Barbie needs some cash




Looking at Mega Brands most recent audited financial statements (December 31, 2012), in many ways they look financially stable.  Their current ratio (current assets/current liabilities) is in decent shape, their debt:equity ratio (total liabilities/total equity) is improving year over year, they had positive earnings for the past two years, and they have a positive cash balance.  So the transaction I’m about to describe wasn’t done in a panic, it was done to take a reasonably healthy company and make it stronger.  Imagine for a second that you are the CEO or CFO of Mega Brands.  You don’t like paying 10% interest since that requires more cash than you feel is really deserved for debt repayment.  You need your other cash resources for day-to-day operations, and you don’t have excess assets that you can sell to generate cash.  What do you do?

Well, you look closely at your balance sheet and you remember that in 2010 Mega Brands issues a whole bunch of warrants.  Warrants are just like a stock option.  It is a financial instrument that gives the investor the right to purchase a common share of the company at a set price.  For general background on options and warrants, see this.  The investors originally paid to get the warrants ($0.50/warrant) and then have to pay again if they exercise their option to purchase the common share (called the strike price, $9.94/share in this case).  Obviously no investor would exercise their warrant if the common share was trading at a price below the strike price.  These particular warrants expire about two years from now and in most cases, finance theory suggests that a holding strategy is optimal.

Mega Brands wanted to raise some cash and had ~240,000,000 warrants still outstanding.  If they could convince all those warrant holders to exercise their warrants, pay the exercise price Mega Brands would receive ~$115 Million.  That essentially enough to cover all the long term debt which would then wipe out the debt with the 10% interest payment.  Early news releases don’t suggest any modified terms, rather Mega Brands executives just had some friendly chats with the major holders of the warrants (i.e. institutional investors) and explained the situation.  The warrants were already in the money since the common shares were trading above $13.  Remember that a warrant holder receives a common share (market value ~$13/share) by paying $9.94/share.  That’s a good deal.  Further, the executives explained that the cash they raised would be used to repay that expensive 10% debt thereby reducing the interest cost and increasing cash available for expansion and dividends.  Win-win for the company and the warrant holders.  No surprise then that approximately 1/2 of the warrant holders have agreed to early exercise.

What will be the impact on the financial statements?  Let’s do this on a single share basis, but in reality closer to 600,000 shares will be issued.  First Mega Brands receives the exercise price from the warrant holders (Dr Cash $9.94) removes the warrant value from equity since the warrants no longer exist (remove at the initial value Dr Warrants (equity) $10) and recognize the new common share being issued in exchange (Cr Share capital $19.94).  Then Mega Brands will turn around and use that cash to reduce their debt, Cr Cash XX, Dr Long term debt XX.  So when the next financial statements get released we should see an increase in equity and an equal decrease in liabilities.

Warrants and options are very common financial instruments.  Mega Brands move to tap into them as a way to raise cash is interesting and a little unusual but quite admirable.


The full financial statements are here.  I encourage you to look at the balance sheet (page 5), and Notes 15 and 16 in particular (pages 33-35).

Note: this blog was originally posted on my site hosted by Pearson Education(

Turkeys, forks and dual class shares

Dual class equity structures are a hot topic of discussion in Canada.  In simple terms dual class equity structures have more than one class of common shares.  These two (or more) classes may have similar cash flow rights (i.e. dividends) but always come with different voting rights.  Remember that voting rights refer to voting for particular members of the board of directors.  Some companies have shares with one-vote shares and no-vote shares or one-vote shares and multiple-vote shares.  In Canada, these dual class share companies are generally controlled by family dynasties – Magna International was controlled by the Stronach family for many years.  Other examples include Shaw Communications (controlled by the Shaw family), Power Corp (controlled by Paul Desmarais), and Rogers Communications (controlled by the Rogers family trust). In Magna’s case, those multi-vote shares provided 300 votes votes per share resulting in the Stronach’s only holding a 1% equity interest in the company but controlling 66% of the votes.  The purpose of such equity structures is that it allows the founding families to retain control while still raising equity on the open stock market from Joe Plumber or Jane Mainstreet.  The problem is that the holders of the less powerful shares take on a ton of the equity risk without getting the benefits of control.  That disparity usually results in the less powerful shares trading at a discount.

In recent years, some of these companies have tried to simplify or clean up their equity structure by consolidating all the shares into one single class with equal voting rights and equal cash flow rights.  Magna did that in 2010 and in my opinion paid dearly to convince the Stronachs to give up their super-voting shares.  Ultimately they were paid a 1800% premium and close to $1B to give up their family shares.

Telus is not a family-owned corporation but as a result of the merger of BC Tel and Telus in 1998, they ended up with no-vote and single-vote shares.  They are now trying to clean that up.  The problem they have run into is that an institutional shareholder that did control the company by holding a substantial number of the single-vote shares would lose control once the no-vote shares are converted into single-vote shares.  A very interesting corporate governance situation.

As a shareholder of Telus (I own both the no-vote and the single-vote shares) the proposed transaction doesn’t affect me very much.  I usually don’t exercise my voting rights at the annual general meetings, I’m just happy to collect the dividends they pay me.  However, if I owned significant numbers of those shares then I would definitely be interested in the settlement.


Voting rights can be an abstract and complicated issue – let me use an analogy.  Imagine sitting down for a Thanksgiving dinner with five other people.  There you are, one of six people at the table, a tasty roasted turkey (or tofurkey if you prefer) in the centre of the table.  The only problem is that there is only one fork at the table.  The person with the fork clearly has an advantage – that’s the multi-vote shares.  The rest of you still have a seat at the table but no real tools to eat the dinner.  If you want to equalize everyone around the table there are two obvious options: (1) take the existing fork away or (2) find five more forks so all six of you have a seat and a fork.  In either case, the person with the only fork at the beginning of dinner probably feels ripped off.  Fixing the dual class equity structures is even more complicated than settling forks and turkey dinners.

There are not any difficult accounting implications to dual class equity structures except appropriate disclosure that outlines the dividend and voting rights.  Dividends are still dividends, share issuances and share retirements are dealt with just like a single class structure.  As discussed above, you should see the corporate governance implications and the difficulty trying to unwind such structures.  Dual class equity structures are becoming rarer in Canada and were never popular in the US.  Keep your eye out as Telus completes the proposed transaction and as the other remaining dual class companies start to clean their equity structures up.  In every case you will find that either the fork-holder or the non-fork-holders will be unhappy – that’s the consequence of cleaning up a mess.

Note: this blog was originally posted on my site hosted by Pearson Education(