Tuesday, November 17, 2015

Data Group Debentures

Two years ago, I discussed the debentures of Data Group as a potential value play. It has not turned out well so far.

Initially, returns were good, as a competitor filing for bankruptcy enabled the company to pick up revenue. But since then, it has been nothing but bad news. A few days ago, the debentures traded for less than half of what they were when I first discussed them.

Then, last week, the company announced its quarterly results along with a bombshell announcement that it was redeeming 75% of its convertibles using shares! This was an identifiable risk going into the investment, but I did not think it a likely outcome because it would wipe out equity holders. The company did it anyway.

From the point of view of convertible debt holders, I don't think this changes too much, except for two things: the interest payment disappears, which is bad, but the upside potential now improves, as the upside to equity is unlimited whereas the debt has a ceiling.

What doesn't change is that convertible debenture holders are still in line behind suppliers, employees and bank debt. As such, this is still an investment that hinges on whether the company can keep its costs in line with its revenues. Previous management was not able to do this, and were ousted.

But it looks like new management has made progress on this front. The company's EBIT (ignoring restructuring costs) for the quarter was $5 million, with a hint in the press release that more benefits are expected to show up in the next quarter. Furthermore, capex is running below depreciation which additionally benefits the company on a cash flow basis.

Assuming revenue continues to decline to offset the as yet unseen cost reductions, that's an annual EBIT run rate of $20 million. Bank debt is $44 million and pension liabilities are another $10 million. That's it! The rest of the capital structure basically belongs to debenture holders, in the form of $11 million in debentures and almost all of the equity based on the current trading price. As such, if the company can hold this EBIT level here, the debentures look pretty good!

That said, revenue is declining so it may be unlikely that this is a realistic EBIT going forward. Whether this investment works out is heavily dependent on whether management can keep this level of profitability. I continue to hold the debentures in that hope!

1 comment:

Anonymous said...

I find the relative price of the debentures and the common confusing. A debenture holder will keep $25 in debentures which should have a better valuation pro forma because they are being created at less than 3x EBITDA so let's say 80 cents on the dollar or $20. For the other $25 you pay at current prices you will get likely more shares than what a shareholder who owned the same dollar value of stock. Shouldn't all common shareholders be trying to sell the common to buy the debs when they trade at such a big discount to par?