Prescience Point believes that shares of Celadon Group (“CGI”, or “the company”) are grossly overvalued, failing to reflect the likelihood of an imminent debt restructuring and wipeout of existing shareholders.
In April 2017, Prescience Point issued two research papers (the “Initiation Report” and the “Follow-Up Report”) on CGI. In our Initiation Report, we concluded that CGI’s profits and TBV were highly overstated in its SEC filings and that the company was at the precipice of bankruptcy. In our Follow-Up Report, we revealed that the company was the subject of an undisclosed investigation by the SEC’s Enforcement Division.
In the prevailing 9 months since we released our reports, CGI’s auditor BKD withdrew its audits of CGI’s financial statements; CGI’s top 3 executives were replaced; CGI disclosed an active formal SEC investigation; and, CGI violated its debt covenants and would have already declared bankruptcy if not for the generosity of its lenders who have amended the credit agreement three times since May.
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Unbelievably, despite all of the challenges and uncertainties facing CGI, its share price has almost quadrupled over the past few months from a low of $1.55 on May 3rd to the current share price of $6.35. Investors appear to believe that, with new management in place and the recent improvement in the trucking environment, CGI is in the midst of a successful turnaround.
However, we continue to believe that CGI is a Zero, and that bankruptcy is the most plausible outcome, for the following reasons:
- After generously amending the credit agreement several times, CGI’s lenders appear to have finally lost patience. In the most recent amendment dated September 29th, a clause was added requiring CGI to refinance its existing credit facility by December 31st. If CGI fails to do so, it appears that its lenders are now prepared to force the company into bankruptcy in order to preserve the value of their collateral.
- CGI’s refinancing efforts appear to be on the verge of failing. As of November 30th, the company had yet to receive a satisfactory LOI for its proposed term loan, and had only managed to secure a non-binding LOI for its proposed ABL which is subject to due diligence. Non-binding LOIs are far from firm commitments as evidenced by Bank of America’s decision to walk away from its proposed $225m ABL with CGI earlier this year after conducting due diligence. Also, based on the cautious tone of CGI’s latest refinancing update, it appears that management is losing confidence in its ability to refinance on acceptable terms for shareholders.
- In addition to the ongoing financial restatements and SEC investigation, we believe that CGI’s difficulties in attracting interest from lenders is also attributable to its dire financial condition. Our research indicates that CGI’s already poor operating performance has further deteriorated in the 3+ quarters since it last reported earnings. For example, CGI has communicated to investors that it expects to report a net loss of $10.0m in Q3’17, as well as a net losses for FY’17 and Q1’18. Additionally, the minimum LTM EBITDAR covenant in the latest credit agreement amendment – $76.4m, $71.0m and $67.0m for the periods ended 9/30/17, 10/31/17 and 11/30/17, respectively – suggests that CGI’s LTM EBITDAR has declined significantly since Q2’17. Lastly, although CGI’s rampant asset liquidations have helped keep it afloat in the short term, these dispositions will greatly pressure the company’s revenue and profitability going forward. Consider that the recently sold Quality business accounted for $12.8m of annualized operating profit in Q2’17.
- In our Initiation Report, we concluded that CGI’s last reported TBV of $10.80 per share as of Q2’17 is mostly fiction. In total, we estimated CGI’s accounting shenanigans had inflated its Q2’17 TBV by $219m, and that CGI’s actual Q2’17 TBV was no more than $.42 per share. Recent evidence has confirmed that CGI’s reported TBV is significantly overstated and is likely worthless, in our view. For example, Element has written down its JV stake by almost 50% over the past 3 quarters, supporting our conclusion that the $100m JV stake on CGI’s balance sheet is likely worthless. Additionally, according to CFO Thom Albrecht, BKD is reassessing the accounting for around 11,000 equipment transactions, indicating that significant equipment write-downs are likely. Lastly, CGI’s continued operating losses will result in further reductions to its TBV.
