my opinion already an interesting special situation. But it gets even more interesting. The structure of the merger is quite complicated, but in general, there will be a merger plus capital increase.

For Portugal Telecom shareholders, it looks like the following:

Each Oi common share will be exchanged for 1 share in CorpCo, and each Oi preferred share will be swapped for 0.9211 CorpCo stock. Each Portugal Telecom share will be the equivalent of 2.2911 euros in CorpCo shares to be issued at the price of the capital hike, plus 0.6330 CorpCo shares.

So on a first look, this looks interesting for Portugal Telecom shareholders. The lower the price of the capital increase, the higher the share in the combined company. Clever Hedge funds might even be able to construct a short OI long PTC trade. Although there is a corridor where either PTC or OI can step back from the transaction if prices would move too strongly in one or the other direction.

Some figures / ratios:

PTC:
Market cap 3.1 bn EUR
P/E 7.4
P/B 1.5
EV/EBITDA 5.5

OI:
Market Cap 6.5 bn BRL (~2.1 bn EUR)
P/E 11
P/B 0.6
EV/EBITDA 4.5

Both companies carry significant debt.

The share prices of both companies reacted at first positively, but in the recent days, OI shares dropped quite significantly and PTC is back to where it was before (after hitting +30% in the first day):

This might be the reaction to the large cash capital increase undertaken by OI in the course of the deal:

As part of the merger, Oi proposes to undertake a cash capital increase of a minimum of R$ 7.0 billion (Euro 2.3 billion), and with a target of R$ 8.0 billion (Euro 2.7 billion) to improve the balance sheet flexibility of CorpCo. Shareholders of Telemar Participações S.A. (“Tpart”) and an investment vehicle managed by Banco BTG Pactual S.A. (“BTG Pactual”), will subscribe approximately R$ 2.0 billion (Euro 0.7 billion) of the cash capital increase

So from an OI shareholder point of view, one could argue that this exercise is somehow quite dilutive.

For some PTC shareholders, the problem might be that the suddenly do not hold a Portuguese/European stock but a Brazilian one. According to the official announcement, the new stock will be listed in Brazil, US and on NYSE Euronext, so technically it should be not a problem for shareholders.

On the “plus side” for this transaction one could argue with the following points

+ A Portuguese company with a potential “PIIGS” discount will be “transformed” into a potential BRIC growth story.
+ The valuation of the overall group might improve as well, as the OI pref shares will cease to exist
+ As PTC shareholder, there is an additional opportunity with regard to the OI share capital increase. The lower the price for the new shares, the higher will be the percentage in the new company
+ it is very likely that the deal will go through. The CEO of both companies is the same guy and regulators will have no reason to object
+ part of the synergies (i.e. lower refinancing costs) might be relatively easy to achieve.

On the other hand, there are also some clear issues:

– Brazil itself is not in the “sweet spot” anymore
– OI itself is struggling. Being only the number 4 mobile operator, especially ROA and ROE is far below the competition
– in the presentation, the CEO committed to pay 500 mn BRL p.a. in dividends. Including the new shares, this will result in a much lower dividend yield going forward from the current 7-8%. As they want to grow, this makes sense, but for some investors this could be an issue
– debt will be relatively high, further capital increase in combination with acquisitions are not unlikely

At the moment, I need to dig a little bit more deeply into this, but in order to keep me motivated and interested, I take a 0.5 % position at current prices (3.40 EUR per share) in Portugal Telecom for my “special situation” bucket.

DISCLAIMER: As always, do your own research. This is not meant to be any kind of investment advise. When publishing this, the author will most likely own the stock already. Do not blindly follow any tips etc. Use your own brain. The author will also most likely sell the stock before posting this on his website.

Short cuts: IVG, KPN, ThyssenKrupp

IVG

Friday night or Saturday is always a good time for another “breaking” news item about the IVG restructuring. This time they came out with an outline of the restructuring plan.

As expected, equity and hybrid capital are effectively wiped out. What I found highly surprising however is this part:

Further, it is, inter alia, envisaged that SynLoan I and the convertible bond will both be transferred to the company by way of a contribution in kind with 100% of their respective face amounts (so-called debt-to-equity swap), which would lead to a quota-ratio of these two creditor groups’ share in the stated share capital of 80% (SynLoan I) to 20% (convertible bond).

This is a great surprise that although collateralized, the Syn loan I is treated “pari passu” with the convertible. I do not fully understand this, but maybe the collateralization has happened to late (and too close to potential bankruptcy) and would have been invalid in case of bankruptcy. This explains the price jump in the convertible this morning I guess.

As usual in such cases, I am surprised that the equity is still valued at 35 mn EUR.

KPN

Interesting development at KPN: After KPN decided to sell its German Eplus subsidiary, Carlos Slim canceled the “stand still” agreement and is now bidding for KPN. I think this will be interesting to watch, as KPN surely doesn’t want to be acquired. I am pretty sure, they will come up with some defences like poison pills etc. Nevertheless I clearly sold out too early . I think I underestimated the “calros Slim” angle here.

