Speculate on Corus Entertainment?
High debt levels make equity a call option on the assets of the firm
Corus Entertainment (CJR.B) has CDN$983 million of debt and its 199 million outstanding shares trade at CDN$0.64 per share. The enterprise value of this firm is CDN$1.1 billion, about 89% of which comprises debt. Here is Corus’ latest balance sheet:
CDN$500 million of the debt is due in 2028; $250 million in 2030; and, the balance is due on demand. The average duration of the debt is ~4.4 years.
Corus is a media company and the bulk of its revenue comes from advertising, a volatile industry. Media companies advertising revenue has a volatility of approximately 28%. Whether Corus can survive depends on whether its free cash flow can reduce its debt to sustainable levels within a few years and persuade its creditors to extend maturities of its debt if needed to do so. The equity of Corus is speculative. But what is it worth?
If the company fails, both shareholders and creditors will likely lose some money in the fire sale that typically follows a CCAA filing. If the company survives, creditors will be repaid and the common shares will have value.
In many respects, the common shares of Corus comprise a call option on the value of the assets of Corus with a strike price equal to the debt and an option life of at least 3.5 years. Since Corus no longer pays a dividend and directs all of its free cash flow to debt repayment, the common equity of Corus can be valued using a Black Scholes model, an approach to the valuation of equity in highly levered or even distressed companies now considered mainstream by valuation professionals.
That returns a value for the equity of CDN$455 million or a bit more than CDN$2.20 a share. By that analysis, Corus shares are both high risk and at current market prices of CDN$0.64 per share, undervalued.
Corus free cash flows allowed repayment of CDN$31 million of debt in the first half of its fiscal year, and while the outlook is soft, it seems likely the company will keep chipping away at debt for the foreseeable future. Asset sales are an option for the company to repair its balance sheet. Last August Corus sold a unit for CDN$142 million. Corus has some 87 separate assets some of which could be sold, but any sales would need to yield prices which capitalized the cash flow of the sold assets at an interest rate less than Corus’ interest rate on its debt for the sale to ease pressure on Corus.
For traders, CJR.B shares are poised for a fun ride. Will it work out for bulls or bears? Time will tell.