Fortuna Silver Announces Offering of Convertible Senior Notes | Arcadia Economics

Well, hello there, my friends. Chris Marcus here with you for Arcadia Economics, fortunately joined by my good friend Dave Kranzler of Investment Research Dynamics, and we just have a quick update because, as you may have already seen, Fortuna Silver has announced an offering of convertible senior notes in the amount of $150 million with an option for a period of 15 days to purchase up to an additional $22.5 million. The company is planning to use the proceeds to repay bank debt, fund working capitals, general corporate purposes, and funding the repayment of the existing 4.65% senior subordinated unsecured convertible debentures, and fortunately Dave, glad to have you here, and would love to get your opinion on the deal that they are in the process of doing.

Obviously we’ve had a reaction in the share price, and perhaps you could also explain what the deal implies. Sure. First of all, I tried to talk to the company, but they can’t really say anything, right? Because it’s kind of a blackout period. But my understanding is this thing is heavily oversubscribed. It’ll price today, I think, and close very quickly. So it’s a done deal. That part about the $22.5 million, I mean, that’s kind of like an underwriter’s green shoe and an equity deal. If there’s demand for it, and I’m sure there will be, the underwriters have the option of taking down another $22.5 million.

And that’s a standard boilerplate convertible bond issuance deal. So I wouldn’t put too much stock into that. Essentially, what they’re using the funds for is to completely pay off the credit facility. So it’ll strengthen their balance sheet in that regard. The convertibles of high grid between debt and equity, right? There’s an option to convert into equity at a certain price. And the trade-off is the buyers of the convertible get paid a much lower rate of interest than they would if this was just a straight bond deal. So there’s a heavy hedge fund participation component of this.

And the reason why the stock got banged like it did, most of the reason for it is that hedge funds, when they’re going to buy a convert, they short the crap out of the stock ahead. They short the crap out of the deal coming, A, it gives them a better strike price on the, or a better conversion price on the converts, right? Because they’re negotiating from a lower stock price level. But hedge funds also, with this kind of deal, they want to take down the bond and earn the rate of interest. Like it’s a fat coupon for them, right? And then they hedge out downside exposure to the equity component.

And so, and what that does is it gives the hedge fund, you know, upside in the equity to the extent that they can, if they convert the shares, cover their short, because they’re not going to fully hedge out the equity component. And then it gives them, you know, it’s essentially, I would call it kind of like a synthetic dividend in the form of a coupon payment on the bond. So that’s why they would short a deal. You short the stock ahead of this. I actually, I loaded up on call options when the stock was under five, because I just figured this thing was going to bounce back quickly.

So in terms of paying down the credit facility, it’s going to give them much more flexibility with how they use their cash flow, because, you know, the main covenant, I think they wanted to get rid of is the EBITDA to interest expense covenant. That was in the credit facility. So they have to maintain a certain level of EBITDA to interest expense. And the covenants also kind of restrict to some extent their ability to do what they want with their cash flow, right? So with this, you know, if they want to, they can probably increase the size of the share buyback.

But I also think the covenants were probably holding them back a little bit on how much they were allocating towards exploration expense. And obviously, they want to aggressively advance Diamba suit. And they don’t have to worry about, you know, how much free cash flow they allocate towards that, or even just operating cash flow. And I also, and again, this is just me reading into this. I mean, I’ve never asked the company directly about this, but I just kind of I think they probably believe the Etsy vein is going to, they’ll be able to extend the wide mind life of San Jose with that.

And my guess is they probably want to devote more cash flow towards aggressively drilling that out. I think they’ve got four drills on Etsy right now. But they want to try, if that does turn out to be an economic deposit, they want to get that going as soon as possible, right? Because then they can keep the San Jose mine going. And then they can also use cash flow from from that to further explore the rest of the property because it’s probably more silver somewhere on the property is my guess. So I think this is a fantastic deal.

It frees up more cash flow from them. They don’t they don’t replaces a debt facility that requires quarterly paydowns on it. And this will, you know, it’s replacing it with a quarter quasi debt equity security, and it’ll probably be around the same interest rate as the existing converts work. Most of which I expect to convert ahead of this deal. And, you know, they essentially have a debt, you know, a debt component to their balance sheet that just requires minimal interest payments every quarter. And they don’t have that’s the only debt service they’ll have. And, you know, if the bull market in this sector keeps going, these converts will convert into equity.

So they won’t even have to worry about paying off. Well, that makes a lot of sense, obviously, in the calls we’ve done with Jorge, he’s talked a lot about making it a fortress balance sheet. So this is one of the steps towards that. And great to get your feedback on how you see that in the short and long term. So, Dave, with that said, we will wrap up for now. Although I think we’ll probably be having Jorge on sooner than later, like you said, there’s still a deal in progress. So not sure yet when that will be happening.

But either case, appreciate you shedding some light on this, especially for people who are a little bit newer hearing some of these types of finances for the first time. So find Dave at investmentresearchdynamics.com. And the link to the press release is in the description field below. And we will see you again soon. Thank you. [tr:trw].

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