Ferronordic (FNMA-PREF.ST) – Preferred Redemption – 12% upside

Current Price – SEK 1070

Expected Price – SEK 1200

Upside – 12%

Expiration Date – Q3-Q4 2017

 

Ferronordic  preferreds are very likely to be redeemed by the company at 12% premium to current market price. Recent communication by the company hints that this is likely to happen before the next dividend payment (Oct 2017). Preferreds trade in Stockholm and it is possible to buy then through IB.

This special situation idea was offered by newly joined member (thank you Michael).

 

Background

Ferronordic is authorized dealer of Volvo Construction Equipment and Terex Trucks (+some other brands) in Russia. It has 70 outlets across Russia. I know it does not sound like the safest investment, but bear with me for a second as I actually consider this situation to be quite safe.

Preferreds were issued back in 2013 (press release). Company was planning IPO at that time and these preferreds would have either been converted to the common stock (currently unlisted) or redeemed. Preferreds had clauses for conversion and redemption price hikes as well as dividend increases if the IPO takes longer than expected. But then the who Russian market turmoil came and IPO was postponed indefinitely.

This brings us to the current situation, where the redemption price stands at 1200 SEK, conversion price at 1300 SEK and dividend yield at 11.4% (with further dividend increases contractually scheduled till 2023). This dividend is well covered by the growing cashflows from the business (2016 FCF of SEK145m vs total dividend payment of SEK52m).

With Russia’s economy back on track and improved Ferronordic performance in Q1 earnings release company announced that it was again putting IPO on the table:

“The Board has decided to initiate the process of evaluating a potential listing of the company’s ordinary shares on Nasdaq Stockholm. A listing of the ordinary shares would give the company greater access to the capital market to support the company’s continued expansion and would enable the preference shareholders to convert their preference shares into ordinary shares.”

 

Shares are likely to be redeemed

The press release of preferred launch was worded in way that suggested preferred holders will have an option to either exchange to common or wait for the company to redeem.

In the event that a preference shareholder does not wish to participate in the exchange offer, the Company has the right, at its sole discretion, to redeem the relevant preference shares at a later stage”.

While I would actually prefer to wait for the IPO, collect juicy and growing dividend in the meantime and then exchange at 1300 SEK instead 1200 SEK redemption, I do not think this is likely to happen. I reached out to management and CFO clearly stated that company can redeem preferreds at any time at its own discretion (so press release from 2013 seems to incorrectly worded). At the same time when asked about the expected interest rate if new debt was to be raised to redeem the preferreds, CFO clearly stated that interest rate would be definitely lower than the current dividend yield. I take this as a hint that preferreds will be refinanced by debt and redeemed before IPO.

This would not only simplify the capital structure and remove dilution overhang before the IPO, but also leave insiders with a larger share of the company. Insiders currently own 40% of the common stock and almost none of the preferreds. If management sees bright future ahead it would make sense to maintain the current ownership structure by levering up (in order to redeem preferreds) instead of giving up part of the company through conversion.

 

Low Risk

Besides another downturn in the Russian economy, I see relatively low risk by owning the preferreds, at least from the corporate governance perspective. Management chose to maintain preferred dividend even during the hard times of 2014-2015 (revenue declined almost 50% due to rubble depreciation and overall slump in the Russian economy). Basically holders of the preferreds were getting paid, when magement’s own 40% stake in the company was not generating any returns. I think this shows management’s determination to maintain spotless capital markets track record before the upcoming IPO. And therefore any screw up with preferred holders is quite unlikely.

As noted above current dividend is well covered by the operating cashflows and with business continuing to grow, dividends are likely to be even better covered going forward. If the IPO takes a while and company does not redeem shares shortly, it would be even better for the preferred holders – it would allow to collect a growing 11.4% yield annually on top of eventual 12% upside towards redemption price. Dividend will continue to increase by 10SEK annually and eventually reach 170SEK in 2023, which would be equivalent to 16% yield on the current price. So at some point the preferreds will become too expensive for the company and will be redeemed.

