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).
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.
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.