ThyssenKrupp

ThyssenKrupp might be an interestign “special situation in the making”. Last week, Berthold Beitz, the 99 year old industrialist who efefctively controlled ThyssenKrupp via the Krupp foundation, passed away. Rumours about an accelerated capital increase are emerging.

It is interesting to see in the shareholder structure that a lot of German inevstors got out (Deka, Union) and Anglos Saxon investors got in in the last few months. This could become really interesting.

Quick update KPN – Sold rights & stock

Today I sold, both the KPN Shares and the rights .

All in all, I got around 2,91 EUR (1.68 for the shares, 1.23 EUR for the rights) which results in a gain of ~ 11.5% before trading cost. Quite a nice outperformance against the AEX with ~ 3.5% in the same time period.

Nevertheless, this was clearly a “bumpy ride” as the chart for the rights shows:

The optimal timing would have been to buy on the second day of the trading period. I guess this was the result of the very short time period between announcement of the terms and the start of trading.

I heard that for instance US investors were completely taken by suprise and couldn’t actively trade the rights.

Main reason for selling was that I was not sure if I want to exercise the rights and I have some other, in my opinion better ideas in the pipeline. Also I am not really optimistic about KPN in the long term.

In general, those “deeply discounted rights issues” are interesting special situations for a short term trade but have to be handled with a lot of care and patience …

Edit:
Someone asked me why I don’t show annualized returns for my single portfolio stocks. In my opinion, annualized returns for single stocks are pretty meaningless. The KPN Trade would have been an annualised 280% but what does such a number say ? As my investment strategy includes a lot of “sleeping” stocks, I think that showing annualized returns on single stock level do not provide any benefit at least not for me. Much more interesting than an annualized return per stock is the potential gap between the current price and intrinsic value.

How to raise capital – Deutsche Bank edition

In a surprise move, yesterday after the close of the stock market, Deutsche Bank announced that the increase their capital by ~2.8 bn.

For this they used the possibility of selling up to 10% of new shares without granting rights to the old shareholders.

So this would be the perfect case for the “formula” I mentioned yesterday:

Equilibrium Price = (price pre-cap raising announcement x # shares + price cap raising x # shares) / total # shares

The closing price of Deutsch Bank was 33.60 EUR. The price for the new shares 32.90 EUR. Outstanding shares were 929 mn, new shares 90 mn.

So the “Equilibrium Price” should have been:

(33.60 * 929 + 32.90 * 90)/ 1019 = 33.53 EUR per share.

Reality check: The stock actually opened around 33.50 but is now up +7.5% at ~35.40 EUR.

Learning experience:

The stock market is full of surprises. For some reason, the capital market considers it as extremely positive that Deutsche Bank increases its share count by 10%. I don’t know why.

And: Don’t rely on formulas…….

KPN rights issue: Final terms

I have covered KPN as a potential “deeply discounted risghts issue” special situation in the past.

Today, KPN announced the final terms for their rights issue (bold marks mine):

2 for 1 rights issue of 2,838,732,182 new ordinary shares at an issue price of EUR 1.06 for each ordinary share
• Issue price represents a 35.1% discount to the theoretical ex-rights price, based on the closing price of KPN’s ordinary shares on NYSE Euronext in Amsterdam at 24 April 2013
AMX has committed to subscribe for the Rights pro rata to its current participation in the issued share capital (excluding treasury shares) of 29.77%
Record Date for Offering is set at 25 April 2013 at 5.40 pm CET
Exercise Period runs from 9.00 am CET on 26 April 2013 until 3.00 pm CET on 14 May 2013• Rump Offering (if any) is expected to take place on 15 May 2013

What I find very remarkable is that there is only a very short time period between announcement of the terms and the start of the trading of the rights. Basically they announced today and trading starts tomorrow.

For the portfolio, I will start with a 1% investment as a rather “short term” special situation based on current prices of around 2.61 EUR per share. Lets wait and see how that one works out.

Severfield-Rowen – Follow up deeply discounted rights issue

A few days ago, I mentioned UK based Severfield Rowen as a potential interesting “deeply discounted rights issue” special situation.

Problem is that I don’t know much about the company. So the problem is always: How do you start looking at a new company ?

That’s when I remembered a very good post of Geoff Gannnon a few days ago:

:
I recently mentioned something in an email that I’m not sure I’ve said before on this blog. I always read the newest and oldest 10-K for a company when I start analyzing it. Reading the oldest 10-K gives you perspective.

I have to confess that normally I would start with the latest report and then work my way back, but the approach of Geoff really makes a lot of intuitive sense to me. So why not try with Severfield-Rowen ?.

The oldest annual report to be found on S-R homepage is the one from 2000.

