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Explaining the "Canada Call" feature

Here's this week's column (the web version). A similar version (though likely with a different headline) will appear in tomorrow's Globe Report on Business.

Great Canadian makes the call

Harry Koza

12:54 EST Thursday, Aug 31, 2006

TORONTO (GlobeinvestorGOLD) - Last week I wrote about the invention of the Domtar, or "Canada Call" provision on corporate bonds. This week, someone actually exercised such a call, something that doesn't happen very often.

Great Canadian Gaming Corp. (GCD-TSX), announced it would redeem its series A and series B senior secured notes on Sept. 29 at the Canada call price.

The bonds, $150-million 5.5 per cent maturing July 21, 2015, which were issued at 150 basis points over equivalent term Canada bonds in July, 2005, and $150-million 5.74 per cent, maturing Oct. 29, 2014, which were issued at 145 basis points over Canadas in 2004, will be called at 25 basis points over equivalent term Canada bonds. That basically means that bond holders will be paid a fat premium for their bonds, plus accrued interest.

Dominion Bond rating Service (DBRS) currently rates Great Canadian Gaming as a triple-B (low) credit, with negative trend, which is rating-speak for "possibly soon to become junk bonds." So the bondholders are making out like bandits: They are getting paid a spread that is tighter than where 10-year Ontario bonds trade.

It seems a bit odd, really, when you recall that the whole idea of the Canada call is to make it unattractive for borrowers to repay the bonds ahead of time (much like banks often charge people hefty penalties for prepaying a conventional mortgage). But, Great Canadian Gaming likely concluded that calling the bonds would be less trouble than not.

Back in March, Great Canadian Gaming announced that it was about to breach a covenant in the trust indenture for the bonds. That covenant required the company to maintain (and not exceed) certain leverage ratios: Failure to do so would trigger a technical default. Default, even of the technical variety, on senior secured debt, can mean that the bond holders basically own the company, and the shareholders get wiped out. On an individual level this is like if you miss a few car payments and GMAC repossesses your Chevy.

That's not an attractive prospect, so the company sat down with its bond holders and a phalanx of lawyers to thrash it out. Now, of course, I wasn't there, but I imagine it went something like this:

The bond holders: "We had no idea you were going to be so aggressively on the acquisition trail, we thought your business was a nice cash cow that would provide a steady stream of milk, er, interest payments.

"After all, there's a hard core of gambling addicts out there willing to pump their mortgage money into your slot machines, and even though over 300 of your industry's best customers commit suicide over their gambling affliction every year, the incessant parade of government advertisements extolling gambling as fun for the whole family handily recruits replacements for them.

"So, we like the cash flow a lot. We're just concerned that you're levering it up so fast that your ability to pay us our interest, not to mention give us our money back at maturity, might be impaired."

Anyway, the upshot was that the company agreed to allow some new strings to be attached to their bonds.

First, they agreed to adjust the net debt-to-adjusted-EBITDA ratio to 3.5 or less at March 31, 2006, 3.25 or less by June 30, 3.0 or less by Sept. 30, 2.75 or less for all of 2007, and 2.5 or less after Jan. 1, 2008. (EBITDA represents earnings before interest, taxes, depreciation and amortization.)
They also agreed to pay a one-time penalty, er, amendment fee, of $1.25-million to the debt holders, and to increase the coupon on the bonds by 37.5 basis points starting
April 1, 2006, continuing until the company managed two consecutive quarters at a net debt-to-adjusted-EBITDA ratio of 2.5. And, in the event of another ratings downgrade by DBRS, the coupon would increase by another 75 basis points until such time as two straight quarters with a debt-to -EBITDA ratio of 2.5 were achieved. And no more new acquisitions unless that ratio could be maintained. Oh, and one more thing: Raise enough new equity to get that ratio down to 2.75 using the balance sheet on March 1, 2006.

Yow, suddenly those 5.5 per cent bonds were looking more like 7 per cent bonds. I'm sure the company's executives must have blanched at these demands at first; to which the bond holders might have said, "If you don't like it, then you can buy back the bonds at 25 beeps over Canadas."
That's not easy to do just like that.  To its credit, the company raised a pile of new equity, and met the new restrictions. But the net effect of them all was keeping it on a very tight leash, and the bonds were suddenly way more expensive than they were originally supposed to be.  I don't know what the company said or did, but if it was me, I'd have been looking for ways to get out of these bonds as fast as I could.  This month, Great Canadian Gaming announced it had a new $450-million bridge facility, and is using the proceeds to call the bonds.

They're now free of the leash, and the bond holders have, as they say in the gaming business, made a nice pass.

Harry Koza,

Sr. Market Analyst,

Thomson Financial,

36 Green Meadow Crescent,

Richmond Hill, Ontario,

L4E 3W7




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