Take Home 16% YTM In Data Group's 15-Month CAD Convertible Bonds

| About: Data Communications (DGPIF)

Summary

For Q4 2015, the company had a 34.8% increase in adjusted EBITDA year-over-year.

Its adjusted EBITDA margin increased from 7.7% in Q4 2014 to 10.3% in Q4 2015.

The company has solid interest coverage of about 3.75x's.

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Our review this week focuses on Data Group (OTCPK:DGPIF), a Canadian document management and marketing company that we been following very closely since our first review in April of last year. Since that time, the company has undergone a remarkable transformation that included significant cost reductions, major debt restructuring and most recently, a complete corporate rebranding. The effects of the multiple changes implemented by its new CEO and management team have only just begun to show up in Data Group's surprising Q4 2015 year end report, which came in well above our expectations for it, and demonstrate what can be achieved in a relatively short period of time with the right leadership. In short, the improvement was dramatic enough to merit a full reassessment of this company's potential yield, not only with the high 16.75% yield of its few remaining 15 month bonds, but as much greater longer term equity investment.

  • For Q4 2015, the company had a 34.8% increase in adjusted EBITDA year-over-year.

  • Adjusted EBITDA margin also increased year-over-year in Q4 to 10.4%, up from 7.7%.

  • Interest coverage for Q4 came in at a solid 3.75x.

  • In addition, Data Group stock recently doubled on the news of its solid Q4 results.

While many fixed income investors are more leery of companies that have undergone debt restructuring, our experience has shown that it can present fantastic opportunities for greater gains once the right criteria for improvement is in place. Data Group appears to have ticked all the right boxes, and not only successfully stabilized its business, but is now focusing on growth. If the company can continue on its current trajectory of growth and profitability, equity investors that stay the course stand to be handsomely rewarded. Aside from the appreciation potential of the company's stock, a limited amount of Data Group's remaining 6%, June 2017 convertible debentures in Canadian dollars, still trade at a discounted price of around 88.5, and offer the more traditionally conservative income investor an extremely attractive 16.75% short term yield in Canadian dollars. Therefore we recommend holding and/or increasing current equity and bond positions within our FX2, FX3 and Distressed Debt 1 Hedge Fund global high yield and income portfolios.

An Update on the Issuer

Based in Brampton, Ontario, Canada, Data Group Ltd. is a managed business communications services company specializing in customized document management and marketing solutions. Data Group develops, manufactures, markets and supports integrated web and print-based communications, information management and direct marketing products and services that help its customers reduce costs, increase revenues, maintain brand consistency and simplify their business processes. Our last review of Data Group revealed a company in midst of restructuring. With its latest Q4 and annual results for 2015, we find a company that has emerged from restructuring and posted robust gains in adjusted EBITDA as well as increasing margins and outstanding interest coverage.

Solid Quarterly and 2015 Results

With Data Group's debt completely restructured and its operational costs reduced through employee reductions and facilities consolidations, the market appears to be very slow in anticipating the company's recent rebranding and forward momentum. We think the most recent reported quarterly results are only beginning to show the rewards for the company's determination and persistence in redefining Data Group as a leading market competitor.

For Q4 2015, Data Group posted significantly better quarterly results that were expected. Adjusted EBITDA was up 34.8% year-over-year, coming in at $8.4 million. Q4 margins also showed improvement over the previous year. Adjusted EBITDA margin increased from 7.7% in Q4 2014 to 10.3% in Q4 2015. Additionally, lower labor costs, improved utilization rates at key plants and higher levels of revenue had a positive effect on gross margins, which improved to 24.4% from 23.3%. Michael G. Sifton, Data Group's President commented on the company's Q4 results, "While Data Group will continue to carefully manage its operations, it is turning its efforts toward stabilizing its revenue, including a renewed focus on core vertical markets….. where it sees opportunities for improved product margin together with growth opportunities."

And while the company registered a large impairment charge in Q3 2015, it is worth noting that Q3 was also profitable when omitting the restructuring costs and impairment charges. (Data Group registered a loss of $32.6 million for Q3, with a total restructuring / impairment charges of $38.1 million for Q3).

Similarly, for the full year 2015, Data Group did show a profit after accounting for adjustments related to its restructuring. Adjusting for the company's restructuring costs ($13.6 million for 2015), a one-time impairment charge of $26.0 million as well as the gain realized by redemption of its convertible debentures (roughly $12.8 million), the company registered an adjusted net income of $5.76 million.

Excellent Interest Coverage

Data Group recently completed restructuring of its outstanding debentures as well as a refinance of its credit facility (discussed later in this review). These changes have provided additional cash flow flexibility in the form of reduced interest expenses. In its most recent quarterly results, Data Group reported operating income of $17.912 million. This figure includes a gain on the redemption of its convertible debentures of $12.8 million. When removing the gain on these debentures (a one-time item), the company had operating income of $5.146 million, with a reported interest expense of $1.370 million, for an interest coverage of 3.75x.

