Debentureholders: Fools and their money... All the following is my opinion only. Read important disclaimer at the end which qualifies everything here.
It is my strongly held view that the proposed amendments to the terms of the Series G Debentures are not good for debentureholders and not even for the unitholders. The prospect of a default on the debenture interest payments is being held out as a bad thing whereas it should be considered a potentially good thing for debentureholders. The Fort McMurray fire is a game changer, and I believe that this new reality is not adequately reflected in this proposal, if at all. In my opinion, the board’s rationale for the changes is, at best, poor, and at worst, potentially misleading. Insiders cannot make this happen on their own–they need the approval of independent debentureholders. For these and other reasons, I believe that debentureholders should seize the initiate and vote against this self-serving proposal.
On the first page of their information circular, the authors present what are apparently the board’s top three reasons for supporting their proposed amendments. Their first reason is to help LREIT avoid defaulting on interest and principal payments on the debentures.
Would default event be a such a bad thing for debentureholders? I would argue quite the opposite–it would be an opportunity which would significantly strengthen our hand. In the most recent quarterly report, LREIT says this about defaults:
“Failure to comply with debt service obligations and debt covenants are events of default that allow LREIT's lenders to accelerate payment of the mortgage loans and/or enforce their security in accordance with the underlying financing agreements”
In a default, debentureholders’ options increase, but importantly, as I see it, we retain control of the process. A default does not mean that the company automatically goes into receivership. Far from it. The terms of the debenture’s trust indenture allow debentureholders to waive a default event. Of course, something would probably have to be offered to the debentureholders in return for our issuing the waiver.
Consider the example of Pinetree Capital Ltd. When Pinetree defaulted on the terms of its debentures last year, debentureholders, through negotiation, obtained the right to nominate three directors to the board, among other benefits. Co-incident with the process, Sheldon Inwentash, the company’s longtime Chair and CEO, retired and two of the pre-existing directors resigned.
[url=https://www.pinetreecapital.com/investors/news_releases/2015/index.php?&content_id=711]https://www.pinetreecapital.com/investors/news_releases/2015/index.php?&content_id=711[/url]
In our case, each missed interest payment, each new event of default, could conceivably result in some significant good for LREIT debentureholders and perhaps the REIT as a whole. Possibilities which come to mind include consent fees (in the form of cash or LREIT units), board representation, an increased interest rate above our present 9.5%, management changes, revisions to the service agreement, a more determined effort to liquidate properties, a say on compensation and strategy, and so on.
Management has apparently attempted to justified or explain the rather harsh proposals by saying:
This seem like a very unfortunate misconception, on the anonymous debentureholders’ parts, of the chain of events that would occur if an interest payment were missed. Why not correct their apparently mistaken notion of the process? And why use it, as seems to be the case here, to explain stripping down their benefits? More importantly, why would debentureholders submit to such tactics? Perhaps they just don’t realize.
At this point, I can hear some people protesting that I am neglecting the most desirable part of the board’s offer. The other half of their story seems to be that everything is so equitable: Shelter Canadian Properties Properties Ltd. and its parent, 2668921 Manitoba Ltd., are doing their part. For example, as they state in the latest quarterly:
“Upon approval of the amendments, 2668921 Manitoba Ltd. has agreed to reduce the interest rate of the revolving loan from 12% to 5% per annum.”
Let’s take a closer look. First, insider-related party 2668921 Manitoba is offering to drop the interest rate on its revolving loan from 12% to 5%. On the surface, that sounds very fair as it is same rate that they are asking debentureholders to accept. The devil is in the details.
In its present form the debentures, our loan to the company, is due in two years. They want us to push the due date to a point three time as far into the future, from 2018 to 2022. That means that we would be eating the meager fare of that low rate for six more years instead of two.
What about our presumably equitably participating partners in this restructuring, 2668921 Manitoba Ltd? Co-incidentally, their revolving loan is presently due in 2018, just like our debentures:
We get stuck with the dud rate of 5% for four extra years (for a total of six) while they apparently get away with exactly zero extra years (for a total of two).
So after two years, when the revolving loan is due, what happens to their rate? Apparently, if it is not all paid off, then they renegotiate it. In that case, my bet is on 2668921 Manitoba Ltd. wanting more than 12% to renew it. What do you think?
And will the loan, in its present form, be around for even two years? In management’s words, “The revolving loan is a demand loan and as such 2668921 Manitoba Ltd. can request repayment of the loan at any time”, so maybe not. They might not have to suffer that 5% for even the entire two years.
But, am I not being a little uncharitable in my criticism? After all, they’ve highlighted more than once recently that insiders and related parties are also doing their part, during these hard times at Lanesborough, by deferring certain payments that they are owed. For example, as reported in the latest quarterly report:
“Shelter and 2668921 Manitoba Ltd. have participated equitably in LREIT's debt restructuring initiatives by providing the deferral of property management fees, service fees, and interest on the revolving loan as well as interest on the second mortgage loan acquired by 2668921 Manitoba Ltd. during the quarter.”
This does seem equitable because we debentureholders are being asked to defer any and all receipt of interest, as well as principal, until 2022.
