EZPW - EZCorp

[DTEJD1997]

Hey all:

 

I bought more shares of this today.

 

Could the bigly price drop be hedging for the convertible debt to some degree?

 

Whatever the cause, I think a 15% selloff is not a rational response.

 

[Homestead31]

definitely some short selling in front of the convert.

 

the other side of it however is that a convertible bond is (potentially) dilutive to the equity.  terms aren't finalized, and there may be some derivatives around the bond to insure against excessive dilution, but you could make the argument that they are selling cheap stock to focus on acquisitions, which is not attractive for obvious reasons.  too early to tell at this point b/c we don't know final terms, and we don't know what they are going to buy.

[Guest roark33]

Why would the insiders be "selling cheap stock"...don't you think the more logical explanation could be that they don't think the stock is that cheap? 

[Homestead31]

that is also possible, but i think it is hard to make that argument when the closest comp FCFS (which is very close indeed) trades at almost double the multiple, and EZPW is taking share from FCFS.

 

it is baffling why they would use (potential) equity currency, but management teams do stupid things all the time when it comes to capital allocation.  this is more surprising b/c these guys are supposedly financially savvy.  in any case, until terms are finalized, we won't know if it is really dilutive, or if there are derivatives or other features that will prevent the dilution.

 

 

 

 

[racemize]

the term loan was really expensive.  Really don't know anything until we get the details.

[ragnarisapirate]

It doesn't matter if the equity they issue is expensive or cheap... just so long as what they buy with it is cheaper.

 

I absolutely love the pawn business. These guys really seem to have turned the corner. I don't presently own any (previous did tho), but am really thinking about buying and making it a significant position. It seems like the big owner is starting to realize the only way his shares will be worth anything is if he isn't so shareholder unfriendly.

 

Think about how the incentives of this deal are probably going to work, and the comp and ownership of the company as a whole. Think of the industry dynamics at the moment.

[DTEJD1997]

Hey all:

 

I am going to guess that EZPW management already has, OR is very close to having deal(s) in MX already lined up.  Now is probably a good time for Americans to be be buying Peso denominated assets.  The election of President Trump has made Mexican assets very cheap for dollar holders.

 

If I were management there is simply no way I would be announcing all this stuff UNLESS I already had acquisitions in the pipeline.

 

I also seem to recall reading somewhere that managements options vest later this year.  So probably better to do this now than later (from managements perspective).

 

 

[racemize]

I've talked to lots of industry experts on pawn stores, and I've been hearing about some deals that EZPW has turned down.  It's my understanding, at least according to various pawn experts associated with EZPW over the years, that pawn stores are generally bought on a PLO+inventory basis.  Generally, pawn stores are bought in the range of 2xPLO+inventory-7xPLO+inventory.  I asked at the annual meeting how a 3xPLO+inventory converts to earnings, and they indicated somewhere around 5x earnings, for an average store. 

 

Anyway, I've heard that EZPW was not willing to buy anything over 3xPLO+inventory in recent months, which does confirm their comments on acquisition discipline.  It also confirms what ragnar is saying that even issuing cheap equity, you can acquire pawn stores even cheaper. 

 

Moreover, in conversations after the annual meeting, they indicated they would be figuring out how to overhaul their capital structure in June (now), so it isn't surprising they are doing something.  Certainly, everyone agreed that the term loan was too expensive.  The lack of pricing is a little weird though, and I think is causing the market to drop like it has.

[Homestead31]

It doesn't matter if the equity they issue is expensive or cheap... just so long as what they buy with it is cheaper.

 

 

 

you are of course technically correct in that it can be accretive whether the equity is expensive or cheap, but that definitely does not mean that this is the best way to finance a transaction.  A convert will give them a lower rate, which will save them $4-5 million bucks a year...  and then in 5 years they'll effectively be selling 20% of the company.  If the stock was presently at a high multiple of normalized earnings maybe that makes sense.  but at a ridiculously low multiple, it is not the best use of equity currency to save $25M by selling 20% of the company.

[KJP]

Here's the pricing on the first $125 million of the convertibles:  https://www.sec.gov/Archives/edgar/data/876523/000087652317000080/a2017-q4convertiblenotesppr.htm

 

Conversion price is $10/share.

