Increasing stake in MegaBrands

[tyska]

 

 

"The company says three significant shareholders — Fairfax Financial Holdings Ltd. (TSX:FFH), Victor Bertrand Sr. and Trimark Investments — have agreed to buy a total of $53.3 million in shares by exercising purchase warrants issued in 2010.

 

Read more: http://www.montrealgazette.com/Major+Mega+Brands+investors+support+plan+chopping+outstanding+debt+level/8152785/story.html#ixzz2Of3HaDfK

"

I'll admit that I didn't see much value in MegaBrands when they got into it.

 

[FFHWatcher]

Does anybody follow the MB warrants?  Why no time value?  Why did FFH, Trimark, Vic Bertrand all convert to shares 2 years before the expiry?  Chou, Krembill, etc. all are converting using a cashless transaction (not investing any more capital but converting to shares using the intrinsic value of the warrants, unlike Bertrand, Trimark, FFH who are putting in $50M or so).  The warrants were in the money.

They had $2. ($0.10 x 20 = $2) of time value when they were out of the money.  Now a few months later, still 2 years to go until expiry, they are in the money and the $2. has virtually disappeared.

 

Any suggestions or possible explanations?

[warrior]

Hi FFHWATHCER,

I do not own MB , but, due to  FFH investment  i have been monitoring MB

Mega did well in all their  restructuring plan and seems that they want to build another facility to support future growth. So, I would reasonably expect future reduction in the rate of cash flow generation. This was a main concern in the past when they raised debt via issuance of debenture, stocks and warrants -on dilutive basis. the proceeds of which ($120 million), when converted, to be put in a trust to be used to pay off the debentures

The strike price on the warrants is $9.94 per share. Company has 12.2 million warrants outstanding,

 

In fact, recent financial performance and stock price ,encouraged  MB to  convert warrants.  So they do not have to worry about  liquidity and its ability to  fund the business.

 

PLEASE SEE  REPORT FORM  BMO ON THIS DEAL

 

Key Points

Mega Brands announced today that it has entered into an agreement with several large holders

who have committed to exercising outstanding warrants; in turn. MB will use those proceeds to

pay down existing debentures at par, on a pro rated basis.

The action is neutral to diluted EPS, but accretive to free cash flow, and, we think, a positive

event that better positions the company financially. We also think it signifies a good deal of

confidence in the business by large holders and confidence on the company’s part to generate

future free cash flow.

Fairfax Holdings, Trimark Investments, and Victor Bertrand, Sr., have agreed to exercise

107,296,000 warrants, which convert to 5,364,800 shares and provide the firm with $53.3

million in cash (20 warrants plus $9.96 in cash entitles holders to one share of common stock).

Combined with $2 million in proceeds from previously exercised warrants, and a regularly

scheduled March 30 debenture pay down of $7.1 million, the total reduction in debt amounts to

$62.4 million, bring outstanding debt down to $52.2 million from $115 million.

This action will result in the elimination of $6.2 million in annual interest expense, and we

estimate that free cash flow should increase by $4.3 million in 2013 and $5.2 million in 2014.

The action will result in a one-time, non-cash write-down of about $2 million of deferred

financing charges. This portion of deferred financing expense was previously being amortized

through the income statement on a quarterly basis.

This action will be neutral to diluted EPS, excluding the deferred financing charge, as the

diluted EPS calculation had assumed full conversion of warrants and subsequent paydown of

BMO Capital Markets Mega Brands

Page 3 March 26, 2013

debentures, and, thus, already added back all interest associated with the debentures. And, by

definition, this action is also neutral to EBITDA.

Though no near-term increase in EPS or EBITDA, we believe this deal shows a good deal of

confidence in MB’s business by three of its largest shareholders. Fairfax, Trimark, and Victor

Bertrand, Sr., collectively own 45% of outstanding shares and 36% of outstanding debentures.

The $53.3 million contributed by these three holders upon exercise of warrants will, in turn, pay

down 46% of outstanding debenture, at par, on a pro rated basis. These debentures currently

trade at $1.07 and carry a 10% rate of interest. Effectively, these holders are willing to give up

almost half of their 10% in interest over the next two years for shares they would have received

anyway by exercise conversion in 2015. We believe the improvement in balance sheet and

added financial flexibility is beneficial to the company and thus the thinking may be that the

long-term benefit to the business could outweigh the forgone near-term interest income for

these holders.

In addition, the company is providing remaining warrant holders with a cashless exercise

option. Holders may exercise their warrants, but in lieu of paying $9.96 per every 20 warrants

to receive one common share, these holders may take the option of exercising their warrants,

pay no cash, but get a smaller number of shares in return.

For example, under the existing structure, the exercise of 20 warrants plus $9.96 in cash results

in the award of one common share. With the cashless option, exercise of 20 warrants, assuming

a current share price of $14.30, awards holders with 0.3035 shares in return. In either case, at a

share price of $14.30, the economic value to a warrant holder is still $4.34 per every 20

warrants. The trade off is that the cashless exercise option reduces the holder’s proportion of

ownership by about 70%, but offers the opportunity to exercise and convert without putting up

any cash (which would have been 70% of the current share price).

In this case, risking that all warrant holders choose to exercise “cashlessly,” we think MB is

basically telling the market it would be willing to forego $65 million in future proceeds. We

think this is a strong signal that, with $6.2 million in annual interest expense savings, the

company can generate the necessary cash through operations or access available credit to pay

off the remaining $52 million in 10% debentures when they come due in March, 2015.

 

cheers!