SFK pulp

[SharperDingaan]

 

Think we're getting old; agreed BV only goes up 40M.

 

Redo the calcs at todays rates & going upwards. If FFH backstopped the entire issue at 1.23 (80% of 1.53) we end up with 122.99M shares (36% dilution) & a BV of 3.84; but to get this there have to be no other buyers, & how likely is that ? given mgmts recent statements about greater liquidity, marketability, etc ?

 

If FFH backstopped at todays price of 1.53 (80% of 1.83) we end up with 112.33M shares (24% dilution) & a BV of 4.20; but to get this we have to rise 20% & still have FFH take up the entire issue. We effectively just start from where we were pre Q1 results release; but again, how likely is it that there are no other buyers out there ?

 

SFK has gone out of its way to structure this offering with FFH having parity with any other buyer above 1.83, & any price rise above 1.83 benefitting all shareholders through reduced dilution. Then keep in mind that this is effectively a control block, were ONE new buyer to take up the entire rights issue. One has to think that the narrowing gap between increasing market price & reducing BV/share (via dilution) isn't accidental.

 

Now assume that the US mills were sold, but the consideration was paid in both cash & a return of newly issued SFK shares. The share price rises, the share count goes back to where it was, debt gets repaid, the buyer can afford to pay a little more as they have an offsetting gain on their share holding, & SFK could do the share repurchase as a general buy-back benefiting all.

 

Obviously we think there are more shoes to drop.

 

SD

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

[alertmeipp]

more beating... down to 1.4..

 

I guess the news sucks :)

[tyska]

A little off topic, but any thoughts of if the rumor of this is what has been creeping FFH stock up lately. See it was almost double average volume yesterday also.

 

 

Dan

 

My apologies for bringing it to attention.  :( wiped out two days of gain in one fell swoop.

[alertmeipp]

I am trying to rationalize the downward pressure. The only reason I see is some accounts (mostly funds) are selling the shares now to raise cash to subscribe to the right offering at discount. At current prices, we are looking at 30% more shares (i.e. accounts will need to come up with additional 30% of their total SFK holding value for the right offering). So it makes for that are fully invested in SFK to sell some now and get ready for the right offering.

 

I think it's an excellent opportunity for those have tons of cash sitting around ready for a fat pitch.

 

P.S. fully invested does not necessarily mean 100% invested, but some funds has sizing limit on individual stocks.

[Cardboard]

You have a stock market worried about the economy: pulp? And I think that the issue you are raising is a problem for most. Look at it this way.

 

For example, if you own 50,000 units or $70,500 worth at current price, you will be forced to spend $22,105 just to maintain your current stake in the company: $40 million divided by 90.473 million units or $0.442 required per share owned. Mutual fund or not, that is money that you may not have available and a big jump or 31% above your current holding value.

 

Also, there is no value creation here. Shareholders are handing out to management $40 million in cash from their own cash reserves to make the company's balance sheet stronger. The operating business is the exact same, but there are now more shares outstanding. You have more of your own capital invested and at a lower rate of return. For an investor, it does not seem like really good allocation of capital. And the more the share price comes down, the worse it gets. You can argue that this brings more certainty to the business and eventually a return to you, but then you have to ask yourself, what were you doing before invested in this risky venture? Speculating?

 

Fairfax knows this and that is exactly why they are the back-stopper and asked for this discount of 20%. They don't like being forced to come up with $7.5 million in cash just to maintain their current stake in the business. By being the back-stopper and at a discount, they commit in theory $40 million, but they have a chance to reduce the dilution impact from this cash raise by lowering their capital invested per share ((market value of current holding + discounted price x new shares)/total shares now held) below others who just subscribe or don't subscribe at all.

 

If you want to benefit from the discount like Fairfax, you have to apply for the additional subscription privilege and hope that many will not subscribe or not fully in the offering. If everyone participates fully in the offering, then the discount really does not exist for anyone including Fairfax. We become all diluted equally by the cash raise and that is it.

