Arctic Glacier AG-U
August 27, 2009 - 11:26am EST by
PGTenny
2009 2010
Price: 1.72 EPS $0.40 $0.465
Shares Out. (in M): 39 P/E 4.3x 3.7x
Market Cap (in M): 63 P/FCF 2x 3x (after AG becomes taxable in '11)
Net Debt (in M): 259 EBIT 30 32
TEV: 321 TEV/EBIT 10.7x 10x

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  • Regulatory Headwinds
  • Personal Account Idea
  • Discount to Peers
 

Description

Date: 8/24/09

Idea: Long Arctic Glacier Income Trust (TSX: AG-U CN Equity)

Price: CAD$1.72 (US$1.61)

Mkt Cap: CAD$67m (US$63m)

P/E: 3.7x

TEV/EBITDA: 5.3x (4.5x normalized for seasonality)

 

Arctic Glacier offers the opportunity to purchase a highly cash generative business with steady end-market demand at a cheap valuation owing to uncertainty over an industry anti-trust investigation and refinancing risks.

This is an idea for PAs only - mkt cap ~US$60m, trading volume ~$125k/day.  Nonetheless I'm writing up for VIC as I've dug up some interesting proprietary information.  I believe the idea offers ~3x upside with limited downside.

Investment Thesis:

  • Strong core business, cash flow generation - packaged ice (bagged ice at convenience stores, supermarkets) is a steady, albeit weather-sensitive business. Company generates ~$30m cash per year (post capex), $50m before debt service
  • o Presently trades at 50% free cash flow yield to equity
  • Valuation hugely discounted by pending anti-trust investigation and upcoming debt maturity (down 88% from peak)
  • o Expect anti-trust fines & related lawsuit settlements to be serviceable out of cash flow - supported by proprietary research with leading academic in the field of antitrust fines
  • o Expect DOJ to conclude prior to upcoming debt maturity allowing debt to be refinanced - if DOJ not concluded in time, expect $60m maturity can be extended for reasonable fee
  • Insider buying - industry mgmt clearly not as concerned about antitrust suit as public market is
  • o Arctic Glacier CEO bought 40k shares in open market since Sept '08
  • o Reddy Ice (main competitor, subject to same antitrust investigation) insiders have bought 210k shares in the open market YTD - stock up 130% over last 9 days on back of announcement of new 10b5 stock purchase plan
  • 3x upside in expected case, DOJ fine & related lawsuits could be much larger than the expected outcome and stock is still fairly priced
  • Near term catalyst in DOJ resolution - both companies expect nearterm resolution, DOJ investigation has gone on longer than usual since the first party plead

Company Description:

Arctic Glacier (US$1.61/share, 3.7x P/E, 5.3x TEV/EBITDA) is a leader in the packaged ice industry in North America.  The company markets its packaged ice under Arctic Glacier Premium Ice brand name to retail customers, such as supermarket grocery stores and convenience stores, as well as to various commercial users, including airlines, bakeries, and meat and poultry processors. The company also sells its ice in bulk quantities to various industrial users, including the food processing, construction, chemical manufacturing, and commercial fishing industries. In addition, Arctic Glacier sells other products, such as bottled water, dry ice, packaged wood, and rock salt, as well as sells and leases ice-making and dispensing equipment in certain markets.

The Company is a Canadian Income Trust and historically has not paid corporate level taxes.  Due to a change in law in 2006, all Canadian Income Trusts will lose this favorable tax treatment beginning in 2011, (assumed full Canadian tax load in all analysis).

Industry Overview:

Packaged Ice industry is dominated by 2 large players - Reddy Ice (35-40% mkt share, concentrated in southern half of US) and Arctic Glacier (~25-30% mkt share, concentrated in northern half of US & Canada).  The remainder of the market is made up of a few smaller regional players and mom & pop outfits, the market is regionalized due to transportation costs.  The two leaders have been aggressively consolidating for the past 5 years.  Aggregate demand for ice is steady on the whole - volume growth of 1-3%, pricing growth roughly at cost inflation.  Cash flow is highly seasonal for both companies - 1st half is typically cash flow negative with the full year's cash generation coming in the 2nd half.

