Hi William,
The reason I'm "digging through Loewen's old garbage" (BTW I like that phrasing) is not to figure out where it's going based on the rearview mirror view of things, but rather to try to see through various accounting fictions in order to get a realistic picture of where they stand today, so that I might determine how the story might play out. If I can come to any confident conclusions that differ substantially from what the market is pricing into Loewen's various securities, I will take a position accordingly. So far I have shorted LWN common, and I will probably soon buy their bonds.
My thesis (and please, please, argue against it if you disagree - you might save me money!) is that the company made some mistakes in the past. Some of these mistakes, for example poor management, can be fixed, and if they are fixed, there's no sense in holding that against the Company's future outlook. In other words, as regrettable as past poor management might have been, and whatever losses or lost opportunities it resulted in, if we now have good management then we no longer have that problem. In a way, prior management troubles can be thought of as a big one-time "non recurring charge" that does not affect the present or future earning ability of the assets.
As a couple of examples, they got hit with a big jury award in Mississippi a few years ago (the Gulf National case), and only a couple of days ago the Blackstone thing. These things are unfortunate, and had a very real hit on shareholders equity, but they do not represent any hindrance to the ongoing (future) earnings ability of the funeral homes and cemeteries.
However, some old mistakes have not yet been accounted for, and in recognizing (in an accounting sense) the damage that was done in the past, today's balance sheet will likely change.
Specifically what I mean here is that they overpaid for a lot of their acquisitions, and a certain part of that was financed with debt. Asset valuation is sometimes somewhat arbitrary and flexible (how much is a funeral home really worth?), debt payments much less so. If they "realize" losses (based on the past overgenerous acquisition prices they paid) by selling these assets at a loss, it does not represent a cash "loss" (that cash has been spent long ago). Likewise, if they keep the assets but write down the balance sheet carrying value to a fair and reasonable amount (that which they would realize in a "willing buyer-willing seller" transaction, or an amount rationally justified by the asset's earnings), the "loss" generated will also be a non-cash one. In other words, the non-cash "losses" that they might generate in either scenario (though perfectly valid from a GAAP accrual standpoint) will have exactly zero effect on the present cash position and real world economic value of Loewen. It will simply be aligning the balance sheet view of the company with the real world situation (in so doing shareholders equity may very well become negative -reflecting my opinion that the common shares are worthless).
This is the reason that I am ignoring the non-cash charges against earnings, both for my "should I short the common" and "should I buy their bonds" analysis. These non-cash charges do not represent the earning ability of the company's underlying assets, and therefore the value of those assets.
So if the value of the Company's assets are somewhat impaired, where might they go from here? If their various assets are unable to generate enough income to pay the interest on the debt, preferred share dividends, and maintain the confidence of the company's creditors and shareholders, then the company has a problem - this is where we are today.
So how do problems like this get resolved? The first question is whether there is anything wrong with the company and its assets per se. Are they unable to operate their assets in an effective manner? If so, perhaps better value could be realized by selling some or all of their assets to someone else who can get better value from them, and therefore be able to pay the company more that the company would otherwise realize by operating the assets themselves.
Or perhaps Loewen can operate their funeral homes and cemeteries about as well as anyone else (I would guess that this is probably the case today). Perhaps they might be forced to sell some of their assets to generate enough cash to help them over their present liquidity crunch (e.g., they need to make a $300M payment in September), but otherwise continue to operate the majority of their assets.
Just because a funeral home or cemetery is a viable business operating in a competent manner generating reasonable profits is not enough though. Depending on what Loewen paid to acquire these assets, they may be realizing a superior or inferior return on their investment. I think that Loewen overpaid for the various sound and profitable businesses they own, and that is the reason that they are having difficulty meeting their interest obligations.
In fact it looks like they overpaid so much that they are now in a crisis, brought on by their inability to maintain the confidence of their creditors. That is why MF thought that they might be forced into bankruptcy (CCAA) protection this past Monday. As it turns out this did not happen, Loewen was able to negotiate an agreement with the creditors to hold off a little longer. Please do not assume though that just because a short made an incorrect guess, there's nothing wrong with the value of the common stock.
Best regards,
- Daniel |