 

Now, if the market keeps tanking and SFK with it, they may have to postpone or cancel this rights offering. We have uncertainty on the issue price and uncertainty on the timing. The market may start to create uncertainty around: “Do they badly need this cash?” I don’t get it. When you need cash, you get it now. You don’t announce your intentions weeks and months ahead of time, create massive uncertainty and then make your share price collapse so much that you can’t raise capital anymore. I didn't think that they needed it, but now that they feel it is needed, I wish they would have taken another route.

 

Cardboard

 

[alertmeipp]

yes, the early announcement is odd, but I think this can be ending up a good opp.

[triedtestedand]

My questions are these:

 

-  It's great that they've been able to refinance, but besides the amounts and terms, what are the other details on the refinancing?  Better rates? Better covenants?

 

- Presuming the rights offering goes ahead (at whatever price), will FFH subscribe at their pro-rata 20% shareholdings, or simply backstop and see if rest of the shareholders pony up first?  The way it sounds, FFH could simply pass on the main offering, and even if all other shareholders picked up their pro-rata portion, FFH would still be able to pick up their own pro-rata portion after the fact, but at a discount ... what's with that??? 

 

- And if this is a piece of a larger puzzle, what might they know/suspect given their position and discussions with SFK that other shareholders might not (e.g. other plans , info r.e. Q2 earnings, etc?).  Or maybe this announcement had to be made to provide full disclosure to other shareholders in context of some other such discussions??

 

Without clarity on this, and with anticipation of having to hold cash in anticipation of such offering, some existing shareholders who's been continuing to accumulate would freeze in the interim, no? (There goes one source of buyers in the near term, and a potential source of sellers.)    And some prospective shareholders would conceivably wait until further details are announced, no?

 

I don't totally get it ... on one hand it sounds like "Hey everyone, FFH is a great shareholder and has our back ... just wait for some more details, this is a good news story" ... but on the other it could be construed as "Hey everyone, we're so hard up for $40M that we need to pre-announce an offering and give just one of our shareholders - we didn't even bother reaching out to any of the others - a sweet deal to try and sell it."

[lessthaniv]

This is why I think, more than ever now, that something must be in the works. As I said earlier, why would they announce the rights offering without announcing the subscription price? They have left themselves open for exactly what is happening! The only thing that I can think of to rationalize this decision is if they already know another transaction will raise the price. Failing that, I think they made a big mistake.  (unless there is some securities law that forced the announced early - none that I'm aware of?)

 

 

[alertmeipp]

interesting point, in theory, if fairfax drives the pps to 45 cents (market cap 40M, and that means share count will need to double to get 40M).

 

Then, FFH skips the main offering, let the stand-by kick in, they could possibly end up with getting 20%+ of the company at a very cheap price (39 cents in this example).

 

I can see why FFH want to shake out retails and drive the share price lower and lower.

 

PS. I don't think we will go to 45 cents, just to make my example stands out.

 

 

 

 

[alertmeipp]

While I believe FFH will be obligated to subscribe on its own shares fully because the standby commitment kicks in...

 

by driving prices the share price lower does increase the cash outlay shareholders will have to make to fund this right offering which would cost more selling.

 

they will end up with 60 millions liquidity - i think they will reach 100millions+ by year end.

 

If anyone thinks a sale is happening, I say don't bank on it.

 

I think SFK may end up being a acquirer (likely backed by FFH).

[Myth465]

I just dont see the rationale. If they wanted to sell why would they need capital. Couldnt they sell the Canadian or US business for cash and then run the other with no debt. Buying assets makes more sense, but I dont think buying with pulp at $1000 makes sense. I could see FFH wanting to buy because they would own alot of SFK and it could be their vehicle to consolidate the market, but you would still be buying at the top. Also Sharper does have a point. SFK makes more sense being acquired due to the lack of cheap access to wood chips.

 

The simplest solution is they want capital to run the business in an un-levered manner and to prepare for the next downturn. I guess only time will tell.

