Debentureholders: Fools and their money... (revised) This post is new version of my last post which is now somewhat shorter and revised for greater clarity and readability.
All the following is my opinion only. Read important disclaimer at the end which qualifies everything here.
The board’s proposal to amend the terms of the debentures would, I believe, seriously erode debentureholder benefits, so it is not a good deal. But don’t just take my word. Consider the market’s verdict.
In April, before either this proposal or the fire, the debentures were trading for about $12 -13. In early May, once investors considered the new reality in Fort McMurray and its impact on the supply and demand for housing, the debentures increased roughly 60% to the low $20s. Then, after the proposal was announced, the debentures fallen to about $9. I believe this is a value-destroying proposal which has killed the debentures’ uptrend in its tracks. The Fort McMurray reconstruction will be a game changer, a new reality, I believe, which is not adequately reflected in the proposal.
Some think that a deal is necessary to prevent a default on debenture interest payments. I believe that such a default is not bad for debentureholders but would actually be good. In my opinion, the board’s rationale for the changes is lacking. They can’t force this on us–they need your votes.
I hope debentureholders will vote against this proposal, as I intend to do.
The information circular gives the board’s top three reasons for supporting their proposal. Their first reason is to help LREIT avoid defaulting on interest and principal payments on the debentures. Personally, I think a debenture default event, like a missed interest payment, would be a good thing as it would significantly strengthen our hand in negotiations.
In a default on terms of the debentures, the holders’ options actually increase, and the holders can retain significant control over the process. A default does not mean that the company automatically goes bankrupt. Far from it. Our debenture terms allow debentureholders to waive a default event. Of course, something would probably have to be offered in return for the waiver.
Consider the example of Pinetree Capital Ltd. When Pinetree defaulted on the terms of its debentures last year, holders obtained the right to nominate three directors to the board. Meanwhile, Sheldon Inwentash, the company’s longtime Chair and CEO, became retired and two pre-existing directors resigned.
https://www.pinetreecapital.com/investors/news_releases/2015/index.php?&content_id=711
For Lanesborough debentureholders, each missed interest payment (each default) could be a new chance to negotiate a concession such as board representation, a more determined effort to liquidate properties, a say on compensation and strategy, and so on.
Management, in an apparent justification of their proposals reportedly stated:
"We’ve talked to many of the debenture holders, who have suggested they don’t want to create a default because then they would be wiped out by the first-mortgage holder. So they said, ‘Do a deferral, so at least there is some prospect down the road that we’ll be able to recover at least some of our principal.’" (See
this Winnipeg Free Press article)
Those debentureholders, I believe, were mistaken in their view of the consequences. Why not enlighten them rather than using their misconceptions to rationalize eroding their benefits?
In my opinion, the board is also justifying this proposal by saying that everything is so equitable: insiders and related parties, such as 2668921 Manitoba Ltd., are supposedly doing their parts. (That numbered company is a related party to our president, Arni Thorsteinson.) For example, the latest quarterly report notes that “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. About the interest rate drop on the revolving loan, on the surface, it looks fair–they are willing to drop their return to 5% just as they are asking us to do with our return on our debentures. But the equity seems to disappear under closer scrutiny. For example, like them, we are currently due to have our loan, the debentures, repaid in two years, in 2018, but they would have us wait four more, until 2022–a huge difference considering the risk we have to endure all that time for such a poor return as 5%. Contrast that to the “equitable” participation of 2668921 Manitoba Ltd–their revolving loan, like ours, is presently due in 2018, but unlike us, their due date is apparently going to stay at 2018. (See
this news release.) So if this proposal is approved, instead of us all having similar due dates, our perverse period of high risk and low return will be three times as long.
And what do you think happens to 2668921 Manitoba Ltd.’s rate when its revolving loan is due in two years? If the loan is not paid down, they get to renegotiate it. My bet is that they will want more than their old 12% to renew it. What do you think?
But, am I being too hard on insiders and their related parties? After all, consider that they say that they are also doing their part, during these hard times, by deferring collecting certain payments which LREIT owes them. As they wrote 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....”
This does seem equitable. We are being asked to defer receiving our interest and principal until 2022, and they are deferring amounts due them, seemingly just like us.
Really? It is all well and good for them to stress how they are doing their part, deferring a service fee here and a management fee there while encouraging us to defer our payments for years and years. These are hard times, they would have us believe, so we all must jealously keep any available cash in LREIT’s coffers. You can be excused if you missed, among all the insiders’ self-congratulatory backslapping, the part where they report having recently paid “down the revolving loan from 2668921 Manitoba Ltd. by approximately $3.9 million.” So they get back roughly 20% of the money owed on their revolving loan just before their return on it might drop from 12% to 5%. Lucky for them, but not for Lanesborough’s other stakeholders, now that the coffers are scant again.
Explain to me how this is helping to ensure LREIT’s survival? Are we to cut our interest rate to preserve cash for LREIT, simply to see this cash go to the likes of 2668921 Manitoba Ltd.? Better that we would have kept it ourselves.
In the spirit of equity, will debentureholders be getting 20% of their principal back early? Fat chance.
Oh, wait, I think I’m seeing more clearly now. Did they mean 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 so, then it’s all starting to make sense.
The matter of whose payments get deferred and whose get accelerated is very important, especially given the up-tick in oil and the Fort McMurray fire. That timing might make the difference between getting paid back everything versus nothing.
Consider this. According to the proposal, debentureholders will miss getting any payments during the expected Fort McMurray construction boom, a period when the cash should actually be available to make payments. By 2022, that construction boom will be history and that cash will have flowed to someone else.
Admittedly, when they were writing this proposal, they could not have foreseen all this, but we do now. The debenture restructuring plan has been overtaken and rendered obsolete, in my view, by recent events.
If the proposal is adopted, are we left betting on 2022 being at the apex of a new oil boom? Otherwise, how will we get any of our money back? What if the next oil boom happens in the interim, and by 2022, oil is again in a bust. Will LREIT even survive let alone have the cash to pay us back. (That’s not to mention all the business risks independent of oil, such as the risk of fraud or mismanagement, that could spell our demise before 2022. Companies disappear all the time for any number of reasons.) So if times are better over the next few years, potentially everyone else will have been getting paid except us.
Do you want to take this risk, and if so, is 5% a year adequate compensation?
Lastly, consider that, if you accept this proposal, you are taking the first offer placed in front of you. Does a shrewd negotiator make his best offer first? I think not. Why vote yes for this, when prospects for an improved offer seem good?
Before accepting any proposal, why not wait for more clarity on how the reconstruction of Fort McMurray might benefit us? Meanwhile, if the offer is significantly improved, I for one would certainly consider it. Otherwise, I intend 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.