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PaperlinX again under fire from hybrids

Friday, 14 August 2015
By Patrick Howard

Long-running saga of PaperlinX Step-up Preference Securities (SPS) is back in play as New York Investment firm, Blue Pacific Partners, demands share conversion and audit of chairman’s remuneration.

In a detailed letter [below] addressed to Robert Kaye and the board of directors of PaperlinX, the investors maintain PaperlinX is unable to move forward until it resolves the SPS situation. They claim the hybrid securities are worth A$260 million and rank above the Company’s ordinary shares in the event of the company winding up.

They estimate the remaining PaperlinX ANZA business, after the recent disposal of the European assets and sale of the Canadian business, has net assets of A$146.7 million and trailing-twelve-month operating profits of A$15.2 million as of December 31, 2014.

As it stands, Blue Pacific Partners say the SPS are worth more than the entire company. If the SPS were exchanged for PaperlinX shares at current trading values their holders would own over 94% of the company, with existing shareholders reduced to less than 6%.

They propose a compromise whereby the board of PaperlinX will agree to an exchange ratio of 1,000 ordinary shares for each SPS Trust unit. This would mean ordinary shareholders would own over 20% of the company, or more than three times the amount they would own in the event of a change of control or a winding up event. SPS Trust holders will own less than 80% of the ordinary share equity.

They maintain this would resolve the impasse and allow PaperlinX to access capital markets and restore a normal capital structure. Blue Pacific values PaperlinX at $125 million. The move reflects a previous failed attempt to convert SPS to ordinary shares.

In a separate call the partners question whether chairman Robert Keyes’ salary of A$300,000, is appropriate for a company whose ordinary share market capitalization is less than A$20 million with a A$15 million of operating profit. In other words, about 2% of PaperlinX’s operating profits are going exclusively to one non-executive director.

They also point to PaperlinX’s former Chief Executive Officer Andrew Price’s comments that he was not allowed to scrutinize payments to consultants or certain executive expenses. Price has threatened to sue the company over his dismissal.Without claiming there is anything untoward, they want the auditors to examine all relate transactions.

The full text of the letter released through APP is here below.

Robert Kaye SC & The Board of Directors
PaperlinX Limited
155 Logis Boulevard
Dandenong South
VICTORIA 3175

Dear Mr. Kaye and Members of the Board,

Blue Pacific Partners, LLC, together with its affiliates (“Blue Pacific”, “we” or “us”), is a shareholder of PaperlinX Limited (“PaperlinX” or the “Company”) and a holder of PaperlinX Step-up Preference Securities (“SPS Trust”). PaperlinX represents a significant investment for us.

In the past several months, PaperlinX has either sold or turned over to creditors virtually all its Canadian and European business operations, leaving the Company with its Australia, New Zealand and Asia Merchanting business (“ANZA”).

Unfortunately, the Company still has over A$260 million of SPS Trust Securities outstanding that rank senior to the Company’s ordinary shares. Given the remaining ANZA business has net assets of A$146.7 million and trailing-twelve-month operating profits of A$15.2 million as of December 31, 2014, it is exceedingly unlikely that the remaining ANZA business is worth more than the value of the outstanding SPS Trust securities.

The Terms of the Constitution & Deed of the SPS Trust securities(1) define the exchange rights of the SPS Trust in the event of various scenarios, including a winding up, change in control or a breach in undertakings. Generally speaking, the exchange ratio is determined using the latest 20-day Volume Weighted Average Price of the ordinary shares. At current trading levels, an exchange today would result in holders of the SPS Trust securities owning over 94% of the ordinary shares outstanding.(2) Existing shareholders would own less than 6% of the Company.

As a result of this potential dilution, the ordinary shares today appear to have little value and such value is difficult to accurately determine. PaperlinX effectively lacks a tangible ordinary share value that can be reliably estimated or measured. Due to this impaired nature of the capital structure, the Company is precluded from the following critical business pursuits:

1. PaperlinX ordinary shares may not be suitable for use as equity
compensation to attract and retain key management and employees using
equity compensation; such equity compensation is critical to align
management and employee incentives to the long-term benefit of all
Company stakeholders;

2. PaperlinX is likely unable to consider strategic alternatives that
would involve ordinary shares as a currency, and PaperlinX may be
precluded from considering other capital structure proposals that would
otherwise benefit all stakeholders;

3. It is highly unlikely PaperlinX could access the equity markets for
financing with its current capital structure, and the current capital
structure may prevent the Company from accessing other forms of capital
that could benefit all stakeholders;

4. PaperlinX is unable to redeem, reduce, cancel, buy-back or acquire any
of its share capital, as it has not paid any distributions to SPS Trust
holders in the past 12 months.

The board’s duty is to act in the best of interests of the Company, and we strongly believe a quick resolution of the impaired capital structure is in the best interest of PaperlinX and its stakeholders. It is incumbent upon the Board of Directors, in their capacity as fiduciaries to both ordinary shareholders and all employees and stakeholders in the Company, to act quickly and judiciously to resolve the current capital structure impairment.

Blue Pacific notes that PaperlinX made a Takeover Offer to holders of SPS Trust securities in late 2013 that expired in February 2014, offering 250 ordinary shares per each SPS Trust security. If this offer had been fully accepted, the holders of SPS Trust securities would have received shares equal to about 52% of the total ordinary share equity(3).