So let’s compare some key figures from 2000 against 2011:

The difference couldn’t be bigger. In 1999/2000 we have a completely unlevered company with OK margins but very nice ROE/ROCE because of a quite efficient capital/sales ratio.

The 2011 company however looks very different. Sales have doubled, but lower margins, significant goodwill and debt including a growing pension liability reduce ROE/ROCE into low single digits.

So what happened in between ? Well of course, acquisitions:

2005: Acquisition of Atlas Ward, however this looked like rather a small fish at a bargain price

But then the big bummer:

2007: Acquisition of Fisher Engineering for a whopping 90 mn GBP

Fisher Engineering seemed to have been a Northern Ireland based company at least, the seemed to have paid partly in new shares according to this article:

Severfield-Rowen has agreed to buy AML for a total consideration of approximately £90m, of which £36.6m will be satisfied by the issue of 1,750,000 new shares at approximately 2,089 pence each with the balance in cash.

The rational given now f course sounds like a big joke, but at that time Ireland was still “hot” (for another 6 months or so:

The Fisher acquisition will extend Severfield-Rowen’s leading market position in the UK and give Severfield-Rowen a stronger presence in the growing Irish steel fabrication market.

In 2010 finally, they started a JV in India, but more on that later.

SO let’s look at 2006 vs. 2007 :

We can see in 2006 a very very healthy company with lots of net cash on the balance sheet, no goodwill nothing. In 2007, profits still went up but didn’t really compensate for the increased invested capital.

Interestingly, 2008 and 2009 were quire ok, however in 2010 S-R was hit by the “Wile E. Coyote” moment:

I spare myself the details, but i think this table is quite telling:

2007 2008 2009 2010
United Kingdom 289.6 314.6 325.4 260.5
Republic of Ireland and mainland Europe 8.9 79.5 23.2 3.6
Other countries 0.9 2 0.8 2.5

The access to the “Fast growing Irish market” for which they paid 90 mn GBP in 2007 had completely “vaporized” in 2010. I have to confess that this seems to be one of the worst timed acquisitions I have seen in my life.

interestingly enough, the still carry proudly the whole acquisition goodwill on their balance sheet. I wonder how the auditors sign this on a subsidiary without sales ?

The rights issue

Propectuses for rights issues are a very good ssource of information, the one from S-r is no exception.

Especially the following paragraph makes clear, how severe the problems are:

Severfield-Rowen will be in breach of one or more covenants under the Existing Facilities on 18 March 2013, being the date of the General Meeting. A breach of any one of such covenants would be an event of default under the Existing Facilities entitling the Group’s lenders to demand immediate repayment of all outstanding amounts and cancel the facilities. As at 14 February 2013 the Group had net financial indebtedness of £44.0 million. In the event that Shareholders’ do not vote in favour of the Resolution and the Group’s lenders demanded repayment of all outstanding amounts and cancelled the Existing Facilities on 18 March 2013, the Group would have insufficient funds to repay the amounts outstanding. The Group would then immediately need to find alternative sources of funds to replace the funds that would have been made available pursuant to the Rights Issue and the Revised Facilities. The actions that the Group would then seek to take to make up the shortfall in its funding requirements (which the Directors believe would need to be pursued simultaneously and immediately), include seeking to negotiate a new facility agreement with its lenders; seeking to obtain a sufficient amount of alternative funding from other sources; seeking to dispose of some or all of its assets or businesses; and/or seeking to find a purchaser of the entire Group. The Directors are not confident that any of the above actions will be achievable. In the event that the alternative courses of action set out above fail, the Group
ultimately may have to cease trading at that time. As a result, Shareholders could lose their investment in the Company.

So it is pretty clear: A failure to get the rights issue approved will lead to a direct insolvency of the company.

Quick valuation exercise

We have seen that the business of S-R is clearly very cyclical. At the moment, the UK and S-R are clearly at a low part of the cycle. Also, years like 2006 and 2007 will not be repeated any time soon.

Over the full 1999-2012 cycle, S-R has an average net margin of 3.7%. The exactly same average is the result of the “Normal” years, taking out 2007-2009 and 2012.

So if S-R gets back to ~300 mn GBP sales, that could result in 11.1 mn GBP normalized earnings. After the capital increase,S-R will have 290 mn shares outstanding. This results ~ 3.7 cents normalized earnings per share or a “fair value per share” after the capital increase of around 37 pence.

In order to make this interesting, the price should be definitely cheaper than that, so I would only buy below 25 pence or so.

Stock price

The rights have been split of on Tue, March 19th. The stocks are trading now around 0,37 GBP

Summary:

Looking at Severfiled-Rowen in 1999 and 2011 is like looking at two different companies. Especially the misguided acquisition in 2007 lead the company in deep trouble. However, despite the very significant decrease in the share price, S-R is still not a real bargain due to the massive dilution of the rights issue.

Only if one believes in a short term recovery of the UK economy, S-R would be a “buy” right now. So for the time being “no action”.

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