On a go-forth basis, total interest expense for the company should be approximately $3.166 million or roughly $792 K per quarter. (Interest expense calculated using the following - $28 M IPD Credit Agreement at 6.95% annual interest, $11.2 M 6% Convertible Debentures, $15.9 M credit facility at Canadian Prime Rate + 75 basis points). If we annualize Q4's operating income of $5.146 M, we get annual operating income of $20.584 M. This calculates to an outstanding interest coverage of 6.5x. For a company that was questioning its long-term viability in the latter part of 2015, this turnaround is nothing short of extraordinary.

Debt Restructure and Credit Facility Refinance

In Q4, Data Group completed the restructuring of its outstanding 6.0% Convertible Debentures. Data Group announced, effective November 12, 2015, that it would redeem 75% of these bonds and satisfy the redemption by issuing common shares of stock in lieu of cash. In mid-December 2015, the company redeemed approximately $33,530,000 of convertible bonds and issued 975,262,140 new shares of common stock.

The value of the shares issued amounted to $19.5 million to satisfy the carrying value of the bonds on conversion date of $32.7 million. As a result, Data Group realized a gain on the bond redemption of $12.8 million (after transaction costs of $0.4 million). The remaining 25% of these bonds will continue to their original maturity in June 2017, with the company continuing to pay interest in cash.

As a result of Data Group's debt restructure, the company was able to refinance its credit facility which would have come due later this year. The company secured the IPD Credit Facility through Integrated Asset Management Corp as well as a Bank Credit Facility with a Canadian bank. The total available through both credit agreements is $50 million, with Data Group currently using $43.3 million (used to refinance its former credit facility).

Stock Appreciation for Bondholders

A majority of Data Group's bondholders received Data Group stock upon the company's restructuring. While the company's stock has been (understandably) affected by the company's recent restructuring, investors should be encouraged by the recent increase in stock value after release of Data Group's Q4 and 2015 results (which increased 100% from $0.01 to $0.02 / share). As of the writing of this article, Data Group (NYSE:DGI) is trading at $0.025/share Canadian. Considering its recent break-out quarter, if the company can continue on this trajectory, shareholders could be handsomely rewarded.

Corporate Rebranding

In order to support Data Group's efforts to stabilize and grow revenue, the company has developed a renewed strategic plan, customer value story and marketplace identity. In March 2016, the company announced a complete corporate rebranding, which includes a new operating name. Effective immediately, the company will operate under its new name, "Data Communications Management".

Risks

The default risk is Data Group's ability to perform. Its most recent quarterly results are beginning to show the positive effects of the company's debt restructuring and expense reductions. In addition to shoring up its balance sheet, these results also show profit margins improving. Data Group has also successfully refinanced its revolving credit facility which provides the company with additional flexibility in the timing of repayments. Considering all of these factors, it appears that the company has turned the corner and is now ideally positioned for growth.

An option that further reduces the default risk of this convertible bond is a conversion of the principal (at par) to Data Group common stock at a 5% discount to the stock's 20 day weighted average valuation at maturity on 6/30/2017.

A more difficult risk for us to identify is the geopolitical risk. With that said, Canada is one of the more desired countries for business to operate within, and it's hard for us to imagine the geopolitical risks deepening from the past few years. Being denominated in Canadian Dollars, this note also exposes bondholders to the Canadian economy and the exchange rate of the loonie.

This convertible bond has a 6.0% coupon yield, paid semi-annually, and carries similar risks to other Canadian-based convertible bonds that we have reviewed, such as the 8.8% Canwel Debentures, the 7.5% TransGlobe Energy Debentures, and the 9% 5N Plus Debentures.

Summary and Conclusion

2015 was a transformational year for Data Group. During the course of that year, the company significantly reduced its workforce, effectively decreased expenses, and smartly restructured its debt. These efforts have clearly begun to pay dividends as evidenced by its latest quarterly results. With new management and a new corporate identity, Data Group (now Data Communications Management), looks to have taken the necessary steps to position the company for long-term viability and growth. With its debt restructuring completed, the few remaining outstanding debentures from this issue continue to offer excellent yields at significantly declining risks for investors. In addition to this, we believe that the stock is tremendously undervalued and should be held until further evidence of the company's growth potential is revealed and evaluated. Therefore, we continue to recommend these bonds, as well as equity positions, for our clients seeking both high income and long term capital gains from equity growth, and have adjusted weightings in our Fixed-Income2.com, Fixed-Income3.com and Distressed Debt 1 Hedge Fund portfolios to accommodate larger positions in each.

Issuer: Data Group Inc.
Ticker: DGI (TSX Exchange)
Stock Price: 0.025 (NYSEARCA:CAD)

Bond Coupon: 6.00%
Conversion Option Price: (too high to be a significant benefit or factor to bondholders)
Ratings: NA
Maturity: 6/30/2017
Pays: Semi-annually
PCUSIP: 23768VAA3
Price: 88.6
Yield to Maturity: ~16.78%

Disclosure: Durig Capital, Distressed Debt 1 LP, and certain clients may have positions in Data Group 2017 Convertible Debentures and Data Group stock.

Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.

Disclosure: I am/we are long DGPIF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.