Just Energy Recapitalization Arbitrage Opportunity

Every month I provide multiple special situation ideas for the subscribers to The Microcap Review. This month there were four ideas, which is typical:

• An odd lot tender with a very low risk profit of ~$100
• A small cap takeover with a 12.8% spread. This one has multiple potential bidders as well, but the deal is still conditional.
• A friendly junior mining deal where the spread is currently 6.7%. These firms share a major shareholder and the deal is all-share, so it seems very likely to close. 
• A recapitalization with a big spread between different parts of a capital structure. This has a hard catalyst, as the transaction will convert all of these to common shares at different ratios. 

While the first three ideas I'm leaving as exclusive to subscribers. If you're interested, you can learn more about a free trial. Many subscribers use the profits from one or two odd lot tenders to pay for the subscription, with the rest of the special situation and regular value ideas being free. This is a great month to take the free trial, as you can get the profits from the first odd-lot tender before you pay anything at all. It's a no-risk proposition, as you can always cancel during the 2 weeks with no hard feelings. 

To give a sense for the ideas, I'm publishing one in full. This is a longer write-up than my normal special situation idea, as it is quite a bit more complicated than average. 

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Just energy (JE)[TSX:JE] is doing a recapitalization. One version of the trade is likely only for Canadian readers, as it is (as far as I know) not possible to buy Canadian convertible debentures in the US. But a US preferred share is an acceptable substitute, and both Fidelity and Schwab pulled up quotes for JE.PA, so I think this should be possible to execute in some form for most readers. 

The firm is an over-leveraged power retailer, but this is really more of a special situation trade, so I won't cover the business in detail. They are converting most of their capital structure to common equity, and diluting the existing common equity dramatically. I usually find about one of these per year in the Canadian convertible debenture market, and they've been very profitable in the past.

The table below shows the number of shares various securities will receive. The subordinated convertible debentures trade in Canada under the symbols JE.DB.C and JE.DB.D. The last price is ~$17 per $100 of par value. Thus, for $170 CAD, the holders will receive 35.92 new shares. The preferred shares (JE.PA) are trading at $3.10 USD, so for $310 USD the holders will receive 33.39 new shares.

Source: News release - English - Just Energy Group Inc.

By contrast, the common shares are trading at $0.39 USD per share. They were shortable at Interactive Brokers at a mid single digit cost of borrow. I also bought quite a few put options (both in Canada and the US), but the trade I'm writing up here is the straight short. The straight short is cheaper, but the puts are less risky, as there is no chance of losing the borrow.

In the exchange, 100 common shares will receive 3.03 new shares, so for $39 USD shareholders will receive 3.03 shares. I'm going to provide a table showing the effective price of the new shares for all three options.

Source: Author's Analysis

As you can see, both the preferred and convertible debentures are trading at a material discount to the common shares. Thus, I am long the debentures and short the shares. For the debentures, I am short 1185 JE for every long debenture. For the prefs, my intention would be to short 11 JE for every long pref.

There is also an option to buy new common shares in a subscription for $3.412 CAD per share. This is cheaper than any of the options in the table. So it might makes sense to size down the long position and plan to cover the short using subscription shares.

I also looked briefly at this as a straight long opportunity. A comparable sold out in early 2019 at 4X EBITDA. Their next fiscal year guidance is $130-$160 MM base EBITDA, which would imply a value of $520-$640 MM for the firm. Pro-forma for this transaction they expect to have $424 MM of debt and 46.6 MM shares outstanding. That implies a share price range of $2.06-$4.63. Suggesting a straight long (of any of these instruments) isn't particularly attractive, and that the rights offering is probably in the neighborhood of fair value, given this isn't a very high quality business.

Source: Just Energy Presentation

Most of my best ideas are not released to the public, and are instead exclusive for members of The Microcap Review. Members get value stock ideas, plus net-net ideas, plus multiple special situation ideas every month. The special situations include merger arbitrage, liquidations, tenders and more. I am currently offering a two week free trial for new subscribers. That free trial allows you to check the service out with no risk, which is the type of investment I like best!