Unintended Consequences

7 Responses to Unintended Consequences

1. 

   Stuart on November 28, 2008 at 9:16 am

   Excellent comment. This is happening among Cdn Energy trusts too. See below, the news release that I received yesterday.

   “For Immediate Release
   TSX: TUI.UN

   True Energy Trust Announces Normal Course Issuer Bid for its Debentures

   Calgary, Alberta, November 27, 2008- True Energy Trust (“True” or the “Trust”) announced today that the Toronto Stock Exchange (“TSX”) has accepted True’s Notice of Intention to make a Normal Course Issuer Bid (the “Bid”) to purchase for cancellation, from time to time, as True considers advisable, the 7.50% convertible unsecured subordinated debentures of the Trust (“Debentures”). The Debentures have a face value of $1,000 per Debenture, a coupon of 7.50%, a maturity date of June 30, 2011, and are convertible into trust units of True (“Trust Units”) at a price of $16.00 per Trust Unit. The Debentures pay interest semi annually on June 30 and December 31. Pursuant to the Bid, the Trust may purchase Debentures up to the maximum principal amount of $8,625,000 (8,625 Debentures), which represents 10% of the issued and outstanding Debentures. At the date hereof, there is $86,250,000 principal amount of Debentures (86,250 Debentures) issued and outstanding, none of which are held by senior officers or directors of True or any
   persons or companies who beneficially own, or exercise control or direction over, more than 10% of the issued and outstanding Trust Units. Purchases of Debentures will be made on the open market through the facilities of the TSX. The price which True will pay for any Debentures purchased by it will be the prevailing market price of the Debentures on the TSX at the time of such purchase. The actual number of Debentures that may be purchased for cancellation and the timing of any such purchases will be determined by True; however, the maximum principal amount of Debentures that the Trust may purchase for cancellation per trading day is $279,000 (279 Debentures), which is equal to 25% of the average daily trading volume of the Debentures for the six months ended October 31, 2008. The average daily trading volume of the Debentures for the six months ended October 31, 2008 was $1,119,000 principal amount (1,119 Debentures).

   The Bid will commence on December 1, 2008 and will terminate on November 30, 2009 or such earlier time as the Bid is completed or terminated at the option of True. Blackmont Capital Inc. has agreed to act on the Trust’s behalf to make purchases of Debentures pursuant to the Bid.

   The Trust commenced a normal course issuer bid on August 28, 2007, which expired on August 27, 2008 pursuant to which the Trust purchased Trust Units through the facilities of the TSX. The Trust renewed the normal course issuer bid for Trust Units on August 28, 2008 and the renewed normal course issuer bid is set to expire on August 27, 2009. During the 12 months ended on October 31, 2008, the Trust acquired 1,249,300 Trust Units pursuant to its current normal course issuer bid and its former normal course issuer bid.

   Management of True believes that, from time to time, the market price of the Debentures may not fully reflect the underlying value of the Debentures and that at such times the purchase of Debentures would be in the best interests of True. Such purchases will increase the proportionate interest of, and may be advantageous to, all remaining holders of Debentures as well as holders of the Trust Units. In addition, the purchases by True may increase liquidity to holders of Debentures wishing to sell their Debentures.

   True Energy Trust is an exploration and production oil and gas trust based in Calgary, Alberta, Canada.
   “

2. 

   Frothy Conundrum on November 28, 2008 at 9:45 am

   Near-term, though, these actions are ‘cash negative’, as in TJ’s example, the company lays out $25MM, plus accrued interest, to do the buyback, as opposed to paying only $4.375MM for the semi-annual coupon payment. It’s also likely that the company will not get any debt financing from the institution(s) they buy the debt back from any time in the next several years, or from those that are close to/tied into the ones that sell.
   It is a good deal for those firms that can/do execute the buyback, but the pool of potential buyers is likely limited to firms that a) have plenty of cash on hand, few to no other needs for said cash over the next twelve months or so, and are cash flow positive from operations(to rebuild cash depleted from a buyback), and 2)
   no need for further debt financing for a couple years or so. I’d submit that those two points, especially the first, put a real limit on the # of firms that can do it, and that the # of firms that can do it and reap a significant gain(non-cash earnings, again) from a buyback-because it would seem that you need to buy back debt that’s trading at a very large discount, much more than the 5-10-15 point discount that larger, better quality issuers are generally seeing on their debt, to make it worthwhile- would seem to be relatively small.
   Of course, the pool of potential subprime credit borrowers who could actually handle a true mortgage(sans teasers, adjustables, etc.) was-it turns out-relatively small too, and lots of action still happened there.

3. 

   mannfm11 on November 28, 2008 at 1:30 pm

   I don’t buy this for the reason that if someone wanted to lend a corporation money, they would merely buy the bonds. It doesn’t wash to me that existing debt would be priced at 25 cents on the dollar, yet the market would make a new loan at a yield maybe 20% below what this example indicates. If I were actually a liquid corporation, I would hire some outfit to buy my debt off the market a piece at a time. Debt at a level like this is more of a case of feared insolvency than how much the debt is. Even though a company would look like a better risk with $25 million instead of $100 million in debt, I find it absurd that a group would give up a claim for $100 million in return for $25 million. I don’t believe the market works that way. 25% is what is generally received out of bankruptcy

4. 

   mannfm11 on November 28, 2008 at 1:33 pm

   I do see what you are talking about though in the sense that the market might be just illiquid and the instution also illiquid.

5. 

   Crimson Ghost on November 28, 2008 at 5:33 pm

   This is potentially very bullish for junk bond funds.

   Unlike stocks many of them are barely off their lows.

6. 

   DefBear on November 29, 2008 at 10:02 am

   HTE announced one of these debenture issuer bids a month ago and then admitted in their conference call that they bought none since the announcement.

   I think they should issue shares to bid for the debentures. Some of these bonds yield more to maturity, than the underlying shares.

7. 

   Shankar Khadye on December 2, 2008 at 1:26 am

   Actually, as the company will start purchasing its own debt in the secondary market, the price of the remaining debt will start going up.

   HICs (Highly Indebted Countries) tried this approach back in 80s. You may find some discussion on this if you google – Debt Relief Laffer Curve.

   Not saying you are incorrect, but it is not that clear-cut as it would appear at first glance.