CANEXUS CORP 6.5 PCT DEBS T.CUS.DB.D

RE:Net Debt Calculation

[Kherson]

6milli wrote: For the purposes of valuation, convertible debt should either be considered as follows and yes it is a slightly circular calculation but one which in this case will not be relevant (in my opinion):

1) the estimated equity value is above the convertible debt equity conversion price, and therefore one should assume the debt is in fact converted to equity and the shares outstanding should increase by the appropriate amount the the principal value of the debt will not factor into the net debt calculation

2) the estimated equity value is below the convertible debt equity conversion price, and therefore the face value of the debt should be considered as other debt would be considered, and thus will factor in to the net debt calculation


The Series III conv debt is convertible at $8.30 per share. The Series IV and Series V are both convertible at $11.35 per share. The Series VI is convertible at $6.50 per share.

Therefore, for the purposes of valuation, the convertible debt should be accounted for within the net debt calculation and not the equity value calculation; if you think the equity value will be greater than $6.50 then you should start valuing some of the convertible debt as equity shares instead of debt.

While the convertible debt was carried on the balance sheet as at Sept. 30/14 for $287.1 million; however, the principal amount of all convertible debt outstanding was $312.9 million and so for valuation purposes this will be the amount used in the net debt calculation.

(If anybody has insight on why the convertible debt is stated on the balance sheet at $287.1 million instead of the principal amount outstanding of $312.9 million I'd be happy to hear the answer.)

Next, as at Sept. 30/14 $257.2 million was drawn on the credit facility - US$225 million and C$5 million. (I assume the stated value takes into account exchange rate differences).

In addition, at Sept. 30/14 short-term borrowings were $8.1 million including $7.8 million in swing line loans and $0.3 million in other bank debt.

In addition, according to the 3Q14 MD&A, "The Corporation had commitments of $45.8 million at September 30, 2014 and $26.5 million at November 6, 2014, primarily related to the expansion of NATO unit train operations and a caustic modernization project at our North Vancouver chlor-alkali plant." This means that they were contracted to spend at least $46 million in the future on expansion projects as at Sept. 30/14 and that they had in fact spent about $20 million of this by Nov. 6/14. There can be some argument made for how to account for this; however I am going to be conservative and therefore will add it all in. Furthermore, by including all expansion capex into the current net debt figures, future cash flow (cash profits less maintenance capital expenditures) can be taken at face value and do not need to be adjusted downwards by the value of future expansion capex. Therefore, for valuation purposes, the extra $46 million should all be added to the net debt calculation.

Net debt = $313m (conv debt) + $257m (credit facility) + $8m (short-term borrowings) + $46m (contracted expansion capex) = $624 million

Therefore, to me a fair net debt value to use for Canexus currently is $625 million.

There are several important factors to consider with the $625 million in mind:

1) $46 million is "future" capex, of which $20 million was spent by early November and therefore arguably definitely should be included in net debt now, but the addtional $26 million will be funded out of future cash flows

2) Any increase in the value of the US dollar will increase the net debt given the high US dollar denominated debt amount.

3) Any future shortfalls in cash flow generation vs dividend payouts will further increase net debt.  Dividends declared per quarter are about $18.5 million (185m shares * $0.10), but because of the DRIP the cash drain seems to be $14-15 million. This does not mean the net debt would increase by $14-15 million per quarter due to dividend shortfalls, the net debt will only increase due to this reason if cash flows before dividends (cash flow before dividends = cash profit - capital expenditures) is less than the cash dividend payout. The good news here is that future capex should be well below the levels over recent history due to the finishing of the NATO expansion project. In addition, we have already accounted for future capex expansion amounts in our current net debt. Since we are talking about it here, maintenance capex should be $25 million annually in the future and there will be significant excess cash from operations over maintenance capex.: "Management anticipates ongoing annual maintenance capital expenditures of approximately $25 million which will be financed primarily out of net cash generated from operating activities."



I'm looking forward to any opinions, thoughts and/or critical analysis of my net debt calculation of approximately $625 million for Canexus.