ELDPA - Elders Limited

[constala]

ELDPA: why you should buy a zero-coupon perpetual junior subordinated security of an Australian distressed company

 

•Elders: a corporate business turn-around.

Elders is Australia’s oldest “agrobusiness” with 175 years of history helping wool and beef farmers with animal feed, wool trading, live export, and financial services.  In the 2000s Elders grew as a conglomerate with debt-fueled disastrous diversification into forestry,automotive…. that led to losses of more than $1 bln and five years of workout followed; along the way the common stock plunged 99% from 2007 to 2012.  In 2012 new management stepped in and decided a return back from a bloated conglomerate into an agricultural pure play by selling off remaining non-core investments and focusing on increasing profitability in the rural services unit, with a focus on high-margin, asset-light businesses.

 

In early 2014 I started a thorough analysis and I thought bankruptcy was getting remote: aggressive action from lending banks was unlikely as Elders is the backbone of rural Australia and debt was amortized fast from a peak of AU$ 1.3 bln to less than $ 150m, without impairment. Light was at the end of the tunnel with forestry exit completed, other non-core assets/business sold to reduce term debt, seasonal conditions improving, cost reductions ongoing.

 

•ELDPA: a fulcrum security

Analysis of the capital structure showed a smart way to play the turnaround: the hybrids (preferred stock). Elders had $150 million par value of hybrid equity shares outstanding trading way below Par and with a Mcap far below versus the common equity whereas they were senior in liquidation, dividend blocker, and yielding potentially a deferred 8.5% coupon:

 

• Perpetual (no maturity date), subordinated, convertible, unsecured notes

• Quarterly distributions, subject to Board approval. Distribution rate is (the higher of) 3 month bank bill swap rate and the  10 year swap rate plus (in each case) a margin of 4.7% per annum

• Non-cumulative. However, Elders is prevented from making distributions or capital returns to ordinary shareholders until  it pays an amount equal to 12 months of back distributions to hybrid holders

• Rank ahead of ordinary shares in a wind up to an amount equal to $100 plus any unpaid distributions in the last 12  months

• Elders can implement face value conversion at a 2.5% discount to the ELD 20 day VWAP

• Hybrid holders may require conversion in an Elders Ltd takeover recommended by the board, taking into account any  premium paid to ordinary holders in the relevant bid

• Hybrid terms can be varied with approval of 75% of hybrid holders who vote

 

Since then Elders’ new management team has delivered, Elders is EBIT positive and term-debt free with massive deferred tax assets.

 

Common MCap is now 188m, Hybrid Mcap is 84m, trading at 56%. This is still not right-again, the hybrids are senior in liquidation, dividend blocker, resumption of dividend is within sight-should take 2/3 years max. Management target for 2017 is $60m of EBITDA, 20% of ROC, there is no term debt left, remember there is a massive DTA, thus EV multiple on a forward looking basis looks still very low, with potential bidders (private equity, foreign money, agribusiness rivals) sniffing. 

 

A tender buy back offer on the hybrids at Par makes a lot of sense, to enable quicker resumption of dividends on the common and profit from current mispricing relative to common. This gives  a potential gross upside of close to 80% for a 2/3 year trade.

Should a tender offer not be on the cards you could still soon enjoy a 8.7/56%=15.5% perpetual coupon with the associated capital gain to add to the total return when dividend will resume....

 

http://www.tradingroom.com.au/apps/qt/quote.ac?code=ELDPA

ASX:ELD for the common

 

[writser]

I spent an hour looking at this so I don't pretend to understand much here at all. But given their balance sheet / cash inflows I think it is unlikely that they will tender for the hybrids soon. $150m is a lot to cough up at this stage. What makes you think they won't opt for a conversion? Have you looked into shorting the common as a hedge?

 

Also, I'm not sure re-initiating a dividend is a top management priority (and they're probably right about that). From the AR:

 

Having now substantially addressed the Company’s debt burden, the Board and Management’s priority in the short to medium term is to direct cash flow back into reinvigorating and strengthening the business to grow earnings and returns. As a result, ordinary share dividends (and hybrid distributions) are unlikely to resume in the near term.

 

So this could take some more time to work out. Still, this looks like a potentially cool idea, thanks for bringing it up. Have to spend some more time on it.

[constala]

writser,

Elders just went through a $57m recap and believe me after the bloodbath suffered by common shareholders in the past decade, to persuade them to buy the common they surely must have planned dividends in the not too distant future, not just pure water blue skies and hopes..... again, before the common holders receive one cent the pref holders must receive 8.7% in full...

