For those who like their financings complex, the recent news from Sherritt International will provide sufficient fodder for at least a few meals.
Over two days, it announced: a $100 million offering of units; a plan to purchase, by way of a Dutch auction, up to $75 million of high-yield debentures; and the pricing of the unit offering, which because of strong demand, ended up at $115 million. And, as a little something on top, the unit offering consisted of a share and half a warrant linked to the high-flying price of cobalt, a metal Sherritt produces. The equity deal is Sherritt’s first in a decade.
The point of all this: the proceeds from the unit offering, led by Paradigm Capital, Eight Capital and National Bank Financial on a best-efforts basis, will be used to reduce outstanding indebtedness, “for general corporate purposes and to fund future growth initiatives.” (As of Sept. 30, 2017, the non-investment-grade-rated Sherritt had $813 million in debt outstanding.)
Specifically, the bulk of the proceeds will be used to repurchase (at a discount to issue price) part of three issues of senior unsecured debentures set to mature in three years, five years and seven years. The face value of those three issues is $720 million, meaning Sherritt is planning to buy back about 10 per cent of what’s outstanding. Post announcement, the prices of all three have risen.
The combination of an equity financing and a debt buyback led DBRS to say, that “a reduction of $75 million in principal debt outstanding and the related interest payments would improve the Company’s credit metrics to be more consistent with the current ratings.”
Dutch auctions have been around years and work on the principle that the price for a defined amount of stock or debt is set by the willingness to pay: in effect a variety of prices and volumes are entered with the sale price being the market-clearing price.
The system is based on conflict between the wishes of the seller and the myriad of buyers. Here, Sherritt wants to buy back the debt at a low price, while the holders want a high price. But to ensure it doesn’t pay too much, Sherritt has set maximum limits on the price it’s willing to pay.
Dutch auctions have been used by many Canadian issuers, often where a large share buyback is being undertaken. Sherritt itself used the model in 2000 as a way of retiring a $675 million offering of convertible debentures In late 2012, Celestica used a Dutch auction as part of a substantial issuer bid. In 2004, Google went public via this route.
Given Sherritt’s non-investment-grade-rating it was limited in what it could do to either reduce its overall debt levels or interest payments. In some cases, issuers in a very strong financial condition will make a tender offer for previously issued high-coupon debt and replace them with lower-coupon debt.
In those situations the issuer will be required to pay a premium to buy back the debt, a cost that’s more than offset by advantages of being able to lower annual interest payments. In recent years, Teck Resources and Barrick Gold have undertaken such moves.
Given it’s low share price, Sherritt was also limited in its ability to raise equity in a conventional manner, namely selling common shares because the discount would have been too high. But by adding a warrant it has, in effect, been able to issue equity at a premium, because buyers own a security that gives them increased leverage to upwards movement in the price of cobalt.