Thursday, 26 April 2007

First Uranium's Convertible Debentures

A friend sent along some questions regarding the recent announcement by First Uranium Corp (TSX:FIU) of its debentures. Thought I would post my comments ....

The Press Release
"First Uranium" or "the Company") today announced the pricing of its private placement of 4.25% senior unsecured convertible debentures (the "Debentures") due June 30, 2012 and an increase in the aggregate principal amount of Debentures to be sold to CDN$150 million. The sale of the Debentures is expected to close on May 3, 2007. The Debentures will bear interest at a rate of 4.25% per annum payable semi-annually and will be convertible into common shares of the Company at CDN$16.42 per share representing a conversion premium of approximately 37.5% to the closing price of the shares on the Toronto Stock Exchange (the "TSX") on April 18, 2007."

My Friend's Questions
I am not familiar at all with Debentures and have no intention of buying any - I wouldn't know how to even if I wanted to - but wonder if I understand correctly that those who buy these debentures will be entitled to buy FIU stocks at $16.42 per share on June 30, 2012 and thus make an investment with a guaranteed return of 4.25% per annum plus the possibility of capital gain of the FIU share price in June 2012 less $16.42? Or are the debentures convertible any time? Or have I misunderstood completely?

My Comments
First, I'm glad that my friend doesn't intend to buy any, even if he could. This is all highly risky and speculative. A quick look at the company's website shows that it is a brand new company founded in 2006 whose shares first began to trade in the last six months. FIU is a company that is developing gold and uranium mines in South Africa. It has no production yet and won't till 2008, if it succeeds in its plans. The stock chart shows how volatile the stock has been in its short history; though it has been all upwards, that could change in a flash if bad news comes out of the company.

Now for the debentures themselves. Debentures are a form of debt issued by the company, with no collateral protection against assets of the company in case there would be bankruptcy or insolvency. We ordinary mortals can buy them and other forms of bonds in the fixed income area of our online brokerage accounts. Given that FIU is a new venture, if it spends all the money it has raised from the start-up equity sale in December and from the debentures on development of the mines but is unsuccessful, how likely is it that there will be any left to reimburse the holders of the debentures their capital, let alone pay the promised interest?

FIU is so new that Dominion Bond Rating Service and Standard and Poors, which rate the riskiness of company debt, do not even have FIU listed. Given the start-up nature of FIU, the riskiness of its debentures would likely be off the end of the scale. Yet, the 4.25% rate
of interest offered is comparable to that of high-grade companies, i.e. it is less than generous.

The date June 30, 2012 is when the debenture face value of $1000 of each debenture bond will be repaid to the debenture holders, if they have not converted into common stock of FIU in the meantime.

Convertible means that at the request/option of the debenture holder, FIU will take back the debt and issue new common stock in its place. The $1000 face value of each bond will be divided by the $16.42 conversion price to determine how many shares will be issued (1000/16.42 = 60.9013) The press release doesn't specify but we assume that the simplest conversion privilege is in effect - that the debenture holders can convert their debt into common stock of FIU anytime they please between now and June 30, 2012. With the stock price of FIU currently trading around $12 per share, a debenture holder will not want to convert. The market price of the stock will have to go above $16.42 to make it worthwhile. In effect a convertible debenture is a combination of a debt/bond and a call option on the stock. The more the market stock price is below the conversion price, the more the value of the debenture is based on its bond value, which is the discounted cash flow of the interest payments and the $1000 face value returned at maturity. When the stock price approaches or exceeds the conversion price of $16.42, the price of the debenture will move with the market stock price.

The final point is that this is immaterial to my friend, to me and to other members of the investment public since it was a private placement, meaning that the debentures were sold on FIU's behalf by RBC and other members of the sellers group, called the underwriters, directly to institutional investors like pension funds (though I doubt they would be buying such speculative securities). Some of the debt may be re-sold by these initial buyers and show up in the secondary market and be available through our brokers at which point we could buy them. Not by me, though!!

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