RE: pref A, B, conversion/value -- a tale of Bob aDouble & GW:
First of all thank you for the excellent posts on the topic of the A versus B price discrepancy. Although I remain and will remain in the common shares only, your comparison of the series 1 versus 2 (A vs B) preferred shares got me thinking and has led me to a deeper understanding of the overall dynamic here. I think I've got a pretty good answer for you about the A's versus B's. My reasoning probably also offers some insight into why C's and D's are also well below the A's.
I'm not going to tout my own post too much but I do think anyone concerned with the preferred shares should read on and think about the scenarios I'm posing.
This takes a little explaining, but my basic thesis is that the A's are valued the highest of all right now (and have been for a long time) because, among all the preferred shares, they have the advantage of having the most straightforward EXIT strategy for a large existing holder. I'm going to contend that most of the rest of it (the reasons we discuss on this board for buying one pref series over another) is irrelevant to a holder in this position.
Before I tell the story of Bob and Mike, I'm also going to put some other facts out there because they tie in:
Fact 1: YLO can't address all of its debt in one fell swoop.
Now through 2013 is the make or break timeframe when it comes to debt. They need to pick and choose what they pay off very carefully. In 2013, 800 million worth of long term debt matures. Other commitments include the current 10% buyback on each of the pref share series. About 1/4 billion in MT notes of various series have been bought back and canceled this year so far. This kind of pace could well continue through 2012. Series 1 preferred shares need to be addressed by Dec 2012 at which point holders can retract the shares at $25. There are interest payments on debentures and dividends on all the different share issues.
Fact 2: The preferred shares trade in very low volume.
While there is a secondary market for the preferred shares via the TSX (YLO.PR.A and so on), these shares don't trade in huge volume like the commons and there is much less of the "liquidity". When no buybacks are happening, the trading volume seems to average about 10K shares a day.
Fact 3: The only preferred shares with a guaranteed, relatively clean exit before 2017 are the series 1.
Fact 4: Preferred shares have dropped far less than commons. This is not because there is any less desire to exit. However, there is just one tiny door.
Common shares have declined from $6 to 80 cents in recent memory (the have dropped from $14 if we go back to pre-recession) while preferred shares have only been cut in half or so. Part of this is probably because there isn't so much day-trading, retail fear and shorting action around the preferred. There's another reason though -- the trading volume just isn't there. In steady state, you might see a YEARLY volume of 2 million shares. In this setting, trying to dump a million shares in a short time will have VERY ugly results.
With these facts out there, let's take the perspective of Bob who manages an income fund. Bob looked at that solid dividend on the Series B shares back in 2007 and decided there was a good alignment with the goals of his fund. He got in with a million of the B series. The economy was chugging along and YLO was considered a solid cash cow with a hundred year history -- a perfect fit for the unit holders of his mutual fund who are probably retirement age and looking for steady income with low risk. With the right to retract the shares for $25 in 2017 and few worries of insolvency, things look really attractive. The company does have the right to convert the shares to commons starting in 2012 but with their commons chugging along at $14 a share with a solid dividend too, there is no reason for such a conversion and even if it happened, it wouldn't cause Bob much worry (just that 5% conversion hit if commons are over 2 bucks).
Four years later, things have changed dramatically. There has been a recession and we may be heading for another. The Internet Marketing guy just bailed, the CFO turned out to be the same guy from Quebecor World and we all know what happened to them. He sold all his shares on Day 1 of the announced buy back program and now he's been booted out. 100 million shorts have turned up. The herd is stampeding for the exits. The analysts are out in force -- sure that nasty Canaccord guy and several others are probably working for the massive legion of shorts. Sure the commons are trading at silly levels at a tenth of book value and someone deep value guy will *probably* step up and start buying the commons. Sure the company is working on a transition. Sure, a buyout could happen. However, if you're Bob, none of that matters. Sentiment is VERY poor and this thing is no longer safe for all the pensioners who hold Bob's fund. Though there is definitely hope for a strong rebound or buyout, on the downside, the fund's holdings could be wiped out entirely. The upside is not that substantial since the shares won't ever overshoot $25. It no longer meets the fund criteria -- to say the least.
