How Canada’s Warren Buffet wagered on Tembec

September 14, 2015

By: Montreal Gazette

Soon after Prem Watsa — the investor known as Canada’s Warren Buffett — became the largest shareholder of Tembec Inc., the bond market started betting creditors may be taking over instead.

The forestry firms’ bonds plummeted to about 68 cents on the dollar after the Montreal-based company warned that if its earnings continue to fall it could breach the terms of a bank loan. That would force Tembec to immediately come up with millions of dollars, and any unexpected cash drains could put it out of business, the company said.

With options dwindling for generating cash amid the commodities rout, Tembec may have to rely on its bankers to cut it a break or on a bailout from Watsa’s Fairfax Financial Holdings Ltd., according to Ed Sustar, the analyst at Moody’s Investors Service who rates the firm.

“Fairfax is behind all of this debt that’s on Tembec’s balance sheet, so they have the ability to lend them money,” he said by phone from Toronto. “We’re kind of at crunch time.”

When Tembec presented its third-quarter results at the end of July, the company said it was low on cash and looking to drum up more with asset sales, debt refinancing or other avenues in the capital markets. Though it projected enough cash to sustain operations and meet financial obligations, the company said it had almost no cushion to deal with contingencies.

Linda Coates, a spokeswoman for Tembec, referred questions on a potential default to the statements on July 30. Multiple calls and an e-mail message to Fairfax weren’t returned.

One hurdle Tembec highlighted was a covenant on a $175 million credit line that demands the previous 12 months of earnings be at least $60 million at the end of each quarter. Earnings below that level could cause the credit line to be reduced by $15 million and may give lenders the right to demand payment of any debt that exceeds the new limit, according to Tembec’s earnings report.

As of the end of the previous quarter, its trailing 12- month earnings before interest, taxes, depreciation and amortization was $63 million, the company said.

Watsa’s Fairfax, with its value-investing style and bets on out-of-favor companies, has drawn comparisons in the Canadian media to billionaire investor Warren Buffett’s Berkshire Hathaway Inc. Watsa’s profited on other long-shot bets, from Irish banks to a Greek commercial property manager, and just entered the world of haute cuisine with a stake in a venture by celebrity chef Mark McEwan.

Tembec isn’t Watsa’s only investment in Canada’s forestry sector. Fairfax is also the majority owner of Montreal-based Resolute Forest Products Inc., whose stock is down about 50 percent from its 2015 high in February.

Fairfax announced on June 12 it had bought about 20 percent of Tembec, only to watch as a month later the company’s $375 million in bonds began their fall as slowing growth in China sent commodity prices tumbling, stoking speculation the company’s cash flows would take a hit. The stock Fairfax bought for $2.25 per share has plummeted to 98 cents.

Tembec has been hobbled by debt taken on in recent years to build a $273 million electricity facility that will power one of its plants for producing high-end pulp, and run on the waste from that same manufacturing process.

The company expects the added efficiency from the new facility, and income from selling excess power to the provincial power grid, will help ease its cash squeeze. But the investment comes at a time when prices for the pulp Tembec specializes in are depressed after more competitors squeezed into the market, according to Standard & Poor’s.

“If they’re building a whole new plant when there’s a perception there’s too much capacity out there, that’s going to kill you,” said Joshua Zaret, an analyst with Bloomberg Intelligence. “That’s a big hole to dig out of.”

By: Montreal Gazette

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