 

[Cardboard]

I think that you nailed it Myth. You can't buy anything in pulp with $40 million or even $100 and if you are about to see a big chunk of change due to a sale then you don't issue a bunch of shares at a dollar.

 

The other thing that really annoys me is this conditionality around the conversion:

 

"Each of the components of the Refinancing Transactions is conditional upon the closing of the reorganization of SFK Pulp into a corporation, which is subject to the approval of SFK Pulp's unitholders at our annual and special meeting to be held on May 19, 2010, and upon the closing of all the other components of the Refinancing Transactions (collectively, the "Closing")."

 

There is nothing in this refinancing that could not be done within the income trust structure. If there is tell me. I would really like to learn.

 

There is also this notion that somehow big U.S. investors will show up post conversion due to liquidity? and other? and drive the share price up. The big change that you will see for certain post conversion is for management to issue the Fibrek Share Option Plan. The special one-time grant with conversion at $3.50 and $5 make you feel good, but don't forget about the regular grants which will be done at market price.

 

They should convert because they need to convert due to Canadian law changing in 2011. That is it. And not tie this to everything else.

 

Instead of management getting involved in financial engineering and the like, I would much rather see a higher sense of urgency and creativity to cut cost at the plants, improve selling prices (15% to 20% lost to discounts in an ultra tight market? unreal), improve processes, whatever. Generate cash the hard way. If we have had an extra $20 million in cash on the balance sheet due to better earnings, then the SGF and GE would have likely signed off on similar lending conditions without the $40 million share issue.

 

Cardboard

[alertmeipp]

Anyways, at 1.4, the pps is very cheap. Should be able to make good money on this one.

 

Just got a reply from IR, FFH will have to subscribe fully for its own shares before the 20% kicks in.

[oldye]

I'm in the camp thats not sure why they need the extra 40m but at the same time I'm not willing to throw management under a bus after a few down days.  How do you know the people willing to take the low bid won't stop taking it next week? 

[Myth465]

SFK is cheap, and should be money good (> $3) at some point, but I agree with Cardboard that this transaction adds no value and at a low PPS may add negative value. Management never really explained the need for it and things were progressing nicely in my opinion. SFK would have been revalued upward each quarter as things improved. Cash flow should go towards debt until Management feels comfortable. I would prefer a refinance without the share issue, unless they see pulp prices falling off the face of the earth in which case I dont really want to be subscribing to an offering.

 

Either way we have alot more moving parts right now and potentially a massive global correction. Things should be interesting and I will likely be buying at some price point, but I dont like the issue the way they have laid it out. FUR did a rights offering which made sense, they wanted to buy loan assets, raised cash, bought assets, and generated cash flow. Thats the way you add value. FFH also raises cash with shares after they have something in mind for the cash.

 

Something is going on, or should be going on from SFKs perspective. I see whats in it for FFH, but cant see why SFK Management would want this. They havent really laid out why.  The only thing I can think of is they are terrified of debt due to their near crash last year. If that's the case then they should have just got it over with at $1.60 or so.

[SharperDingaan]

The market cannot tolerate the fact that we don’t know the price of the rights offering, & hence the dilution that it will generate. ....

 

(1)To continuously sell is to lower the price, drive up the potential dilution, & further drive down the price; ie: self-fulfilling momentum trading.

(2) Analyst cannot ‘sell’ the deal until the price starts rising & the potential dilution starts declining; eliminating price support.

 

But .......

(1) We also know that pulp prices have been rising over Q2, & the average FX rate has fallen; most would expect Q2 EBIDTA to be at least comparable or better than Q1, & positive net earnings.

(2) We have agreements to refinance & extend the debt terms at far lower rates; ie BK threat removed & material interest savings.

(3) We have 40MM in additional equity, & more operating cash, that should increase the EBITDA/EV valuation (all else equal). We also have a very carefully structured deal with FFH’s hands all over it, but we think FFH has suddenly become exceptionally dense? (because we haven’t seen all the pieces yet)

(4) Debs are trading like the BK threat were removed, and the Deb to common arbitrage is looking increasing promising.

