September 29, 2021
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Closing out September, the Canadian new issue equity market could not have been more boring. We can point fingers at several macro factors causing this damper: from the Evergrande debacle to the FOMC meetings - regardless, equity markets are closed, therefore debt markets are open. Given how quiet ECM desks have been across the country, this sets the stage for a nice segue into debt land.
As you may recall, I previously discussed convertible financings as a good and bad alternative for issuers. Leaning on that piece, please allow me to paint a picture for you: equity markets have been closed for several months, if not quarters…many CSE and TSXV-listed constituents are cash flow negative (some of which have cash burn profiles that could make your eyes bleed)…the same constituents have minimal assets.
Closed equity markets + high cash burn + no assets = bad news.
You may or may not be thinking “someone must be willing to provide capital”. Well you are correct…someone is, but at a cost. A very high cost.
My dear friend OPM recently put out a great piece on AIP’s Convertible Debt Fund , gaining lots of traction throughout the capital markets community. OPM goes on to highlight AIP’s “questionable” deals, absence of loan losses, and stellar marketing of fund performance. But, AIP is the perfect candidate (whether right or wrong) to fund the aforementioned illiquid or soon-to-be illiquid CSE and TSXV-listed companies.
So let’s run a scenario…
A company is listed on the TSXV - for the purpose of this example, let’s call the company “Rush Water” or “Rush”. Rush raises tens of millions of dollars worth of equity while private, communicating its intentions on going public within 6-months. Several months later, as the new issue market begins to print record numbers and stocks breach all-time-highs, Rush raises more equity in an RTO round. For illustrative purposes, let’s say Rush completes its RTO round and lists on the TSXV at $8.25/share. At open, shares trade down 50%. Several months go by and shares are now at all-time-lows, trading below $2.30/share.
Now, catch me on any other day and I’d likely say “who cares”. Sure shares are marked-to-market, but if the business is good, and you don’t have LPs to answer to, buy! buy! buy! For Rush, this isn’t the case. Rush is burning about $25M a quarter, and is in need of immediate funding. With equity markets closed, and minimal assets to lend against, this is where AIP comes in.
AIP would extend their friendly hand, providing a convertible delayed-draw loan to the folks at Rush. If it were my guess, the loan would look something like this:
24-month term, payable monthly
12% cash coupon
100% equity coverage, convertible at a 25% premium, 3-year term
30% warrant coverage, striking at a 40% premium, 3-year term
3% up front fee payable upon signing the term sheet
5% break fee
Board seat
I don’t think I need to delve into how predatory this loan is, but to drive home a point, at face value the loan appears to cost 12% - in reality, the all-in cost of capital is 35% - right in the wheelhouse of AIP.
It likely does not stop there. If I were a betting man, I would think peer funds would advance this loan and proceed to short the stock - whether there is available borrow or not.
Would I pay $100M for Rush? Likely not. Would I pay $20M for Rush…just maybe.
To complete the picture, I’d imagine there are many term sheets, like the one above, floating around to companies in dire need right now. And if not now, in several months.
ECM World
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RDARS Inc.
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Cheers,
G.G.