Less than 8% of all SPS Trust holders agreed to tender into this offer, which serves as evidence that SPS Trust holders view 52% of the ordinary share equity of the Company as wholly inadequate compensation for their senior position in the capital structure. Further, Blue Pacific notes the Company spent over $2.1 million dollars in costs associated with this failed offer.(4)

Blue Pacific hereby proposes the following middle-of-the-road solution that it believes will be amenable to both ordinary shareholders and SPS Trust holders:

The Board of Directors should promptly request the responsible entity of the SPS Trust to convene a meeting of its holders to consider a special resolution to amend the Trust’s Constitution to vary the exchange terms for each SPS Trust unit, conditional upon PaperlinX agreeing to an exchange ratio of 1,000 ordinary shares for each SPS Trust unit, and to immediately exchange the SPS Trust units for ordinary shares.

After such exchange, ordinary shareholders will own over 20% of the ordinary share equity, or more than three times the amount they would own in the event of a change of control or a winding up event. SPS Trust holders will own less than 80% of the ordinary share equity. The capital structure will no longer be impaired, and the Company will have a functional ordinary share capital base that it can use to advance its business objectives.

Blue Pacific estimates that the Board can unlock substantial value for ordinary shareholders by moving forward on this proposal. We estimate that PaperlinX may be worth in excess of A$125 million. This estimate may prove conservative, as it represents a discount to stated net assets of 15% and about 7.4x trailing-twelve-month earnings before interest, taxes, depreciation and impairment (“EBITDAI”) of $16.9 million, lower than publicly-traded peers Veritiv and Inapa(5). Conservatively, this valuation does not include any of the cash proceeds from the sale of Spicers Canada, which was sold for C$63 million less than six months ago.

At Blue Pacific’s estimated equity valuation of A$125 million, ordinary shareholders’ pro forma 20% equity position would be worth around A$0.038 per share, about 50% higher than the recent 20-day VWAP. The SPS Trust securities would accordingly be valued at about A$38 per unit(6), representing greater than a 60% haircut to their par value of A$100. At the same time, such exchange would cause an immediate accounting gain for ordinary shareholders of over A$160 million, from the retirement of a large liability at a substantial discount.

Separately, Blue Pacific notes that Mr. Kaye receives a salary of A$300,000, and that PaperlinX’s current ordinary share market capitalization is less than A$20 million and the Company generates A$15 million of operating profit. In other words, about 2% of PaperlinX’s operating profits are going exclusively to one non-executive director, and Mr. Kaye only owns about A$25,000 worth of ordinary shares. It seems that this level of compensation may not be appropriate for a non-executive chairman.

Finally, Blue Pacific has submitted a question to the auditor pursuant to Section 250PA of the Corporations Act. Recently, PaperlinX’s former Chief Executive Officer Andrew Price made comments in the trade press stating he was not allowed to scrutinize payments to consultants or certain executive expenses.(7) While Blue Pacific does not allege that the Board has done anything wrong, we do believe this statement raises certain questions that any responsible shareholder should ask. Specifically, Blue Pacific has asked PaperlinX’s auditors to thoroughly review all related party transactions, including any consulting arrangements with shareholders or otherwise, and that the Company fully disclose such transactions in the annual report. Also, Blue Pacific has asked PaperlinX’s auditors to thoroughly review all executive and board perquisites and other related forms of compensation, and asks that all executive and director compensation be fully disclosed in the remuneration report of the Company’s annual report.

We hope that you will act with a great sense of urgency to pursue a timely resolution of the capital structure impairment to prevent any further deterioration in the value of PaperlinX.

Disclaimer: All information, estimations, and calculations described above are pursuant to Blue Pacific Partners’ own research, estimates and opinions. All investors must conduct their own research and diligence and form an independent conclusion. We have strived to disclose all sources and reasoning for our conclusions, but other investors may reach different conclusions and estimates using the same information.

Notes:

1. See PaperlinX Step-up Preference Securities Product Disclosure
Statement and the Constitution of the Trust, both available
in “Investor Information – PaperlinX SPS Trust – About SPS Trust” at
www.paperlinx.com.

2. The current 20-day VWAP is A$0.024, and a Redemption Amount of A$262.5
million, divided by the VWAP x 2.5% results in an issuance of 10.775
billion new shares, resulting in a total sharecount of 11.44 billion
shares. The ordinary sharecount prior to the exchange is 665.2 million
shares, and represents 5.8% of the total pro forma shares outstanding.

3. The SPS Trust had 2.85 million securities outstanding, and if each had
exchanged each in to 250 ordinary shares, SPS Trust holders would have
held 712.5 million shares compared to 665.2 million shares for ordinary
shareholders prior to the exchange.

4. Pursuant to Press Release dated 4 March 2014 – Close of Takeover Offer,
only 7.85% of SPS Trust holders accepted the takeover offer; PaperlinX
paid $2.1 million of costs directly related to the takeover offer
according to page 71 of the 2014 Annual Report.

5. Net assets of ANZA at December 31, 2014 were $146.7 million; $125
million represents 85% of this figure; Trailing-twelve-month EBITDAI
for ANZA as at December 31, 2014 was $16.9 million; Inapa trades at
about 13x EBITDA and Veritiv trades at over 9x EBITDA.

6. If SPS Trust holders receive 80% of the common equity and it’s valued
at A$125 million, this implies a value of $100 million, and there are
now about 2.63 million SPS Trust units outstanding. Accordingly, these
shares would be worth about $38 per unit.

Best Regards,

Christopher Sommers
Blue Pacific Partners, LLC

 

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