 

 

[racemize]

Terrible price. This is quite disappointing.

[KJP]

Is management's LTIP vesting based on growth in EBITDA or EBITDA/share?  The 10-K suggests it's just EBITDA growth. 

[Homestead31]

it is just EBITDA, not EBITDA per share, but they are rewarded in stock, so they should be focused on EBITDA per share to some lesser extent regardless

[KJP]

it is just EBITDA, not EBITDA per share, but they are rewarded in stock, so they should be focused on EBITDA per share to some lesser extent regardless

 

The most important consideration is to ensure that they vest.

[KJP]

I'm not an expert on convertibles or options pricing, but if you use 60% volatility (which is roughly the implied volatility on EZPW's December 2017 $10 calls) and a $7.70 current stock price, Black-Scholes would value a 7-year warrant on 1 EZPW share with a $10 strike at about $4.44.  If I understand the transaction correctly, the company is effectively selling a bond plus 12.5 million of those warrants.  Black-Scholes would value those 12.5 million warrants collectively at about $55 million. 

 

The annual interest on the notes is $3.6 million ($125 million * 2.875%)

 

After fees the company expects proceeds of $121 million from the offering.  If you subtract the $55 million value of the embedded warrants, that leaves a $66 million principal value for the embedded bond, implying an effective interest rate of about 5.5% (3.6/66).  Is that correct?

[odin]

I can't speak to your math, but your effective yield makes sense intuitively. 

 

The 2019 converts are far out of the money and shouldn't have a huge amount of option value.  These were trading at about +290 to 2019.  Your 5.5% effectively yield is +340 over the 7-year.  I think this is close to where EZ would be able to issue straight bonds.

[KJP]

I can't speak to your math, but your effective yield makes sense intuitively. 

 

The 2019 converts are far out of the money and shouldn't have a huge amount of option value.  These were trading at about +290 to 2019.  Your 5.5% effectively yield is +340 over the 7-year.  I think this is close to where EZ would be able to issue straight bonds.

 

Thanks for the sanity check.  I'm interested to hear management's justifications for this on the next call.

 

 

[racemize]

So, we can't read the details yet, but there is one redeeming thing about these convertibles versus the old ones.  They have a call feature, which is:

 

The Company, at its option, may redeem for cash all or any portion of the Convertible Notes on or after July 6, 2021, if the last reported sale price of the Class A common stock has been at least 130% of the conversion price then in effect for at least 20 trading days, including the trading day immediately preceding the date on which the Company provides notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

 

So, if the stock is trading over $13 for 20/30 days between July 6, 2021 and January 1, 2024, EZPW can call it in at par.  If we are  right, then the stock should be over that by then.  And maybe if we are right, then they will have the cash to call it in then.

 

They can convert based on some other conditions we don't know about yet though:

The Convertible Notes will mature on July 1, 2024, unless earlier converted, redeemed or repurchased in accordance with their terms. Prior to the close of business on the business day immediately preceding January 1, 2024, the Convertible Notes will be convertible at the option of the holder only upon the occurrence of certain events and during certain periods, and thereafter, at any time prior to the close of business on the business day immediately preceding the maturity date.

 

So, in some sense, it could be considered 'good' that the conversion price is lower, as it makes it easier for EZPW to call in sooner.  It seems like this is one of those "clever" trades where you get less interest charge if things go right, but there are shitty results if it doesn't go the right way.  I'd rater they have the higher interest term loan, honestly.  Or just raise a 7% bond. 

[KJP]

So, we can't read the details yet, but there is one redeeming thing about these convertibles versus the old ones.  They have a call feature, which is:

 

The Company, at its option, may redeem for cash all or any portion of the Convertible Notes on or after July 6, 2021, if the last reported sale price of the Class A common stock has been at least 130% of the conversion price then in effect for at least 20 trading days, including the trading day immediately preceding the date on which the Company provides notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

 

So, if the stock is trading over $13 for 20/30 days between July 6, 2021 and January 1, 2024, EZPW can call it in at par.  If we are  right, then the stock should be over that by then.  And maybe if we are right, then they will have the cash to call it in then.

