Seaspan Preferred's: Switch From Series D Into, Well, Anything

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Includes: PFF, SSW
by: Mythbuster
Summary

Series D preferreds are almost 4% overpriced vs. other issues.

This would only be justified if they were about to be called. They aren't.

If you are long then sell and switch into something else. If you are a Speculator, short against other issues.

This article will set out a case for why the D series of Seaspan's (NYSE:SSW) preferreds are overvalued vs. all other issues

Below are the basics for each of the perpetual preferreds as of market close on 12/15/17 .

Symbol

Coupon

Call date

Price

Clean Yield

ssw-d

7.95%

1/30/18

24.18

8.31%

ssw-h

7.88%

8/11/21

23.48

8.48%

ssw-e

8.25%

2/13/19

24.21

8.62%

ssw-g

8.20%

6/16/21

24.03

8.63%

*Clean yield strips out accrued interest

As you can see, the series D trades at the lowest yield. The only reason to explain the richness of this preferred is that some in the market must believe that there is a chance that Seaspan will call some or all of its series D bonds next month when they become callable. In my opinion there is a less than 1% chance of this happening which makes these shares ~90 cents or 3.75% overvalued vs. the E and H shares (the price at which they would have the same yield).

The following are the reasons why this issue will not be called.

  1. From Seaspan's most recent 6-K (quarterly report), "In June 2017, the Company entered into a preferred share repurchase plan for up to $10,000,000 of its Series D, E, G and H preferred shares, which expires in December 2017. The Company did not make any repurchases during the three and nine months ended September 30, 2017." Given that all of these issues are trading meaningfully below $25, why on earth would they redeem something at $25 when they could expand the program and make purchases in the open market below par.

  2. Companies call preferreds for two main reasons. One is because they can issue new securities at a lower yield to replace them and the other is because they have excess cash and believe shrinking liabilities would be the best use of that cash. Neither is the case. In October, they issued a 10 year senior unsecured note (sswa) with a 7.12% coupon which now trades at 23.95 (a yield to maturity of ~7.9%). As the company has expressed a desire to shrink debt to equity and preferred stock does not count as debt while this note does, one has to think that the rate they would have been able to get on a preferred would not have been pretty. This is a highly levered company where the seniority of debt over preferreds might actually matter. For a 10 year senior debt instrument to currently be trading at 7.9% ytm, there is no way they could issue a perpetual preferred (a longer dated instrument that is lower in the cap structure) below that rate to replace the series D's which have a 7.95% coupon.

  3. They will not use cash to redeem the issue without replacing it. They have significant debt maturities over the next couple of years and using cash to redeem what for them is actually an attractive instrument with no maturity date would make no sense at all. If they could issue more preferreds at the 7.95% coupon that the series D has, they would be far more likely to issue MORE than they would to be call them at par. Additionally, if you read the prospectus for SSWA, the company states that "We intend to use the net proceeds from this offering to repay a portion of a secured credit facility with an annual variable interest rate based on LIBOR plus a margin of 3% and a maturity date of May 31, 2019." Additionally if they "do not use all of the net proceeds of this offering to repay the secured credit facility, we may use the remaining proceeds for general corporate purposes, which may include funding vessel acquisitions and repaying other outstanding secured (my emphasis) indebtedness." There is no mention of preferreds. If you read their most recent quarterly earnings report, they included the below:

    Liquidity

    At September 30, 2017, our cash and cash equivalents and short-term investments totaled $309.0 million and our restricted cash totaled $23.6 million. Our primary short-term liquidity needs are to fund our operating expenses, repurchase of our 2019 Notes, debt repayments, lease payments, payment of our quarterly dividends and the purchase of the container ships we have contracted to build. Our medium-term liquidity needs primarily relate to repayment of our 2019 Notes, debt repayments lease payments and potential future vessel acquisitions. Our long-term liquidity needs primarily relate to lease payments, debt repayments, the future potential repayment or redemption of our 2027 Notes and preferred shares and potential future vessel acquisition.

Again, no mention of preferreds.

Having laid out a case for why I don't think they will be redeemed now, next I will discuss why going forward the issue is not attractive in other scenarios as well.

Perhaps you are thinking this company is awesome, and shipping is looking better and I think this company will be doing fantastically well and maybe in a year they will call this bond. If that's your opinion than yes this preferred would be a good investment... but it would still be worse that all the other preferreds and here's why…

Let's say all of a sudden Seaspan can issue new perpetual preferreds at 6%. This would make all of their preferreds which are around 8% likely to be called as soon as possible and replaced with new debt. Since the series D will be immediately callable they will not be able to trade much through par. The series G on the other hand with 3.5 years left before its callable will look incredibly juicy with an 8.2% yield and will instead trade much more like a preferred with a 3.5 year maturity instead of a perpetual and can trade meaningfully through par.

Without getting too mathematical about it and using rough math for illustrative purposes:

Let's say there are 2 bonds with an 8% coupon and one bond is callable in a year and the other is callable in 3 years. Lets also say they both trade at a 6% yield to maturity. What would the price of the bonds be? The 1 year bond would trade 25.50 such that you would lose 50 cents or 2% when the bond are redeemed at par but you'd get your 8% in interest for 6% net. The three year bond on the other hand would trade up to 26.50 as you'd lose $1.50 or 6% of principal when the bond is redeemed at par but make 24% (3 years of 8% interest) or a net of 18% over 3 years (6% a year).

Another way to think about it conceptually is that the issuer of a callable bond owns a valuable option, the right to call back the bond at par. If a company issued two bonds today that had the exact same details except one was callable immediately and one was callable in 10 years, which bond would be worth more? Well obviously it is more valuable to the company to be able to call the bond whenever they want rather than having to wait ten years and as the bondholder you are effectively selling the company this option. Therefore the bond with the later call date should always be more expensive than the bond with the shorter call date assuming they both have the same maturity.

So where does this leave us? Below are my views from the perspective of different types of investors.

  1. If you own SSW-D in a non-retirement account, you should without question sell it and replace it with something else. I am not going to enter into a detailed analysis of senior bonds vs. preferreds and seniority vs. tax consequences as that is a whole different can of worms, but clearly all of the other preferreds offer more value.

  2. If you own SSW-D in an IRA account where there is no tax advantage to owning preferreds over bonds, SSWA is clearly a better choice. Quite simply you have a senior bond with a 10 year maturity and a 7.9% YTM vs. a perpetual preferred that may never be redeemed and is lower in the capital structure for which you only get an extra 40 bps of yield…. This is a no brainer.

  3. If you are a professional/levered investor who goes long and short and uses margin as opposed to a long only income investor than there are various options. Personally I like being short SSW-D and long some combination of SSWA and SSWN (this bond has really good value if you can lever) in greater size. The biggest problem with this is that borrowing SSW-D shares to short is quite expensive if you can even find them, so you need to be tactical about it or the borrow cost would kill you. If this were not a hard-to-borrow stock and traded at a normal borrow rate, this would be a top trade for me.

Feel free to reach out to me with any questions. I intentionally did not delve into my personal views about the credit-worthiness of this company (subjective), to instead present an objective quantitative view about how one can approach the various preferreds regardless of your view of the company.

Disclosure: I am/we are short SSW-D. 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.

Additional disclosure: I am short SSW-D and long SSWA and SSWN