RE:Preferred Shelf?I don't think it's reasonable to make a bunch of negative inferences on the Shelf Prospectus. This deal opens doors, commits to nothing, and presupposes none of the concepts you’ve presented here. It's flexible (e.g., debt, equity, warrants, etc.), fast, and cheap. I will post more about this shortly as it's an interesting concept, but for now it:
- It provides optionality -- that's the long and short of it. In practical terms, it could mean:
- Avoiding limitations on the timing/volume/sequence of good acquisitions – because you can only do so much at any given time.
- Taking on larger scale acquisitions that would be ordinarily out of reach. Reality matters – there’s a hard debt covenant, measure by total debt to cap. And I think there’s a presumed soft one too. This is driven by market revulsion of debt-laden forestry outfits careening from boom to bust. I expect them to stay largely deleveraged all equal, within reason, even if it gives up a slightly suboptimal cost of capital.
- Using a competitive advantage which is the best equity in the space. Buying Norbord for cash? Would be 50+%. Canfor buying Norbord? They’d want 30%+ plus as a premium. West Fraser strolled in and took it for 13.6% more because of this strength. Screaming good deal, but a win-win for all.
- Agility to pivot -- say they are buying Hampton or SPI as it’s the best call. Then, suddenly, Canfor agrees to a deal with Mercer. Deals have a " Superior Proposal Determination and Right to Match". Well, then they’d weigh in and take Mercer, too. Why not? They need a sawmilling foothold in Europe and won’t allow Canfor to take Mercer uncontested. But you don’t turn aside a better deal that’s more synergistic just sitting around waiting to intervene.
- Drives a less off-putting approach to capital return. It’s time to learn some manners and sit at the big kid’s table meaning:
- Conducing full-scale M&A in a backdrop of appropriate and robust return of capital. This is the big one.
- Encumbering your cash (as you should) with a framework like any normal company would (50%+ of FCF to investors at minimum; flex on the NCIB; fit in gaps with divs). You need to be able to readily leverage more cash should the situation arise and just hoarding it on balance sheet is not OK.
- It's clear they aspire to join the mainstream blue-chip type entities, have to appease the Norbord crowd, and the heavy weighting to buybacks is no longer as suitable as the share price rises.
- Means the dividend is going up, not down.
- Why have the Shelf in place?
So, it's not “dilutive to shareholders” as common sense dictates you use debt/cash for expensive names. You don’t issue shares valued at 8x to buy timberlands valued at 17x. We are used to viewing the forestry firms as fools, but WFG has the sophistication to understand what an optimal capital structure is. You have the Managing Director of Brookfield Asset Mgmt , a $68B juggernaut, on the board. This is not a bunch of morons and they have skin in the game.
The converse get to 9x valuation and then take out Interfor, worth at best 6.5x. An equity deal at a 20% premium implies paying about $400M more than current value, which would be less than the NPV of the US SE synergies which would be at least $20M/annually I suspect. So the premium is a wash, and you buy a company that was valued at 6.5x and is now going to have that name earnings stream valued at 9x.
As for "conflicts directly with the notion the shares are undervalued" well that's not a reasonable take as you only do it where it makes sense, would otherwise carry prohibitive debt levels, or if it facilitates the transaction (and therefore lowers your costs materially). You don't issue equity to take out a from of a higher valuation multiple, but a lower one or peer? Just maker sure you get more than you spend e.g. Norbord.. Moreover, it's an important way to get to "yes". An all-cash deal commands a much larger premium. Less successful firms who have a lower valuation multiple like... well anyone in Canada other than West Fraser have the lowest global market valuations anywhere so there can take out equally inept peers via equity but that's it.
"Only be looking at issuing debt"? Nope. There are debt to cap covenants as noted, not that you'd want to go that high anyway. If you want to buy PotlatchDeltic and get into the stable timberlands game it's going to cost you the better part of $6B on a debt basis, but could be done for $5B on an equity basis. It’s outside of the realm of what’s feasible currently.
Last of all, nope, it don’t mean the "wont be paying out these fat earnings as a fat dividend”. The Ketcham’s like anyone else put up with being marginalized for long enough. It’s not just survival model anymore. Paradoxically spending less on cash M&A and more on divs will make this a 10x company which provides the financial firepower to take down big targets and accelerate the desperately needed industry consolidation. I don’t view the following accurate summary by Hansen and Juslin as acceptable, and nor should anyone. Fortunately I see an end in sight.
Generally, the industry targets a 12% return on capital employed, but the value was often closer to 5%, a level considered to be actually destroying value or capital. Many industry analysts attributed the poor performance to the fragmented nature of the industry. Fragmentation often results in overcapacity, lack of price discipline, and an overall inability to influence trends in the industry. Hanalyst727 wrote:
Unless WFG is planning to issue preferred shares, a shelf is just dilutive to shareholders, and conflicts directly with the notion the shares are undervalued as evidenced by the share buyback WFG is currently undertaking and the "higher for longer" bull thesis.
Their earnings and balance sheet are so strong they should only be looking at issuing debt to finance any further takeovers. Issuing long term debt and/or preferred shares to finance takeovers in an inflationary environment is exactly the right thing to do - especially since WFG is clearly capturing the leading edge of the inflation wave a'coming.
The shelf "also strongly suggests they wont be paying out these fat earnings as a fat dividend" makes zero sense. This optionality will facility a more converntional div stream if anyhting, whihc is going to be requited to get to 9x and 10x valuation multiples and out of the local cesspool. Moreover, the may find equity-droven growth is indeed optional and address capital strucute via somrhing like a dividend recapitalization. But these guys have been so bad for so long I think optics trumps finance re: baalnce sheet strenght so keeping it clear is pragmatic irrespecive of how cheap the debt is. Any equity names oyu buy in the space could be sub 1 year ROIs so whethert your using a 4% or 8% hirdles done't much matter.