Even if CGI is somehow able to refinance and remain solvent, we believe CGI shareholders will still incur significant losses. In order to effectively run its business, CGI will need to substantially reduce its debt balance which stood at $455.3m as of Q2’17. With access to the equity markets likely cutoff due to a lack of audited financials, we believe that the company will need to exchange more than $250m of its existing debt for equity in order to reduce its debt to a target leverage ratio of 2.0x LTM EBITDAR. Given that current TBV appears to be worthless or close to it, we estimate that such a debt-for-equity swap would be priced at no more than $1.00 per share – diluting existing shareholders by at least 90%! Thus, all roads appear to lead to a disastrous outcome for shareholders.
We hope that current and future investors and creditors familiarize themselves with the risks we have addressed and take immediate action to preserve the value of their holdings.
Developments Over the Past Nine Months Have Validated Our Research
Since we published our initial short recommendation on CGI almost nine months ago, a number of developments have transpired which have either confirmed or reinforced many of our key research conclusions. These developments include the following:
- BKD withdrew its audit reports: In our Initiation Report, we concluded that CGI would restate its historical results due to the myriad of accounting improprieties we highlighted. On April 25th, this prediction came true as BKD withdrew its audits for CGI's FY'16, Q1'17 and Q2'17 financial reports. In a subsequent press release on October 2nd, CGI indicated that it did not expect BKD's audit work to be completed until sometime after 12/31/17. In our view, the lengthy amount of time it is taking for BKD to complete its work indicates that CGI's financial reports are likely to be restated significantly.
- CGI replaced its top 3 executives: In our Initiation Report, we presented evidence that CGI management had not only fabricated CGI’s financials, but had also used a related party (19th Capital) to enrich itself at the expense of shareholders. In the months following our report, CEO Paul Will, COO Eric Meek and CFO Bobby Peavler were all let go and replaced by the company. In our view, this swift cleaning of house by CGI confirms that the concerns we raised about management’s conduct have merit.
- CGI’s liquidity issues have intensified: In our Initiation Report, we concluded that CGI would be insolvent in 1-2 quarters due to its deeply negative and rapidly deteriorating FCF and limited revolver availability. Since we published our report, CGI’s liquidity issues have intensified. The company has been firesaling assets and recently raised $22.6m in term loan financing in order to keep itself afloat. CGI also violated its debt covenants, and its credit agreement has been amended three times since May. If not for the generosity of its lenders, CGI would have already declared bankruptcy.
- CGI revealed that it is the subject of a formal SEC investigation: In our Follow-Up Report, we revealed FOIA data confirming that CGI was the subject of an ongoing SEC investigation. We concluded that this investigation would result in enforcement actions against CGI and its management team. CGI verified our findings when it disclosed on October 2nd that the SEC had undertaken a formal investigation related to the company. Public companies are only required to disclose SEC investigations that they deem to be "material." The fact that management judged this investigation to be serious in our view indicates that future enforcement actions are likely.
CGI’s Refinancing Efforts Appear to be on the Verge of Failing
Since BKD withdrew its audits in April, CGI’s lenders have generously amended the credit agreement a total of three times as they have patiently waited for the company to get its financial house in order. However, it appears that their generosity and patience is wearing thin as the sixth and most recent amendment contains a new clause requiring CGI to refinance its current $221m credit facility by December 31st, indicating that they are now willing to let the company fall into bankruptcy in order to preserve the value of their collateral.
Section 6.02 of the Credit Agreement is hereby amended by adding the following new clauses (w) and (x) to such section:
(x) on or before November 22, 2017, a certificate signed by a Responsible Officer of the Borrower confirming that the Borrower has paid the necessary due diligence or similar upfront fees required under one or more letters of intent executed in connection with a prospective transaction or transactions that would enable the Borrowers to repay in full all Obligations under the Loan Documents on or before December 31, 2017. (Sixth Amendment to Credit Agreement, Pg. 4, 9/29/17)
Thus, CGI must refinance its existing credit facility in short order, or else it will almost assuredly have to file for Chapter 11. Unfortunately, despite months of effort, the company has made little progress in securing new lenders, and based on the cautious tone of CGI’s November 30th press release, it appears that management is losing confidence in the company’s ability to do so. These developments have led us to believe that CGI’s refinancing efforts are on the verge of failing and bankruptcy is the most plausible scenario.
Article by Prescience Point
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