YRC Worldwide And The December 'Financing Transactions'

| About: YRC Worldwide, (YRCW)
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A significant amount of movement in the YRC Worldwide (NASDAQ:YRCW) stock price recently was due to announcement of their "refunding" efforts, just a few days prior to Christmas. The press release contained a series of transactions involving their convertible debt, with the total sum of equity raised totaling close to $300 million.. We examined these transactions a bit closer to discern what exactly is the benefit of the change in financing. At first glance it looks like a successful effort of YRCW raising more equity to keep operating capital (CASH) positive and continue their transformation. Closer review reveals the adjustments in financing are not as great as it first appears…. Here was their current debt picture at year end 2012 per the 10K filing. Their total long term debt interest payments in FY2012 was $150.0 million, not including $78 million of off balance sheet operating lease payments (expensed under Oper supplies)

YRCW Total Debt Outstanding FY2012 (10K)

$Par Value $MM

Std. Int Rate

Restructured Term Loan

298.7

10.0%

Term A Facility

105.0

8.5%

Term B Facility

222.2

11.3%

Series A Notes

161.2

10.0%

Series B Notes

91.5

10.0%

6% Notes

69.4

6.0%

A&R CDA

125.8

3-18%

Lease Fin.-Capital Lease

306.9

10-18%

1380.7

Basically, the company raised $250MM to pay off the 6% notes(their cheapest financing) which mature this February 2014, and the Series A Notes which mature in 2015. In addition, holders of the Convertible Series B notes, (balance approximately $50MM) are converted into equity common shares as well. No cash is raised here with the B notes, a convertible high yield debt holder is simply becoming an equity holder.

The exact details are below: All the pieces add to roughly $300MM

  1. Company raised 30MM in an offering of equity of roughly 3 million shares thru MLV Brokers…..on or about Dec3rd, we think this was priced close to 10.00 / share, raised $30MM, dilution +3 million shares in an open market offering.
  2. Company agreed to exchange$50.56MM 10% Series B Convertible Notes due 3/31/2015 , Convertible prior at 18.50/share. The sweetener here for the hedge fund holders of these notes is the security is now convertible at 15.00 per share.
  3. Company raised $214.5MM of common equity at 15.00-16.00 per share, with the proceeds used for general company purposes (namely to retire the 6% Notes Due Feb 15th, 2014.) However, the stock purchase agreement and registration rights agreements dictate that the other$167MM of 10% SERIES A notes due 3/31/2015 must be redeemed in full by 7/20/2014, or 6 months after the closing of the refunding/exchange offers, expected to be on or about January 20th. This cash of 167MM is most likely put in a trust so that the Series A note liability and additional PIK accrual will cease in February.
  4. Company raised $36MM by selling Preferred Equity shares at $60 each, convertible into common at $15/ shares, creating 600,000 shares of preferred.

So after checking the language on all the moving parts, the question is, how much money are they really saving ?

Here is the math we examined, for each note retired and the annualized interest savings on debt.

SECURITY Retired & SAVINGS created on an annual basis

6% Notes: 69.5MM redeemed 2/15/2014, saves 6% on an annual basis or 4.2 mm in cash

10% Series B Notes: Exchanged for equity at 15.00 per share, does not create or raise any cash but saves 10% x 68.2MM or roughly 6.82MM per year in forgone interest payments

10% Series A Notes: Continue to accrue at 10%, these are PIK or (Pay in Kind) so the company was never paying cash interest here, but rather the balance of the notes was "neg" amortizing upward, to the tune of $157.6MM in 2011, and 173.5MM at Q3 2013. Cash savings here is zero, but at least the notes balance will stop accruing in 2014, and it looks as though the agreements state the Series A notes must be redeemed within 6 months of the "closing date" or Jan 20th, 2014. That cash equity raised must be put in a trust and held to pay off the Series A notes.

"New" Pref'rd Equity: These securities not being retired, but the $36MM raised by preferred accrues at 5% for months 1-12, accrues at 10% months 13-18, and accrues at 15% months 19-200, or whenever it retires. So NO savings on $36MM at an average cost of financing of 11% or so.

So on a CASH basis, the interest savings is only $4.2MM plus 6.82MM, or a total of approximately $11 million dollars annually, not including the extra cost of the new preferred stock. This also does not include the Series A Notes, which are accruing at 10% per year, but are not paid in cash and never were paid in cash but "Pay in Kind". Once those Series A notes are repaid /redeemed the interest savings will be an additional $16MM on paper, but zero on a cash basis. Looking at their financials the last five years (given the massive restructuring in 2010), it appears the company is still burning cash at a healthy rate in the low operating (neg operating) margin truckload and LTL business. Clearly , according to the recent conference calls and releases, YRC Regional continues to perform with better operating ratios but YRC as a whole still has considerable challenges.

