I'll cut right to the chase. "Yes." In more ways than one, this week's deal to "reduce debt by $300 million" at YRC Worldwide (NASDAQ: YRCW) is indeed a game-changer for America's biggest LTL trucker.
When you consider that shares of YRC have roughly doubled in price since earlier this month when the Teamsters union agreed to take an up-or-down vote on a new labor agreement offered by YRC you get an idea of how important the deal might be to YRC, or at least how important investors think it is. There is, however, still the question of whether investors are right.
So let's review. Last month, when outlining YRC's options, I argued the company basically had three roads open to it: First, it could declare bankruptcy. (YRC doesn't much like this one). Second, management could recapitalize the company by selling shares to raise cash and pay down debt. Third, the company could extract wage concessions from its workers, hoping to regain profitability.
From the details YRC has revealed, it appears they've decided to straddle those last two lanes.
YRC's debt reduction deal: By the numbers
In essence, what YRC has described as its going-forward plan consists of two parts:
First, YRC needs the Teamsters to approve a labor agreement extending earlier-agreed 15% wage cuts into 2019, and permitting management to farm-out work when it needs to, among other concessions. All else hinges on this, with CEO James Welch warning that if the votes come in on January 8 and workers reject the agreement, "it would unfortunately mean some very difficult decisions for the company and its employees." (For a translation of what that means, read this).
Second, and contingent on the first point, YRC has convinced holders of its "Series A" and "Series B" convertible debt to ante up $250 million for 16.6 million-odd new shares of YRC common stock. YRC will then turn around and use this cash to pay off $69.4 million in debt coming due in February, and begin paying down $952 million in debt that comes due in March 2015. Helping with this last goal, some creditors will convert $50 million of debt into common stock, while others give YRC cash in exchange for "preferred stock," convertible into common.
Sounds great! What's the catch?
If you're keeping track, this all adds up to even more than the $300 million in "reduced debt" that YRC touted on Tuesday. But make no mistake: YRC hasn't convinced its bankers to write off this debt. All it's getting them to do is convert debt into equity.
And the 16.6 million new shares' worth of equity that the debt is getting converted into? That's enough to dilute existing shareholders out of two-thirds of their stake in the company. To a lesser extent, this resembles the gambit YRC played back in 2011 -- when YRC handed 97.5% of its equity over to creditors.
Any other catches?
Glad you asked, because yes, there are a couple. As already mentioned, this whole deal hinges on YRC's Teamsters agreeing to extend their pay cuts into 2019. It also depends on creditors, controlling at least 90% of YRC's $124 million pension fund debt, agreeing to extend the deadline for repaying this debt. If either of those plans hits a bump in the road, the whole deal drives into a ditch.
And the upside?
In short, YRC's revival still isn't a sure thing. So why are investors so keen to buy it, despite the uncertainties? Well, because there's a whole lot of upside if everything goes right.
For example, by converting $300 million-plus worth of debt into equity, and potentially negotiating lower interest rates on the rest, YRC hopes to reduce annual interest payments by as much as $50 million. The company is only burning about $55 million annually in negative free cash flow today. Combine $50 million in interest savings with some modest reductions in the cost of labor and YRC could actually turn free cash flow-positive in the not-so-distant future.
Such a development would open up new pathways for YRC to follow. Free cash could be deployed to reduce debt, for example, further reducing interest obligations. It could encourage -- indeed, has encouraged -- investors to believe the company has a future, increase the share price, and enable YRC to sell additional shares to raise cash at higher valuations, so as to pay down debt even faster.
At least ... that's what investors appear to be thinking. But what do you think? Sound off below.