 

Given the nature and materiality of the plusses, most people would value the stock at a premium to the 1.85 it traded at prior to the Q1 earnings announcement; but because our manic Mr Market is suddenly offering it at 25% less, we’ve phased?

 

All Mr Market has shown, is that this stock can easily move down 25-30% from pre-announcement; it can also move up 25-30%. And FFH seems to have anticipated at least a 20% reaction.

 

Assume we’re totally wrong ..... & there is no reengineering in the background. Isn’t 25%+ off still a gift, versus what you’d rationally expect?

 

Enjoy the opportunity; they don’t come by that often.

 

SD

 

[Cardboard]

"Just got a reply from IR, FFH will have to subscribe fully for its own shares before the 20% kicks in."

 

Alertmeipp,

 

Just curious, who got back to you on a Sunday? FFH or SFK?

 

Also, I don't know if you have all seen it or not, but there was an Early Warning Report issued on SEDAR on Friday, indicating that Fairfax did not own anymore any convertible debenture of SFK. All sold in 2007. There was an error in the Fairfax press release on May 12.

 

Cardboard

[dowfin1]

The way I read the press release is:

 

1.  No dilution to existing SH if they fully exercise their rights.  For such a holder, just more invested capital for the same proportionate ownership of the corp. which should be more valuable by $40 M -- so it's a wash regardless of the subscription price for the new shares.  So I am not bothered at all if the price drops because I still must pay about $.44 per sh now owned to avoid dilution.

($40M/90.5M sh out)

 

2.  The subscription price and FFH's standby price are the same under all circumstances.  Some posters seem to think that FFH will get a better price per share or that the 20% discount applies only to FFH's share bought under the standby.

[alertmeipp]

Cardboard,

 

SFK.

 

I was surprised to hear back from the IR so quick too. The email address is posted on SFK website.

 

A very prompt response indeed, that's always a good sign for investors.

 

 

 

[alertmeipp]

About the early announcement, they had to announce it once the backstopped deal is reached with Fairfax as it is considered material information, they will have to disclose it because of the securities law.

[Uccmal]

The way I read the press release is:

 

1.  No dilution to existing SH if they fully exercise their rights.  For such a holder, just more invested capital for the same proportionate ownership of the corp. which should be more valuable by $40 M -- so it's a wash regardless of the subscription price for the new shares.  So I am not bothered at all if the price drops because I still must pay about $.44 per sh now owned to avoid dilution.

($40M/90.5M sh out)

 

2.  The subscription price and FFH's standby price are the same under all circumstances.  Some posters seem to think that FFH will get a better price per share or that the 20% discount applies only to FFH's share bought under the standby.

 

I think that was the way I understood this as well.  The 40 million will create some number of new shares.  The number of shares created by the rights will vary but this is irrelevant.  That is why I dont understand the market reaction.  For 10000 shares presently held I would need to spend about $4400 to keep the same proportion of Fibrek no matter what happens to the stock price in the interim.  

 

So without any change in the underlying business economics the book value is increased to 480 M from 440.  There are more shares but collectively they now hold a company worth 40 M more than the day before.  So two choices:

1) Ignore the offering - I now own ~ 10% less of Fibrek than I did the day before but the whole of Fibrek is worth 10% more.  

2) Participate - I still own the same amount of Fibrek but it is worth exactly the amount I put in more than it was the day before.

 

The one caveat is that FFH gets a deal if I choose not to buy rights.

 

Someone above posted that the sell off may be due to some shareholders adjusting their count lower to have cash to subscribe in the offering.  There may be some truth to this.  I may do it myself.      

 

Unless my read on this is completely out to lunch.  

[Cardboard]

Uccmal and Dowfin,

 

The answer lies in metrics such as Earnings per Share and Book Value per Share pre-deal and post-deal. You don't get diluted per say in your ownership % of the business if you participate, but the business itself gets diluted on a per share basis.

