Tuesday, March 25, 2008 0 comments ++[ CLICK TO COMMENT ]++

Fairfax Injects $350 million Into Struggling AbitibiBowater

The main contrarian forestry industry stock I'm following is AbitibiBowater (ABH). If you are looking at the forestry industry, you can either go for forestry companies that produce wood products or paper products. I decided to avoid the wood companies due to the housing uncertainty. ABH is a leading paper company which I haven't posted much about lately because I'm waiting to see if the company can stabilize its operations. Abitibi and Bowater merged a few months ago to create the largest paper forestry company.

On top of horrible fundamentals (weakening paper demand, increased costs due to C$ increase, overcapacity in the industry), ABH has high leverage. Lately there have been some concern about ABH's ability to re-finance its debt. There was one big positive move recently, which occurred when Fairfax, run by Prem Watsa, a value investor, decided to pump $350m into the company:

According to the terms outlined in the news release, Fairfax is buying the five-year debentures with an 8 per cent interest rate, which can be paid in the form of additional debentures at a 10 per cent rate. The $350-million (U.S.) in debt is convertible into AbitibiBowater common shares at $10 a share and has a subsidiary guarantee.

If the debentures were fully converted, Fairfax would hold 35 million new shares of AbitibiBowater, which currently has roughly 51.9 million shares outstanding.

The market cheered the news but, as has been the case with struggling companies lately, it involves a lot of share dilution. Overall, I think this is good news for the company since it removes some of the financing problems and provides a stable long-term-oriented investor.

If one waltzes into distress investing, it pays to keep in mind that dilution is a huge risk. Unlike a "normal" share price decline, dilution can involve massive stakes being sold off (up to 40% of the company given away; in the case of Ambac, it was 66%) and it crystallizes the loss. That is, when a share price declines, it an always rise back because of the possibility of irrational market pessimism; but if shares are diluted, you are basically giving away ownership of the company and you won't ever get it back.


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