 

They can convert based on some other conditions we don't know about yet though:

The Convertible Notes will mature on July 1, 2024, unless earlier converted, redeemed or repurchased in accordance with their terms. Prior to the close of business on the business day immediately preceding January 1, 2024, the Convertible Notes will be convertible at the option of the holder only upon the occurrence of certain events and during certain periods, and thereafter, at any time prior to the close of business on the business day immediately preceding the maturity date.

 

So, in some sense, it could be considered 'good' that the conversion price is lower, as it makes it easier for EZPW to call in sooner.  It seems like this is one of those "clever" trades where you get less interest charge if things go right, but there are shitty results if it doesn't go the right way.  I'd rater they have the higher interest term loan, honestly.  Or just raise a 7% bond.

 

I suspect that there are going to be broad rights to convert early.  For the reasons discussed earlier in the thread, it appears that whoever is buying these notes gave up 300 - 400 bps of yield to get the conversion feature/embedded warrant.  It's hard to believe someone would give up that much yield and also agree to a call feature that would render the embedded warrant worthless if the stock price rises above $13/share. 

 

Said another way, if the events triggering earlier convertibility were very narrow, the call feature would essentially cap the potential payout on the embedded warrant at $3/share (at a share price above $13 the company should just render the warrant worthless by issuing equity to redeem the bonds, rather than have them convert to equity at $10), implying a total potential payout on the embedded warrants of $37.5 million (12.5 million shares at $10 conversion price * $3/share).  That max potential payout has to be balanced against a real probability of the warrant being worthless if the stock price is below $10 or above $13.  Hard to see how that payout profile can possibly justify surrendering 300 - 400 bps of yield.

 

Long story short, either I don't understand the transaction (quite possible) or there are going to be broad rights to convert early.  Either way, the prospectus supplement for this offering will be educational.

[racemize]

Or perhaps they just don't think the company is worth more than 13--the market is quite pessimistic after all. I'm very interested to read the details.

[Homestead31]

Terrible price. This is quite disappointing.

 

there seems to be a big lack of understanding with how convertibles work.  i definitely am not an expert, but from what i can tell from reading the stuff on the 2019 convert, while $10 is the "conversion price," it is not REALLY the conversion price b/c of derivatives. 

 

For example, the 2019 convert had a "conversion price" of $16.065, but then the 10k goes on to describe hedges around that, and then selling warrants with a strike of $20.83 - about 30% higher.  So basically the sold the convert which is 1 part bond, and 1 part long dated call option with a 16.065 strike.  then they buy a long dated call option with a similar or the same strike, and then they sell a warrant (which is basically a long dated call) at $20.83.  the combined result is that nothing has happens at $16.065, but if shares go to $20.83, they are on the hook.  Also from the 10k the effective interest rate on the 2019 converts was 8%, while the face rate is 2.125%.  that jump from 2.125% to 8% is because of the costs to buy back the 16.065 call that they were short from the convert.

 

bottom line is that the $10 price is mis-leading, because that is not the price that which dilution will happen at.  using the 2019 bonds as a guide, real potential dilution will likely be at $13.

 

to be clear, i STILL think $13 is cheap, but it isn't as cheap as $10.

[racemize]

Terrible price. This is quite disappointing.

 

there seems to be a big lack of understanding with how convertibles work.  i definitely am not an expert, but from what i can tell from reading the stuff on the 2019 convert, while $10 is the "conversion price," it is not REALLY the conversion price b/c of derivatives. 

 

For example, the 2019 convert had a "conversion price" of $16.065, but then the 10k goes on to describe hedges around that, and then selling warrants with a strike of $20.83 - about 30% higher.  So basically the sold the convert which is 1 part bond, and 1 part long dated call option with a 16.065 strike.  then they buy a long dated call option with a similar or the same strike, and then they sell a warrant (which is basically a long dated call) at $20.83.  the combined result is that nothing has happens at $16.065, but if shares go to $20.83, they are on the hook.  Also from the 10k the effective interest rate on the 2019 converts was 8%, while the face rate is 2.125%.  that jump from 2.125% to 8% is because of the costs to buy back the 16.065 call that they were short from the convert.

 

bottom line is that the $10 price is mis-leading, because that is not the price that which dilution will happen at.  using the 2019 bonds as a guide, real potential dilution will likely be at $13.