 

A buyback offer fully in cash at Par or Par+cumulative Coupons ie 108.7% is only part of a wide range of possibilities.

 

It is very frequent for those type of capital instrument to be bought back before they become expensive, and out-dated/out of scale compared to the new scope of the business. In 2012-2013 I x4 my money with the Unipol/Fondiaria hybrids in Italy....same kind of narrative. In Europe Insurance companies and banks launch those balance sheet arbitrage/debt management all the time.

 

Elders could be creative and propose a mix of cash, debt and equity (common, and/or a new junior hybrid with different terms?).

 

A predator and there are quite a few circling Elders could be better off buying the hybrids before the take-over, lessening their cost significantly.  Indeed under the terms of the preference shares, a takeover or merger scheme recommended by Elders directors entitles investors to ask for the stock to be converted into ordinary shares so they can participate. Not only that, but the formulas for calculating conversion at that time include allowing preference-share holders to get half the premium above the average market price being paid to ordinary shareholders in a takeover. Essentially that means anyone bidding for Elders has to factor in covering the $150 million face value of the preference shares, and maybe a little more.

 

Another key point there is a Coupon Step up "remarketing  event" on 30 June 2016, which will increase the coupon to MAX (3m bill rate,10y swap rate)+7.20%.

 

That would increase the coupon to +/- 11% depending on the prevailing rates by then... (3.7% now)!

 

The company would be very foolish NOT to buy back those prefs below face value before they become such a drag on the cash-flows for perpetuity...I let you do the maths; it is a no-brainer.

 

 

 

 

 

 

[Hielko]

Because the prefs are non-cumulative the company has a strong incentive to not pay any dividends in the near future. As a common shareholder delaying dividends at the expense of preferred shareholders is a pretty good deal as long as the company has good reinvestment opportunities since as a common shareholder you profit if the business grows in intrinsic value. It seems to me that this is exactly what they intent to do based on the language in the latest annual:

 

Having now substantially addressed the Company's debt burdern, the Board and Managment's priority in the short to medium term is to direct cash flow back into reinvigorating and strengthening the business to grow earnings and returns. As a result, ordinary share dividends (and hybrid distributions) are unlikely to resume in the near term.

 

I also don't think that the increasing coupon is a big deal. If the company is smart they delay paying dividends for a long time, and then when the time comes they redeem the preferreds at par + 1yr of coupons. Seems to me that you are mostly betting on management feeling a moral obligation to start paying preferred coupons when the business is healthy again.

 

I actually don't really understand why investors buy these kind of securities anyway.

[writser]

I guess the attractiveness depends on what you define as the 'near future'.  If you believe they will tender for the hybrids in the next 2/3 years this is obviously a great investment. But I agree with Hielko that that timeframe is probably too optimistic. If I were the CEO I would also prefer to invest in the company first for a couple of years - **** the hybrids, I can just ignore them. $150m is a lot to cough up at this stage and they'd screw over existing shareholders by exchanging the hybrids for common shares so that's probably not going to happen either.

 

And if the retirement of the hybrids takes anywhere over 4/5 years your expected return starts to diminish sub 15% quickly. @Constala: what makes you so sure about your timeframe?

[constala]

@writser: I recall management mentioned a time frame between 2 and 3 years for the dividend resumption.

In this record low interest rate world we are living in, what price do you give today for a forward perpetual stream of 11% (with upside to rising rates)?

 

[Hielko]

@writser: I recall management mentioned a time frame between 2 and 3 years for the dividend resumption.

In this record low interest rate world we are living in, what price do you give today for a forward perpetual stream of 11% (with upside to rising rates)?

What a 11% perpetual income stream is worth isn't really relevant since this security will almost certainly be called/converted when dividends resume.

[constala]

from Hielko "I actually don't really understand why investors buy these kind of securities anyway.".....

 

Generally, I find the  mood on this forum fairly representative of the value equity analysis framework and mentality: everything that differs from good old common equity is treated with a degree of caution, if not contempt. I beg to differ; fixed income instruments and hybrid securities are not as negatively convex as they seem when they are bought below Par.

 

My point is simplistic: you can buy today ELDPA at 56% and it will be worth between 80% (assuming buyback before the 30 June 2016) to 108% (resumption of divs) in less than 3 years. Elders has moat, history, and relevance, a skilled manager, and positive cash flow and momentum, they just have to deliver on their conservative plan. Nothing "blue sky" here is needed for investment success. This is a double digit return with very high visibility on the time frame.