But if you look more closely? Well, it is all well and good for insiders and related parties to stress how they are doing their part, deferring a service fee here and a management fee there, encouraging you to defer your debenture interest and principal for years and years. We must jealously keep cash in LREIT’s coffers, you know. Hard times, and all. You can be excused if you missed, among all this self-congratulatory backslapping, the part where they say that, after the quarter’s end, they paid “down the revolving loan from 2668921 Manitoba Ltd. by approximately $3.9 million.” Wow, that’s lucky on 2668921 Manitoba Ltd.’s part to get roughly 20% of the money owed on their revolving loan back just before their return on it might drop from 12% to 5%. Good save. Well played. Maybe not so lucky for LREIT’s other creditors, though, now that the coffers are back to looking pretty bare again. Explain to me again how that’s doing ones part to help ensure the viability of the enterprise? Are we to cut our rate to save the REIT money, simply to see these savings not shoring up LREIT's coffers but flowing to the likes of 2668921 Manitoba. Better that we would have kept it than have that happen, I say.
So, anyway, in the spirit of equity, the debentureholders can, at least, likewise expect an early 20% payback of the principal of their outstanding balance too, right?... Right?... Excuse me... Hello?
Oh, wait, I think I see it now. My mistake. Sorry. Now I’m thinking they must have meant the sort of equitable participation where one of the parties, the special one, gets all kinds of benefits and stuff that the others, the lowly ones, don’t get. If that’s what they meant, then it’s all starting to make sense.
I would argue the question of whose payments might get deferred and whose might get accelerated is much more important than you might think, especially with the recent turn of events, both in the oil industry generally and in Fort McMurray in particular. The timing of payments might make the difference between getting paid most or all of what you are owed and getting paid nothing.
Consider this. The authors of this plan to amend the terms of the debentures don’t want to pay us a cent until June of 2022, not interest, not principal. We will miss getting any interest payments, not the presently agreed rate of 9.5%, and not even the proposed paltry rate of 5%, during the expected Fort McMurray construction boom, a period when the cash should be flowing to allow them to actually make our payments. That construction boom will be long over by 2022. The money will still have flowed but to someone else.
In the defense of the authors of the proposal (whether they deserve a defense or not), when they were writing their amendments, they could not have foreseen the events in Fort McMurray and how they would probably favorably impact Lanesborough over the next few years. But we do see this now. Why wouldn’t debentureholders want to see some of this building-boom cash flow their way in the form of continued (not deferred) interest payments. That will not happen if they vote for this plan which has been overtaken, and I would argue rendered obsolete, by recent events.
If this proposal goes forward, are we left then to bet on 2022 being at the sweet spot in the boom bust cycle of the oil business? What if the next hoped-for oil boom happens in the interim, and by the time 2022 rolls around, we find ourselves at the bottom of an even worse trough. Let’s say that LREIT doesn’t survive that one. (That’s not to mention all the other unpredictable risks that could kill the trust while we wait for 2022. Even during a boom period, companies disappear all the time for any number of reasons–think fraud, mismanagement, and sheer bad luck to name a few.) So while, perhaps, everyone else involved with the REIT will have been getting paid (at least something, and maybe everything) during the post-fire building boom and during any interim oil boom years, are we to roll the dice and bet it all on 2022?
Speaking of bets, imagine that a friend approaches you with a wager. The stakes are large, similar, let’s say, to the face value of your LREIT debentures. They suggest that you will bet on some small, debt-ridden oil services company not only still existing but prospering in 2022. It doesn’t matter how well it does in the meantime, it’s all down on 2022. What kind of payoff would you require to make that bet? Would you risk it all for just 5% a year added to your stake, or would you require more? How much–12%? More? How about 20% a year? If you are not even sure about that, then you certainly wouldn’t agree to take 5%, would you? Well, maybe you would, if you were tricked into it; but otherwise, surely not, right?
I want you to consider one other way of thinking about this proposal. If you accept this, you are accepting the first offer that is being handed to you. Does a shrewd negotiator make his best offer first? If you went to an estate auction, would you yell out your best offer at the start of bidding? In both cases, I think not. I cannot believe that this is anything close to their best offer. Why accept anything less than the best?
On final thought--consider the market’s verdict on this deal. In April, before this proposal and before the Fort McMurray fire, the debentures were trading for about $12 to $13. In early May, when investors began to appreciate the impact of the fire and how it had changed the supply and demand for housing in our primary market, the price of the debentures increased roughly 60% to the low $20s. Then, since the proposed amendments were announced, the debentures have fairly steadily declined to their present level of $10. I believe that, today, they would still be in the low to mid $20, perhaps even into the $30s or $40, if it were not for this, as I see it, value-destroying proposal.
The board and management of LREIT can and should make a better offer. Even then, it might not be in our best interests to accept it. I think we all should wait to get some more clarity on how the aftermath of the Fort McMurray fire will affect us. Then I think we should wait to see whether or not LREIT makes the next interest payment. If they do, great. If they don’t, great–we’ll be in an even stronger negotiating position. But if a significantly better offer is made, I for one would certainly consider it. Otherwise, my intention is to vote “No”.
Important disclaimer: All the above is my opinion only. I am not an expert on anything discussed, and it is possible and perhaps likely that I may be ill informed on certain aspects. It is presented for fair comment and discussion purposes only. None of it is intended to be taken as fact. As such, it is all not reliable. So do not use any of it to make decisions or judgements or to form opinions, and do not use it as the basis of any action. If you do plan to form decisions, judgements, or opinions or to take action on anything discussed, first seek your own independent, expert advice.