19 COMMENTS

  1. over2u

    I find it very strange that CFO basicaly says that press-release is incorrect in material respect. Some sanctions from stock exchange may follow, not talking about lack of confidence in what Company claimed (i.e. screwing pref holders). But I personaly don’t think that is an optimal way to play out this situation – you also need to take a 3 month lock-up after IPO, which may result in not that risk free transaction after all.
    On redemption of prefered shares: as I understood it is 400m SEK (~$50m), with EBITDA’17 of $20m and Company holds some cash on its balance – $28m, so given the Company’s guidance that ND/EBITDA won’t exceed 2.0x the redemption seems feasible

    1. dt

      Company’s right to redeem was likely worded differently in the Preferred prospectus (I have not seen the document) – so I doubt anything has changed, just the wording of the press release was ambiguous. Not sure what you mean by ‘optimal way to play the situation’ – as I described in the write-up in my opinion redemption before the IPO is the most likely scenario.

      1. over2u

        In my view press-release was very clear that the company’s right is conditional upon investors not participating in equity offering. I believe that you can’t misrepresent in your press-release material terms of the offering – from my exprerience each press-release is thoroughly checked by lawyers and investment banks (but the situation maybe different for microcap)

        I meant that even if conversion at IPO was still on the table, given the lock up, it may not be the best option for someone who doesn’t want to bear the risk of the company.

  2. FM

    “Each preference share will entitle its holder to subscribe for an amount of ordinary shares of series 2 corresponding to SEK 575 divided by 50% of the price per each ordinary share offered in the IPO. The conversion right is combined with a lock-up period of up to three months after which the ordinary shares of series 2 will be converted into ordinary shares. The ordinary shares of series 2 have the same rights as ordinary shares in Ferronordic Machines. An exchange into ordinary shares at these terms implies a discount to the IPO share price of approximately 13% (excluding compensation for accrued dividend and Outstanding Amount, if any).”

    Hi dt, how did you come up with a conversion price of 1300 SEK? 1000 x (1+13%?)?

    1. dt

      “After 25 October 2014, the amount used for exchange into ordinary shares of series 2 will start to increase by SEK 5 per month until 25 January 2016 when the value to be used in an exchange into ordinary shares would equal SEK 650.”

      650 SEK / 50% = 1300 SEK

  3. Michael Chi

    Glad you liked the idea! Imho, press release is pretty clear that the company can redeem pref. any time but the pref also have thr right to convert to Common share in the event of IPO. But I agree that the most likely way forward for the company is to redeem the pref at 1200.

  4. dt

    My position in Ferronordic got closed out at 1175SEK (had a limit sell on it since initiation). I expect the company to redeem shares at 1200SEK before the next dividend payout, thus the remaining upside of 2% was not worth holding on to. Quarterly earnings will be announced today and there might be some updates regarding IPO preparations and preferred redemption, so it might turn out that I closed the position slightly prematurely.

    Overall this Ferronordic special situation resulted in low risk 10% return over 2.5 months.

  5. dt

    As noted above, I closed out slightly prematurely. Ferronordic reported good quarterly results and announced that they are proceeding with IPO (expected in H2 2017).

    http://ferronordic.ru/shfiles/Press%20Release%20Ferronordic%20Machines%20AB%20Interim%20Report%20January%20-%20June%202017.pdf

    Most interestingly press release had the following comment regarding preferreds:

    “The listing will also give our preference shareholders the right to convert preference shares into ordinary shares.”

    From this it seems that preferred shareholders will not be redeemed but will be allowed to convert at 100SEK higher price (1300SEK vs. 1200SEK). The only way this makes sense for the company (and for insiders) is that avoidance of leverage is a priority.

    If this is the case, then Ferronordic preferreds continue to be an interesting special situation running towards IPO and 1300SEK/share conversion (+ potential share price pop right after IPO).

