Complicated doesn't begin to describe it. The term sheet for Bombardier Inc.'s financing with the Caisse de dépôt et placement du Québec is utterly baffling.
In sticky situations, such as this desperate financing, it's common to see the investor that steps up to save the day offered some sweeteners. Maybe it gets warrants to juice its return if the company rebounds, maybe it is promised a minimum profit should the troubled company pay back the investment early. The Caisse, it seems, is getting all that, and then some, which makes the deal look extremely valuable to its stakeholders.
But the veneer starts to crack under closer scrutiny.
Trying to explain the financing's key terms, Bombardier and the Caisse argued the deal is best understood by looking at it from three angles: the Caisse is advertising a "minimum" 9.5-per-cent annual return by investing in convertible shares issued by Bombardier's train unit; the Caisse could make more than this if the train unit performs better than expected and is ultimately taken public, or is sold to someone else; and if Bombardier buys back the Caisse's 30-per-cent train unit stake any time after three years, the Caisse is guaranteed to make at least a 15-per-cent compounded annual return.
Unfortunately, that attempt to clarify matters falls at the first hurdle. When asked on a conference call whether the 9.5-per-cent return on the convertible shares would be paid in cash, the way a bond coupon would be, neither Bombardier nor the Caisse would confirm. Caisse chief executive officer Michael Sabia argued there is some flexibility in the arrangement, and it was later revealed the 9.5 per cent would likely be invested back into the business for a few years.
The uncertainty fostered a sense of disbelief by some on the call. Analysts desperately trying to wrap their head around the deal couldn't understand the simplest of its terms.
Later, the Caisse explained its investment is best thought of as a "payment-in-kind" bond – which puts an entirely different spin on the financing. PIK bonds, as they are known, are little heard of in Canada, but they were commonly issued in the United States in the lead-up to the financial crisis and have started making a bit of a comeback.
The way to think of these investments is to consider them as zero-coupon bonds, where annual interest payments aren't paid at regular intervals and are instead lumped together and paid all at once when the bond matures. This structure provides the issuer with financial flexibility because its cash flow can be diverted to other things, such as being invested back in the business – something that's clearly beneficial to Bombardier in these dire times.
Canadian pension plans already have some recent experience with these investments. After Ares Management LLC and the Canada Pension Plan Investment Board teamed up to buy Neiman Marcus in 2013, they issued PIK bonds to help finance the deal. The big difference is that CPPIB, like Bombardier, was the issuer; in the new financing, the Caisse is the investor taking the bet.
It isn't yet clear how the Caisse will earn its minimum 9.5-per-cent return. If things go sour, the Caisse says it has stress-tested every scenario and is confident this gain is almost a sure thing. The terms require Bombardier to keep minimum cash levels on hand, which could theoretically be used to pay the Caisse back, and the pension fund ranks senior to other train unit investors and also has a veto on dividends.
If the train unit performs well, the pension fund will likely convert its stake to shares and then sell them to reap the profit.
But in finance, hefty returns don't come without high risk. Having now secured $2.5-billion (U.S.) from the Quebec government and the Caisse, Bombardier is telling investors it has a "safety net," because cash flow won't be a concern for a number of years. The same isn't so true for the Caisse. Though the pension plan could earn a juicy return from investing in the new deal, the commitment isn't completely safe.