 

to be clear, i STILL think $13 is cheap, but it isn't as cheap as $10.

 

The press releases for the previous convertibles included all that information.  In this case, they did not undertake those transactions, so I do not think they apply, unless they are going to enter into those contracts separately. 

 

I also think that extra cost from the 2014 AR is because of the embedded value of the call of the convertibles, not the hedging transaction.  KJP posted math to show how you get from the listed value to the accounting interest cost.

[racemize]

Just for reference, the previous press release in 2014 used the exact language used in the current ones, excluding the call feature and the warrants/hedging.  Here is what the 2014 indenture said regarding the conversion (http://app.quotemedia.com/data/downloadFiling?webmasterId=101533&ref=9667102&type=HTML&symbol=EZPW&companyName=EZCORP+Inc.&formType=8-K&dateFiled=2014-06-23):

 

Section 4.01.  Conversion Rights.  (a)  Subject to and upon compliance with the provisions of this Article 4, each Holder shall have the right, at such Holder’s option, to convert solely into cash all or any portion (if the portion to be converted is $1,000 principal amount or an integral multiple thereof) of such Security (i) subject to satisfaction of one or more of the conditions described in subsections (b) through (e) of this Section 4.01, at any time prior to December 15, 2018, under the circumstances and during the periods set forth in subsections (b) through (e) of this Section 4.01, and (ii) irrespective of the conditions set forth in subsections (b) through (e) of this Section 4.01, on or after December 15, 2018, and prior to the close of business on the second Scheduled Trading Day immediately preceding the Maturity Date, in each case solely into cash at an initial conversion rate of 62.2471 shares of Class A Common Stock (subject to adjustment as provided in Section 4.04, the “Conversion Rate”) per $1,000 principal amount of Securities (subject to the payment provisions of Section 4.02, the “Conversion Obligation”). In no event may any Security be surrendered for conversion after the close of business on the second Scheduled Trading Day immediately preceding the Maturity Date.

 

(b)                      Prior to December 15, 2018, a Holder may surrender all or any portion of its Securities for conversion solely into cash during any fiscal quarter commencing after the fiscal quarter ending on September 30, 2014 (and only during such fiscal quarter), if the Last Reported Sale Price of the Class A Common Stock for at least 20 Trading Days (whether or not consecutive) during the period of 30 consecutive Trading Days ending on the last Trading Day of the immediately preceding fiscal quarter is greater than or equal to 130% of the Conversion Price on each applicable Trading Day.

 

©                        Prior to December 15, 2018, a Holder may surrender all or any portion of its Securities for conversion solely into cash during the five Business Day period after any five consecutive Trading Day period (the “Measurement Period”) in which the Trading Price per $1,000 principal amount of the Securities, as determined following a request by a Holder in accordance with the procedures described below, for each Trading Day of the Measurement Period was less than 98% of the product of the Last Reported Sale Price of the Class A Common Stock and the Conversion Rate on each such Trading Day. The Bid Solicitation Agent shall have no obligation to determine the Trading Price per $1,000 principal amount of the Securities unless the Company has requested such determination in writing; and the Company shall have no obligation to make such request unless a Holder provides the Company with reasonable evidence that the Trading Price per $1,000 principal amount of the Securities would be less than 98% of the product of the Last Reported Sale Price of the Class A Common Stock and the Conversion Rate.  No later than the Trading Day after receiving such evidence, the Company shall instruct the Bid Solicitation Agent to determine the Trading Price per $1,000 principal amount of Securities beginning on the Trading Day following the Trading Day on which the Bid Solicitation Agent receives such instructions and on each successive Trading Day until the Trading Day on which the Trading Price per $1,000 principal amount of Securities is greater than or equal to 98% of the product of the Last Reported Sale Price of the Class A Common Stock and the Conversion Rate.  If the trading price condition has been met on any Trading Day, the Company shall so notify the Holders, the Trustee and the Conversion Agent (if other than the Trustee) in writing on such Trading Day.  If, at any time after the trading price condition has been met, the Trading Price per $1,000 principal amount of Securities is greater than or equal to 98% of the product of the Last Reported Sale Price of the Class A Common Stock and the Conversion Rate for such Trading Day, the Company shall promptly so notify the Holders, the Trustee and the Conversion Agent (if other than the Trustee) in writing.