    Interested in hearing any other thoughts on this.

  6. Paul

    The election period for the conversion has started and lasts until Oct 10. Unfortunately US residents are restricted from participated and will be redeemed at SEK 1200. Eligible preferred holders will be converted at SEK1300 plus double accrued unpaid dividends for a sum of SEK1309.33. They will also receive another dividend of SEK60 (record date Oct 25). In total it seems US holders will miss out on SEK169.33 of value plus the IPO pop.

    1. dt

      Paul, I see the situation somewhat differently.

      Here is the whole Prospectus for the conversion http://ferronordic.ru/conversion_prospectus/Prospectus-Conversion.pdf

      Points worth noting:

      1) Preferred shares will not be redeemed till 2018 AGM (likely May 2018), thus preferred holders who choose not to convert will definitely receive the October dividend as well as continue to accrue further dividends until redemption. I somehow missed this fact of accrued dividends initially and sold out prematurely. Even with my assumption of high likelihood of redemption, the expected pay-off should have been 1200SEK + 60SEK in already announced dividends.

      2) Ordinary shares will start trading on the 27th of October, but the current holders of preferred shares will initially receive ‘Series 2′ ordinary shares (13th of Nov), which will then be converted to Ordinary shares (27th of Dec). Thus there will be at least two months delay before the current preferred holders will be able to sell their newly received ordinary shares.

      3) I am not so sure about the IPO pop as this is not a standard IPO and no new shares are being issued. Anyone willing to participate in it, can easily acquire the preferreds below the IPO price.

      4) Actually I am not even sure what kind of shares will be tradeable from the 27th of Oct as management and other current holders of ordinary shares will be in lock-up period of 365 days and 180 days respectively whereas preferreds’ holders will need to wait for two months before receiving their ordinary shares. So who will be the sellers on the 27th of October? The only option is that not all of the current owners of ordinary shares will be in lock up.

      5) Also in case of redemption there are potentially worrying tax consideration. Prospectus indicates that the whole redemption amount might results in 30% withholding tax by Swedish authorities for non-residents (see page 87). Part of this might later be claimed back by filling refund documents with the tax authorities. This should apply only to those that choose not to convert – in conversion one simply received fixed amount of newly issued shares.

  7. Paul

    Interesting. I hold my shares through and IB account, which specifically indicates US holders are not eligible for conversion and does not allow them to apply for conversion. A brief outline of the process is available here:

    http://ferronordic.ru/en/conversion

    It seems redemption is the default and only option for US holders. I hope I am wrong. I am currently working through the prospectus.

    1. dt

      Agree that for US holders redemption is might be the only option. The point I wanted to make is that the redemption will not happen right-away, but rather only in mid 2018. So US holders should still be able to collect two rounds of dividends before being redeemed at SEK1200.

  8. Melkiades

    Hi there,
    I hold few FNMApref, l’m living in Germany and I have just said YES to conversion via IB.
    Seems like a good offer (10% discount + pending div) however there is indeed a 3 months freeze time.

    “The listing price has been fixed at SEK 150 per ordinary share. The first day of trading in the ordinary shares is expected to be 27 October 2017″

    Let’s see how it develops.
    Happy investing!

    1. dt

      See my comments above – you will not be able to trade the newly received shares at least until 27th of Dec.

  9. Freedomist

    Received notice from IB. Which is better, convert to common share now or wait for redemption after IPO?

  10. Paul

    Interesting notice from IB:

    Please be informed that 50% of outstanding FERRONORDIC MACHINES AB-PREF shares will be redeemed. Swedish coupon tax will be applied. Expected record date is 2017-11-24 and pay-date 2017-11-30.

    Allocation of exceeding shares to be will be decided through lottery.

    Cash consideration is SEK 1,200 per share plus accrued and unpaid dividend, expected to be approximately SEK 12.00 per share.

  11. Paul

    IB did not allow me to convert to common. Apparently this option was not available to US citizens

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