9mos 2013

2012

2011

2010

2009

2008

Net Loss attrib to Common

(74.2)

(140.4)

(409.3)

(325.8)

(619.5)

(977.6)

Net Cash Prov by Oper Activities

(3.0)

(25.9)

(26.0)

0.7

(379.3)

219.1

Capex

(56.5)

(66.4)

(71.6)

(19.2)

(36.3)

(161.5)

Estimated Free Cash Flow

(59.5)

(92.3)

(97.6)

(18.5)

(415.6)

57.6

So for a company that paid $150MM in interest in 2012 according to their 10K, and 10Q filings, the savings with the recent equity offering amounts to roughly 9MM - 11.00 MM per year, or roughly 7% of their total interest cost on an annual basis. Their 10K lists most of their funding obligations, (term notes, ABL lines, pension deferred obligations, and capital leases) with nominal (stated) interest costs between 10% and 14%. Given the large size of the debt obligations, without principal reductions, the only way to raise money was for YRCW to raise equity at 15-25% rates via massive dilutions, (outstanding shares will go from 10.2 million shares to over 30 million shares after all the exchanges). Keep in mind their thin operating margins in a very crowded trucking space. Unless their bankers lower their interest rates to below 9% we do not see how the company can ever be cash flow positive. They have deferred major capital equipment purchases for 5 years now, and the only new equipment coming along is under operating leases at very high rates. (their operating lease expense in 2012 was $78 million)

In addition, as for EBITDA generation, each year their depreciation number is getting smaller and smaller as their fleet is old and heavily written down already via depreciation. You cannot increase depreciation unless you (1) add more assets to depreciate (which they have not added trucks for 5 years) or 2) you alter the depreciation schedule. We compared YRCW depreciation schedules for their revenue equipment and it is at least 5-7 years higher than any other truck company we could find. Remember, the shorter depreciation schedule, the heavier the depreciation in the given yearly period. CNW, ABFS, and SWIFT seem to use truck depreciation schedules between 3-7 years. EBITDA will continue to be under pressure going forward as depreciation is declining each quarter (old fleet is getting smaller). Based on their 10K information, we believe nearly half (50%) of the truck fleet is model year 2001 or older. The latest 3rd Quarter Q refers to risks that "we have deferred certain capital expenditures and expect to continue to do so for the foreseeable future, including the remainder of 2013". Based on prior 10K's it is clear that the company's fleet has not been upgraded since 2009, with only small amounts of capex, $50MM or so used for "engine replacements and trailer refurbishments". Other Seeking Alpha authors have commented on their older fleet as one of the greatest risks in June and July articles. https://seekingalpha.com/article/1540932-a-closer-look-at-yrc-worldwides-notes-to-the-financials

Clearly EBITDA dreams of $450MM per year based on their "old" restructured debt covenants is not happening any time soon, as these numbers were all pushed back to $250MM of EBITDA to keep the covenants from being violated. So $60MM of EBITDA per quarter is the current goal(hope) , and one must consider that depreciation is $45MM of that number. If depreciation drops to $35MM per quarter they need to create $25MM in operating earnings per quarter to get there. Unless there is a dramatic and fast catalyst to propel their operating margins higher the burdens of declining depreciation and heavy interest cost will smother any future growth or recovery in free cash flow. The agreement with the hedge funds to raise $250MM was simply an exchange for a secured 10% convertible instrument into unsecured equity albeit at a lower strike rate, the exchange moved the strike down from 18.50 to 15.00, so convert bond holders (the 5 hedge funds) saw an immediate increase in the value of their holdings. We think the holders of Series A and Series B were forced into this situation to create some breathing room.

Why would a mid teens yield fixed income instrument holder move from secured to unsecured and lose his coupon of 10% as well ? It's quite possible that "secured " convertible debt was never really secured to begin with, as the ABL facility and the term facility are the major collateral holders and constitute the bulk of the company's debt. YRCW 's balance sheet is underwater (negative equity on paper, or total shareholders deficit in the latest Q) by roughly $665 million and their assets (trucks, trailers, and real estate) seem priced unusually high for transportation assets when compared to peer trucking companies and other valuation metrics. Why would senior lenders lower their rates below 10% for a company so highly levered, expensively financed, and which exhibits such marginal operating ratios…? Even Swift (SWFT) which is not as highly levered as YRCW and has positive book value and strong cash flows is borrowing on their junior debt at 10% currently. Any new lender or refinancing of the term notes or the ABL facility is not likely going to be below 9%, so at most the future savings would be 1-2% on $600 million, which is what they need to roll over in 2014/2015. So many assets on the balance sheet are currently tied to debt obligations, its not clear how much collateral that new lender will require to lend under these operating metrics. 75%?, 80%? Loan to collateral? Hence the reason why the Series A and Series B secured interest notes had to give up their collateral upon closing of the "financing transactions" ………maybe there's not enough collateral to go around for the next round of financing, or the value of the long term assets is being examined a bit closer to re-sale values not book values .

In summary, the road ahead will indeed be difficult for YRC trucking given their thin margins, heavy union labor costs, very heavy interest obligations and challenging competitive landscape. Other trucking companies are already warning Q4 is not likely to be pretty given the severe weather in the U.S. and the changes in trucking driver hour minimums. The market reacted to the recent "refunding" as if the company had made an enormous gain on its heavy debt load. In fact, the gains only appear to save $10 million to $20 million annually, not the $50 million quoted in other publications. We see the refunding as more of a desperate move to release collateral for re-negotiation of their larger $625MM term loans and ABL facilities, - the true "owners" of the company, not the shareholders. YRC itself has stated in its 10K that its assets may not be sufficient to cover its debt if its liabilities are accelerated. We wait for what the auditors will say in this 2013 10K whether they include language of a "going concern" nature or not. With such a large debt overhang, negative equity, thin margins, and the oldest trucking fleet of the majors, we do not see how any EBITDA target (or covenant) could be met in the next two years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.