Stress is the result of two or more competing forces acting on an object. It’s also a state of mental or emotional tension resulting from adverse circumstances. Both of those definitions apply here. Arcan, you’re killing me.
The chart above is the last three years for Arcan Resources Ltd.’s common shares. The charts for the two trading classes of debentures look pretty much the same. They ain’t pretty. (Indirectly I own both the debentures and the common shares.)
Last summer Arcan announced an unsupportable deal that punished the debenture holders (my original commentary, click here). Then Arcan announced a deal that gave the debentures control of the company (recent commentary, click here). That December proposal made sense – debt ranks ahead of equity, so in hard times the debt holders have more say than the equity holders.
But, there was a gotcha, as in, a missing nine million dollars of value in the transaction. If the debt holders get 87.5% and the current equity gets 7.5%, then someone was getting the other 5% (worth nine million dollars) for free.
It turns out that nine million dollars of value will be handed for free to only some of the debenture holders. That LuckyGroup will be issued 5% of the post transaction common shares (“Bonus Shares”), and no one else gets them. The small holders like me, even if we support the deal, will not be paid any of the Bonus Shares. The LuckyGroup gets carried for free on the rest of us voting.
I asked Mr. Penner (Arcan’s President and a director) for the corporate explanation for the Bonus Shares. Mr. Penner has had a long and successful run with various companies in the oil patch. His response was a very well written explanation of Arcan’s likely doom and a justification for the Bonus Shares. With no sarcasm or criticism, I thank Mr. Penner for his lengthy thoughtful response.
There are two justifications offered by Arcan. First, with Arcan’s demise clearly in sight, the LuckyGroup threatened to enforce its debt rights, hired legal counsel and engaged in negotiations with Arcan. Because the negotiations resulted in the December proposal to the benefit of all security holders, the LuckyGoup, according to Arcan, should be paid for its efforts and expenses. Second, without the support of the LuckyGroup, Arcan will be unable to muster enough votes to have the proposal approved by the debenture holders, so Arcan will guarantee that support with the Bonus Shares.
The latter explanation makes sense and is not uncommon – similar fees get paid on standby financing commitments for rights offerings. But, the first explanation (reimbursement of expenses) is not defensible, unless every debenture holder will get its expenses reimbursed as well.
As to exactly who will get the free nine million dollars of value, Mr. Penner advises that Arcan is prevented by a confidentiality agreement from identifying the members of the LuckyGroup, but as least one member is easy to figure out. Stornoway Portfolio Management issued its own press release announcing that two of its funds hold “significant investments in Arcan’s Debentures”, and that it had agreed to vote in favour of the December proposal. Stornoway did not mention it was being paid a fee for that support, which as a Compliance Specialist I find troubling. If it is part of the LuckyGroup, then Stornoway omitted a key part of the story.
One more significant fact: Mr. Penner wrote that “As part of the transaction executives have been asked to sign off that there will be no change of control payments”. This means we can eliminate management bonuses as a contributing factor behind the December proposal. The directors and management team are also shareholders and debenture holders, so they will each be diluted by the Bonus Shares, same as the rest of us.
And finally, one fact that might or might not be relevant. One of Arcan’s independent directors (Mr. Robert Dales) hit the SELL button and blew out almost 450,000 shares on Dec 24. Regardless of the amount, the optics are extremely poor. Mr. Dales obviously doesn’t think much of Arcan going forward.
So the two forces acting on me (and all small security holders) that are causing me stress:
Force 1: Vote for!!! Arcan is no corporate lightweight. It has a strong diverse board of directors. Mr. Penner and the management team have had prior operational and corporate success elsewhere. The auditors and legal team are national firms. The LuckyGroup (regardless of who they actually are) have to be experienced market participants. I assume they’re all paying attention, following best practices, and doing what they think is best for the shareholders overall. Given the failure of the August proposal, they know the December proposal will be scrutinized. They have to know what they’re doing. Right? Right? So I should vote in favour of the proposal.
Force 2: Vote against!!! Paying the LuckyGroup nine million dollars for merely enforcing its rights is oppressive to all the other debenture holders and to the resulting equity base if the proposal is approved. Even if I vote in favour of the proposal, I don’t get Bonus Shares. Plus, the failure of the LuckyGroup members to disclose being paid the Bonus Shares taints the December proposal. Why are they hiding it? The proposal is unfair. I should vote against the proposal.
Those two forces act on me and push me in a new direction. After some thought and discussions with various people in and out of the financial industry, I see the following:
The recent plunge in oil prices accelerated Arcan’s demise but did not cause it. The operational failure has been coming for some time (see the charts above). I have to respect Arcan’s leadership team and advisors. If this is the best they can do, it’s a reluctant painful admission by them that they failed. The overall exploration program at Swan Hills did not succeed, and some of the major operational risks disclosed in the prospectuses and other corporate documents actually came to pass. If I vote against the proposal, there is nothing else in the corporate cupboard for Arcan to offer me.
This is the nature of investing. I’ll take my lumps and support the proposal.
But not without a lot of stress. Dammit, Arcan.
Mr. Clausi is an experienced investment banker, executive, director and shareholder activist. A graduate of Osgoode Hall Law School called to Ontario's bar in 1990, ... <Read more about Peter Clausi>