TransAlta prefs move not popular

Shareholder reaction has been negative

For a company that’s raised about $1 billion from selling rate reset preferred shares, TransAlta has an unusual way of showing its appreciation.

The Calgary-based company announced a share exchange whereby the four classes of its preferreds would be converted into a “single” new series of preferred shares. Those plans, which are subject to a shareholder vote, call for a different exchange ratio for each class of preferreds, for a higher dividend and a minimum reset spread of 6.50 per cent for the new series.

Reaction to the plan, which would see holders give up any potential capital gain from continuing to hold the existing preferreds, in return for higher quarterly income, has been quick — and negative.

For instance, the trading prices of the preferreds — some of which were trading at very low levels — rose as investors showed they were prepared to pay more for a security that comes with a higher dividend.

But existing holders aren’t pleased. “This exchange, if successful, will effectively take away the potential capital gain associated with the current shareholders including myself who bought the shares at a deep discount. This is extremely unfair in my mind,” said one, who asked not to be named.

Another professional investor said TransAlta is the latest issuer to take advantage of the depressed preferred share market, noting that RONA, as part of being acquired by Lowe’s Inc., offered pref share holders $20 a share, an offer that was soundly rejected. Later RONA upped the offer to $24 a share and holders accepted.

This investor said TransAlta’s plan is probably a “good/opportunistic” move for the company and may make sense for holders of prefs shares that are trading around $18-$20.

But, he said it “doesn’t seem to make sense for holders” of the prefs, which are trading at around $12 a share and have already been reset to a lower rate. Last March TransAlta chose not to redeem a $300 million issue that was up for reset but chose to fix the rate, in accordance with the formula, at 2.709 per cent, down from the previous 4.60 per cent. “There’s permanent impairment upon accepting new paper for them.”

James Hymas, who runs Hymas Investment Management and who also publishes the PrefBlog, wrote “all of this analysis leads to the conclusion that this is a rotten deal for the preferred shareholders, so rotten that we may call it a sleazy attempt by the company to pull the wool over the eyes of unsophisticated retail investors.

As the company admits, they look forward to reducing the corporation’s notional capital balance of preferred shares by approximately $300 million.”

After noting that an analysis based on implied volatility would require an even higher dividend than the 6.50 per cent TransAlta is offering, Hymas said the $300-million “is money that currently can potentially be earned by the current shareholders.”

That $300 million could occur with price increases on the extant issues; from an increase in the five-year government of Canada yield, or “from straightforward spread narrowing. The company is giving up nothing – NOTHING! — in order to capture this entire amount for themselves,” he wrote.

TransAlta, which argues the plan would reduce dividend volatility, would enhance trading liquidity and result in higher dividends, said a $300 million reduction in its notional capital balance of preferred shares “strengthens the balance sheet and improves certain financial ratios.”

Perhaps but in the meantime, DBRS has assigned a provisional rating of “adequate credit quality” with a negative trend to the proposed new issue of preferreds.