 

Cardboard

 

 

[Cardboard]

I have always wondered about this provision in these kind of documents. Do you know someone or a case where this has been used? It forces the corporation to pay you for your shares instead of you selling them on the open market. In this case, it would take only 1% of outstanding shares to prevent the conversion to pass and along with it all financing activities. The condition could get waived, but it could create delays. Still, why setting the bar so low?

 

 

Right to Dissent

Pursuant to the Interim Order and the Plan of Arrangement, Unitholders have Dissent Rights with respect to the Arrangement Resolution, as though the Units were shares of a corporation governed by the CBCA, by providing a Notice of Dissent to the Fund at 1010 de Sérigny, Suite 100, Longueuil, Québec, J4K 5G7, Attention: Patsie Ducharme, Vice President and Chief Financial Officer of SFK Pulp, by 4:00 p.m. (Montreal time) on the last Business Day immediately preceding the date of the Meeting, provided such holder also complies with Section 190 of the CBCA, as modified by the Interim Order and the Plan of Arrangement. It is important that Unitholders strictly comply with this requirement and understand that it is different from the statutory dissent provisions of the CBCA which would permit a Notice of Dissent to be provided at or prior to the Meeting. Provided the Arrangement becomes effective, each Dissenting Unitholder will be entitled to be paid by the Fund the fair value of the Units held by such Dissenting Unitholders determined as of the close of business on the last Business Day before the Arrangement Resolution is adopted. See Appendix B and Appendix E for a copy of the Interim Order and the provisions of Section 190 of the CBCA, respectively. It is recommended that any Unitholder wishing to avail himself or herself of his or her Dissent Rights seek legal advice, as the statutory provisions covering the right to dissent are technical and complex. Failure to strictly comply with the requirements set forth in Section 190 of the CBCA, as modified by the Interim Order and the Plan of Arrangement, may result in the loss or unavailability of any Dissent Rights. Beneficial Unitholders who wish to dissent, should be aware that only registered holders are entitled to dissent. Accordingly, Beneficial Unitholders desiring to exercise Dissent Rights must make arrangements for such Units beneficially owned to be registered in such holder's name prior to the time the written objection to the Arrangement Resolution is required to be received by the Fund or, alternatively, make arrangements for the registered holder of such Units to dissent on such holder's behalf. Pursuant to the Interim Order, a Unitholder may not exercise Dissent Rights in respect of only a portion of such holder's Unit. See "The Arrangement – Right to Dissent".

It is a condition to the Arrangement that Unitholders holding not more than 1% of the outstanding Units shall have exercised Dissent Rights in respect of the Arrangement that have not been withdrawn as at the Effective Date. See "The Arrangement – Conditions Precedent to the Arrangement".

 

Cardboard

[Uccmal]

Uccmal and Dowfin,

 

The answer lies in metrics such as Earnings per Share and Book Value per Share pre-deal and post-deal. You don't get diluted per say in your ownership % of the business if you participate, but the business itself gets diluted on a per share basis.

 

Cardboard

 

 

 

Yeah well,  The theory behind it is that there should be more EPS/share which should increase the BV going forward.  This of course includes a potpourri of assumptions with it. 

 

FWIW - It looks like they intend keeping going as a going concern rather than selling. 

 

Finally, we on the board have invoked CFX as the gold standard.  Right now it is trading at 1.6 BV.  If Fibrek even reaches 1 x BV my stake, including the rights, will have gone up by about 7x.

 

I will have seen my alltime biggest loser become my all time biggest winner.   

[Myth465]

Looks like SD is right. We are getting a chance to reload. SFK makes up a decent chunk of my portfolio so I am sorting out what to do.

 

SFK trades at around 2x EBITDA if you annualized the Q1 numbers. I think 5x EBITDA is the correct multiple to use for value given the commodity nature of the business and the debt load. If the pulp run looks a bit more sustainable then perhaps we can use a higher multiple. What do you guys think?