 

Last time I looked investing was about making money, guys, it is not the olympics games of diving, there are no extra bonus points for elegance or difficulty.

 

I am all ears if you can suggest other instruments of which you can ascertain the forward price, gross return, timeline with such inexorable precision and that offer 15%/20% IRR!

 

 

 

[Hielko]

I have absolutely nothing against non standard securities, but I do have a problem with non cumulative preferred stock. It's almost the same as giving someone a loan that the never have to pay back, and they also don't need to pay interest if they don't want to. It's just a crappy deal where you are at the mercy of the management team.

 

It might play out the way you envision, but I'm not so sure that there is a timeline with inexorable precision.

[constala]

Just a quick update, as ELDPA is now 69 bid/69.8 offer (was 56 on my early 5 dec 2014 thesis).

 

Heavy consistent buying on ELDPA (strategic buyer?) and also on the common ELD with a new institutional shareholder surfacing

in January on ELD common: AMP with 5%.

 

ASX 200 Index reshuffle end of March could render ELD eligible, as MCap now sufficient: AUD 275m; that could explain some tactical index weighting speculation on the common.

 

Business momentum/drivers are good with cattle price beating records in Australia, and a weak currency helping exports, and management reasonably optimistic on 2015 outlook.

 

Par still the 2y term price target on ELDPA...

 

 

 

[constala]

ELDPA is now 75 bid (from 56 6 months ago, a 34% return )The company target Ebitda is 60m for FY 2017. Thanks to its deferred tax assets a fair EV/EBITDA (acquisition) multiple should easily reach x 10. Remember Elders is fast regaining strategic value for a lot of different pockets of money (Private Equity, Asian, domestic players). So we could easily get a 600m Entreprise Value. We can ignore debt, there is no long term debt any more, debt is just short-term, trade receivables backed, secured financing. So all the EV should be reflected in the Market Cap of the Common + Market Cap of the the Hybrids. Common Market Cap is now 321m. so there is plenty upside left for the common, even if we can assume the hybrids can be retired at, or close, to Face Value of 100%: 145m.

 

The company said they will restructure the capital sometimes in 2016 or 2017. That means retiring=buyback offer for the hybrid ELDPA which is getting too big/the new Elders perimeter of business, and too expensive (and dividend blocker, participates in any take-over bid, senior in liquidation)....

 

There is a clear catalyst: the Coupon Step up "remarketing event" on 30 June 2016, which will increase the coupon to MAX (3m bill rate,10y swap rate)+7.20%. That would be 10.50%! ie AUD 15.2m dividends just for the hybrids holder....that is far too high Elders should hurry to buy it back if the common equity holders are to receive any dividend....The buyback could be cash (one coupon)+ a swap into another preferred, and/or some common equity....Anything is possible but one could assume it will be done around par...or par+coupon.

 

It should be a fairly straight trajectory form 75 to 100+coupons in about 12 months. That is a ~40/50% return.

[Grotifant]

Elders buys back up to AUD 30m worth of Hybrids on-market up to a price of AUD 80 / share financed through by this year's earnings. Notice attached. 

01650541.pdf

01650541.pdf

[constala]

Pay day!

 

ELDPA reached 96 this morning and there is a 95 takeover on the table.

 

From Australian newspapers:

"Elders is raising $102 million from investors so it can buy back the group's hybrid securities and simplify its share structure.

Elders on Friday announced a $77.4 million one-for-four non-renounceable entitlement offer at $3.40 per share. It also said it had completed a placement of 7.35 million ordinary shares to institutional and sophisticated investors at the same price, raising $25 million. The $102.4 million raised in total will be used to acquire Elders Hybrids at $95 each. Chief executive Mark Allison said the offer to acquire the hybrid shares represented an excellent opportunity for holders to monetise investments. It also provided an opportunity for Elders to "normalise" its capital structure, to the benefit of its ordinary shareholders.

 

"The proposed simplification of our capital structure is the final step in the transformation of Elders from the complex and highly-geared conglomerate it once was to the simplified and efficient business we now are," Mr Allison said. "Importantly, removal of the hybrids will allow Elders to fulfil its undertaking to ordinary shareholders to recommence dividends at the completion of the 2017 financial year."

 

[Radio Free Cash Flow]

Really nice result. Sad to say I sold my hybrids at around 75. Shoulda been more patient!