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Rona’s preferred shareholders still getting a ‘lottery ticket’ deal

A man drives a forklift in front of a Rona home improvement store in St. Eustache, Que., just outside Montreal, on Thursday, July 16, 2015. The Lowe's home improvement chain is buying Quebec-based Rona Inc. in a deal valued at $3.2-billion.

Ryan Remiorz/The Canadian Press

Rona Inc.'s battered preferred-share investors may not be getting as fat a premium as common shareholders in the $3.2-billion takeover by Lowe's Cos. Inc., but they should be thrilled with what they're being offered, money managers say.

As part of the deal, the U.S. home-improvements chain is offering $20 for each Class A rate-reset preferred share of Quebec-based Rona. The offer, which is based on a fairness opinion from Scotia Capital, represents a 59-per-cent premium to the closing price of Rona's preferred shares before the deal was announced.

While that's lower than the 104-per-cent premium being offered to common shareholders, it's still a highly attractive offer given that Rona's preferreds – like most rate-resets – have been hammered by a massive drop in government bond yields and are facing a potentially hefty cut to their dividend on their March 31 reset date.

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"I'd be jumping for joy" at the $20 offer, said Jeff Herold, chief executive officer of J. Zechner Associates, which manages preferred shares for pension and endowment funds as well as the NexGen Canadian Preferred Share Fund.

"Given that the preferred shares were trading at around $13, people just got a lottery ticket," said Mr. Herold, whose firm does not own Rona preferreds.

Rona's preferred shareholders have no say on the takeover of the company, but they will have a separate vote on Lowe's $20 offer for their shares. If they do not approve the offer, the preferred shares would presumably continue trading under their current terms. Based on Wednesday's closing price of $19.99, investors expect the offer to be approved.

Some Rona preferred shareholders said it's possible Lowe's might make a higher offer for the preferreds. "Perhaps they could be persuaded to offer more money. Perhaps. I'm not banking on it but not discounting it either," said Benj Gallander, co-editor of Contra the Heard Investment Letter. "These are early days."

Don't hold your breath, said preferred-share fund manager James Hymas, president of Hymas Investment Management. Rona's preferred shareholders don't have the leverage to squeeze more money out of Lowe's, he said.

"They can always try, but I don't know how far they'll get," said Mr. Hymas, who does not own Rona's preferred shares.

Rona raised $150-million with an offering of six million Class A rate-reset preferred shares in 2011, but it wasn't long before the shares – which initially yielded 5.25 per cent on their $25 issue price – began to stumble. In 2013, they sank after DBRS downgraded the shares to speculative grade, Mr. Herold said.

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When government bond yields fell sharply that same year, and then dropped off a cliff in late 2014 and early 2015, Rona's preferreds plunged even lower as the prospect of a hefty dividend cut loomed.

Assuming the the five-year Canada bond remains at its current yield of about 0.6 per cent, Rona's preferreds are poised to reset on March 31 at a yield of about 3.25 per cent – the five-year Canada yield plus a spread of 2.65 percentage points.

Under that scenario, the current annual dividend of $1.3125 would be slashed by about 38 per cent, to $0.8125, in order to yield 3.25 per cent based on the preferred share's $25 par value.

After all the suffering Rona's preferred investors have endured, they should be happy that Lowe's is willing to take them out at $20, Mr. Hymas said.

"You don't want to kill the goose that lays the golden egg," he said. "They're not going to sweeten that deal. There is no reason to."

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