 

(d)        If, prior to December 15, 2018,  the Company:

 

(i)            issues to all or substantially all holders of Class A Common Stock any rights, options or warrants (other than under a shareholder rights plan where an adjustment is not made for such issuance under Section 4.04) entitling them, for a period of not more than 45 days after the announcement date of such issuance, to subscribe for or purchase shares of Class A Common Stock at a price per share that is less than the average of the Last Reported Sale Prices of the Class A Common Stock for the 10 consecutive Trading Day period ending on, and including, the Trading Day immediately preceding the date of announcement of such issuance; or

 

(ii)          distributes to all or substantially all holders of Class A Common Stock the Company’s assets, securities or rights, options or warrants to purchase the Company’s securities, which distribution has a per share value, as reasonably determined by the Board of Directors, exceeding 10% of the Last Reported Sale Price of the Class A Common Stock on the Trading Day preceding the date of announcement for such distribution,

 

then, in either case, the Company shall notify the Holders and the Trustee at least 20 Scheduled Trading Days prior to the Ex-Dividend Date for such issuance or distribution.  Once the Company has given such notice, Holders may surrender all or any portion of their Securities for conversion solely into cash at any time until the close of business on the earlier of the Business Day immediately preceding the Ex-Dividend Date for such issuance or distribution and the Company’s announcement that such issuance or distribution will not take place.

 

Holders may not exercise their conversion right in connection with any distribution described in this Section 4.01(d), and notice of such events shall not be required, if such Holders participate at the same time and upon the same terms as holders of Class A Common Stock and solely as a result of holding their Securities, in any of the transactions described in this Section 4.01(d) without having to convert their Securities as if they held a number of shares of Class A Common Stock equal to the Conversion Rate, multiplied by the principal amount (expressed in thousands) of Securities held by such Holder.

 

(e)        If a transaction or event that constitutes a Fundamental Change or Make-Whole Fundamental Change occurs prior to December 15, 2018, regardless of whether a Holder has the right to require the Company to repurchase the Securities pursuant to Section 3.02, or if the Company is a party to a Specified Transaction (other than a reclassification of the Class A Common Stock that increases the rights thereof relative to the Class B Common Stock pursuant to which holders of the Class A Common Stock solely receive Common Equity interests that are listed or quoted on any Permitted Exchange or that will be so listed or quoted when issued or exchanged in connection with such transaction or transactions and as a result of such transaction or transactions such consideration becomes the sole Reference Property for the Securities) that occurs prior to December 15, 2018, then all or any portion of a Holder’s Securities may be surrendered for conversion solely into cash at any time from or after the date that is 90 Scheduled Trading Days prior to the anticipated effective date of the transaction (or, if later, the Business Day after the Company gives notice of the anticipated effective date of such transaction) until 35 Trading Days after the actual effective date of such transaction or, if such transaction also constitutes a Fundamental Change, until the related Fundamental Change Repurchase Date.  The Company shall notify the Holders, the Trustee and the Conversion Agent (if other than the Trustee) as promptly as practicable following the date the Company publicly announces such transaction, which will be at least 90 Scheduled Trading Days prior to the anticipated effective date of such transaction to the extent practicable, or if giving such advance notice is not practicable, within five Business Days of the date upon which the Company otherwise determines that the effective date of such transaction is reasonably certain, but in no event later than the actual effective date of such transaction.

 

Given that b) and c) neuter the call feature in the current press release, I hope they are not present for the ones just issued. 

[Ismael]

If I were Cohen I would prefer the management be incentivized to increase EBITDA instead of EBITDA per share so that in a few years, when the smoke has blown over, I can reinstate the “consulting” fees.  If the cash flows are larger, then I can charge a higher “consulting” fee.  Is there any other reason to emphasize EBITDA vs EBITDA per share?  Also, it looks like the majority of the RSUs vest in Sept 2018 instead of Sept 2017.  Am I missing something here? 

[racemize]

The compensation is based on FY18 performance, which starts 10/1/17.  So the expectation is that none of the reporting matters until Q1 for their compensation.