Arcan Resources’ Latest Proposal; Still No Respect for the Debenture Holders?
Last August Arcan Resources Ltd. tried to end-run its debenture holders. Arcan, a producer of light, sweet oil from the Swan Hills area of the Western Canadian Sedimentary Basin, proposed that $160M of debentures would be retired for only 82.5 cents on the dollar, plus warrants in a new SpinCo. That discount would have been painful for the debenture holders, but would also be a normal risk of investing. What made the proposal insulting to the debenture holders was that Arcan also proposed returning capital to the equity holders, ahead of the debenture holders being paid in full.
As we reported then My Debt trumps your Equity, the proposal was generally derided and at the meeting held on August 20, the proposal was soundly rejected. (I indirectly hold some of the debentures and shares, and I voted against.) Arcan’s team was reminded that debt ranks ahead of equity.
Arcan has been facing operational challenges for some years. The debentures have traded down from a year high of $83.25 to $40, and the common shares fell from a year high of 57 cents all the way down to 6 cents. With the plunge in the price of oil and the debentures coming due in 2016 and 2018, Arcan had to come up with a new proposal or face insolvency.
In a press release issued late last Friday night after the market closed, Arcan proposed:
- All of Arcan’s debentures would convert to equity at 15 cents per share, representing approximately 87.5 per cent of Arcan’s postex change common shares;
- Current holders of Arcan’s issued and outstanding common shares retaining an approximate 7.5-per-cent interest in the company upon completion of the exchange;
- Reduction of Arcan’s total pro forma debt, as at Sept. 30, 2014, from $324M, to $150M;
- Reduction of Arcan’s annual cash interest and financing expenses by approximately $10.9-million;
- Employees, trade creditors and customers not affected by the exchange; and
- The exchange is expected to be completed early in the first quarter of 2015.
Note that the common shareholders don’t get a say in this. The bus will be driven by the debenture holders, as it should be. Debt ranks ahead of equity.
Given the current oil environment and the poor position Arcan put itself in, this isn’t a bad proposal. It finally respects that debt ranks ahead of equity, simplifies the capital structure, eliminates over $10M of interest and financing expenses, improves debt ratios and improves the company’s liquidity with its credit facilities. Overall, that’s a good day’s work. My sense is that the debenture holders will approve the transaction, assuming there are no hidden gotchas like management bonuses, retention payments, change of control payouts or hidden fees.
And that’s the part that really worries me. The debenture holders were treated poorly in the last proposal. Here, the press release tells us that the debenture holders will get 87.5 % of the post-transaction common shares, and the current shareholders will end up with 7.5 % of the post-transaction shares. Those add up to 95. Shouldn’t they add up to 100%?
Who is going to get that other 5% of the company? If $160M of debt equals 87.5%, then that missing 5% is worth over nine million dollars. Somebody in this deal appears to be getting a free nine million. I’m looking to hearing from Arcan as to who will be that lucky beneficiary.
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>