Now, and for about 9 months, Bob's #1 priority is his exit strategy. 2017 is suddenly looking very far away. With 800 million in debt maturing in 2013 and the many other commitments, as a series 2 holder, he knows that the company probably ISN'T going to convert or redeem his shares. They've put out a token 10% buyback to assuage the analysts and build confidence but that's about it. Worse still, so far the buy back has been focussed on those annoying Series 1 guys since they must be dealt with in 2012. The only way out is through that low volume secondary market and there just aren't enough buyers -- all the income investors who would typical buy up these shares know Bob's pain and aren't going to help him out. Bob is stuck with low volume from some retailers who are being contrarians and taking on some higher risk with the hope of growth as well as dividends. However, most of retail is steering clear too because that freakin' prospectus is darned near impossible to figure out and the volumes on the preferred's are just ... well.... BORING! Leave the "preferred" shares for Warren Buffet they say. We move faster than those preferred's could ever go. Too freakin' complicated.
So, in desperation, Bob's lobbying the company for more buybacks but thus far, they've stuck with their guns and capped it at 10% though they have agreed to suspend the common buybacks. The situation is not looking too good for a clean exit. At 10K shares a day, it takes something like 5 years to cycle through the float. Some have tried to break for the doors ahead of the pack but when they did, it was NOT pretty even with a few hundred thousand shares -- that's when the stock tanked by nearly half. That's why it's sitting so low now and with the company buying back the series 1 first and no major buyers, there's not been much to make it rebound. Exit is Bob's central dilema and Bob is not alone. Most of the investors who bought the prefs in 2007 got in for similar reasons and are also working on exit strategy.
Now let's look at Bob's friend Mike. Mike's profile and holdings are similar to Bob's but he didn't like the 2017 timeframe. The economy had been chugging along for quite a while since the dot com bubble burst and Mike, being older than Bob, realized that probably meant something bad was going to happen soon enough. So Mike jumped on board but he planned for an earlier exit by purchasing Series 1 with a 2012 retraction clause. Like Bob, Mike is on the way out for similar reasons. His situation is dire too, but he knows that the sheit doesn't really hit the fan until 2013 when 800 million in debt comes due. So, he's getting more sleep than Bob.
Mike's exit is there for sure. The company is not going belly up during his timeframe (maybe never buy Mike doesn't care). So far, the company has said they're still committed to a cash payout which would be really sweet -- Mike would get out unscathed unlike just about everyone else on board the big yellow bus. In reality, he's probably going to get converted to common shares at 12.5 per 1 preferred share sometime next year. However, since 2007, he's made about 6 bucks in dividends and the commons are probably going to rebound anyway since the company is working on some kind of turn around. If they don't rebound, Mike knows that can call up his buddy Gus who is a high end trader connected to big money. Gus can call up some friends and drive the commons for a while and get Mike a higher exit point since every retail trader and his uncle will jump right on board if, one morning, anonymous starts buying up huge blocks. (It's Google, it's Google!! Come quick!) Bottom line, one way or another, Mike is going to get out relatively unscathed and can keep justifying his fund's high managed fee since he beat out Bob and friends.
So.... there's my theory. A long and sordid story but I believe this is the crux of the matter when it comes to the preferred shares. Does this mean you shouldn't, as a small to mid sized investor, buy up some of the B series? Or the C & D's which are really in the same boat? I wouldn't say that because you are probably not buying in huge quantities and can get out cleanly. This especially true since an ex-div pop is probably coming and since most of the 10% buyback is still pending for B, C, and D series. There should be enough volume to support you and keep you from getting stuck.
However, I do think that as an investor in the preferred shares, you should keep the sordid tale of Mike and Bob in the back of your mind.
Mark