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Cerberus deal sets the bar for Yellow Media bondholders

Yellow Media Inc. president and CEO Marc Tellier: Yellow Media bondholders have no real leverage until next year, when the company must refinance its debt. The biggest risk is that in the meantime, morale at Yellow Media gets so bad that the company’s main asset, its sales force, starts leaving.

Graham Hughes/The Canadian Press/Graham Hughes/The Canadian Press

For investors wondering what's next at two fallen Canadian angels, Yellow Media Inc. and Research In Motion Ltd., two deals in the United States provide some hope of hidden value.

Private-equity firm Cerberus Capital Management is buying half of AT&T Corp.'s directories business in a deal that values the whole enterprise at almost $2-billion (U.S.), suggesting Yellow Media is worth more than bond markets are pricing in. And AOL Inc., once the dominant online company, is selling its patent portfolio at a huge premium to the market's expectations, creating the possibility that RIM's trove of intellectual property is similarly undervalued.

New York-based Cerberus is paying $750-million cash and giving AT&T a $200-million note in return for 53 per cent of AT&T's Yellow Pages business. What that indicates is there ought to be about $1-billion of value in Yellow Media at this point, based on simple back-of-the-envelope calculations. Montreal-based Yellow Media is a little less than half the size of AT&T's Yellow Pages unit, but sales are falling three times faster at the AT&T business.

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That is, of course, assuming Cerberus didn't vastly overpay. This is the same crew that bought Chrysler and the financing arm of General Motors right before the financial crisis and ensuing recession. That ended badly.

But giving Cerberus the benefit of the assumption that its people have some idea of what they're doing, the purchase has set a bar for what Yellow Media bondholders, who are now mobilizing, will expect to receive in a restructuring. While the valuation is not enough to create any real recoveries for stockholders, or even preferred shareholders, it is enough to suggest there are gains in store for bondholders gutsy enough to buy Yellow Media paper at distressed levels.

Broadly speaking, Yellow Media has about $1.5-billion of debt that has been trading at about 50 cents on the dollar. If there's $1-billion of value, that suggests the bonds should be closer to 67 cents on the dollar.

Some bondholders argue there's more. Applying market multiples to the free cash flow generated from Yellow Media's old-line and online operations, some bondholders argue you can get to a range of $1.4-billion to $2.2-billion.

The issue is timing. The business is decaying, and Yellow Media's bondholders have no real leverage until next year, when the company must refinance its debt. The biggest risk is that in the meantime, morale at Yellow Media gets so bad that the company's main asset, its sales force, starts streaming out the exits.

At this point, the bondholders will be arguing that Yellow Media's board needs to give up the fiction that directors and management are working in the best interests of stockholders, who are hopelessly underwater, and try to save the company. That means a packaged restructuring, avoiding a liquidity crunch that destroys the business as customers and employees flee.

There are bondholders who would agree to take a bit less, so that a bit of money could be handed to preferred shareholders and even common shareholders, to secure a restructuring sooner rather than later to preserve the bulk of the current value. But the operative word is "bit." For common shareholders, it would likely be only a few pennies, helping management save a little face.

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The AOL example shows that there is also potential hidden value at RIM. AOL is selling and licensing patents to Microsoft in a transaction worth about $1.1-billion, generating a burst of cash. It's a short-term fix. Much of the cash will simply be handed to shareholders, which prompted a huge surge in AOL's stock.

Waterloo, Ont.-based RIM looks a bit like AOL, except sped up. Both dominated their business – RIM in smartphones and AOL in online access – and both have watched that dominance disappear as faster, smarter rivals have swept in.

RIM's revenue declines have been much sharper, however. According to Bloomberg, New York-based AOL's revenue has fallen 29 per cent since it was spun off from Time Warner Inc. in 2009. RIM shareholders have watched revenue fall 25 per cent in the past four quarters.

So would a patent sale change anything for RIM?

A deal for part of its patent portfolio would bring in cash, adding to RIM's current hoard of $2.1-billion, and give investors a view on what the whole portfolio would do by providing a mark to market. AOL's patent sale price is many times what the market estimated, suggesting that similar hidden value might surface in a sale by RIM.

For the moment, RIM is focused on bringing its new-generation operating system to market. It doesn't need money. Selling a stake in the patents only makes sense if RIM wants to finance something transformative. AOL, by giving the cash to shareholders, is signalling it doesn't have a big transformation in mind. And there's no sign at this point that RIM does, either.

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