Anti-Trust Investigation:

Background:

  • In March '08, Arctic Glacier, Reddy Ice & Home City Ice (non-public midwestern player) received subpoenas from the DOJ regarding anti-competitive practices - general allegation is that the large players conspired to carve up turf across the country and avoided competing with each other
  • o DOJ raided Reddy Ice's offices in March '08
  • o Multiple states followed with their own investigations, customer and shareholder lawsuits followed as well, there is a second DOJ civil investigation under the false claims act for ice supplied to government entities
  • o A former employee of Arctic Glacier sued under RICO claiming he was terminated because he refused to participate in the scheme
  • Both Reddy Ice and Arctic Glacier have fired their head salespeople as a result of the investigation
  • o DOJ likely has both firms dead to rights - an informant supposedly taped meetings for the FBI
  • Home City Ice reached a plea agreement with the DOJ in June 2008, sentencing guidelines are for $24-48m fine - though this number is typically discounted significantly in final resolution, as discussed below. This is standard operating procedure for the DOJ to settle early with a smaller player in the market and use that as leverage to force a settlement with the larger players.

Sizing DOJ fine & related lawsuits:

I found a number of research papers put out over the past 10 years from an economics professor who is a thought-leader on optimal deterrence theory and sizing of DOJ and European antitrust fines in practice (I'll refer to him just as "The Professor" so he doesn't get incoming calls on this).  The Professor has a database of >100 DOJ fines for domestic companies and has cut & diced the database to produce a regression with strong explanatory power (R2= 71%).  In my discussions with him, he was kind enough to take on this project to use his historical regressions for predictive purposes.  As an aside, I'm trying to help the Professor find a way to commercialize the academic work he's done.  If any members of VIC community need anti-trust fine expertise please get in touch with me and I'll introduce you. 

Assuming 100% of each company's sales are "affected sales" (affected by anticompetitive cartel activity), he expects anti-trust fines of $45m for Reddy Ice and $25m for Arctic Glacier, with private market settlements (customers, shareholders etc.) approx. 1.75x the size of the anti-trust fines.  Using the high end of these numbers, that means approx. $125m for Reddy Ice and $70m for Arctic Glacier. 

It's important to note that Home City Ice has already entered a plea agreement that suggested $24-48m of DOJ fines.  It is my understanding however that this is Home City's "pre-discount" number (headline guidance, but real numbers come in much lower).  The Professor expects the final DOJ fine to be approximately $2-5m for Home City.  It is also important to note the DOJ takes "ability to pay" into account when assessing fines and generally tries not to put companies into bankruptcy.

Upcoming Debt Maturities:

Arctic Glacier has a $60m 5.35% note due January, 2010.  Unless the DOJ situation is resolved prior thereto, it will be difficult to refinance this debt.  I expect Arctic Glacier will be able to reach a settlement in Q3 or Q4 this year, given the time that has elapsed since the DOJ received it's first plea from Home City Ice.  However, it is difficult to anticipate DOJ timing with conviction.

Assuming the DOJ settlement remains unresolved in January, I expect Arctic Glacier can extend the maturity on this debt for a fee -- perhaps 300bps ($1.8m) and an upward revision in interest rates.  The debt is 100% owned by John Hancock, the insurance company.  I haven't been able to reach the right portfolio manager, but speaking with a few bank desks I understand they don't have a reputation for being particularly harsh on borrowers.  I expect they still feel safe in their senior secured note - total senior secured debt is covered by tangible assets (1.0x 6/30 at seasonal peak, 1.25x at year end) and sr. sec. debt / EBITDA is 3.1x at 6/30, 2.4x at year end. 

The remainder of Arctic Glacier's debt comes due in 2011 - the $161m L+175 revolver ($128m drawn at 6/30 w/c peak) is due in May, 2011.  C$100m of 6.5% subordinated converts are due in July 2011.  Arctic Glacier will have to refinance all this debt at once and face today's interest rates once the DOJ fines are known.  I've assumed they do this at the start of 2010.

The Company will generate ~$50m of cash between June and Dec (per table below, est. $57-58m cash from ops, $7.5m capex), bringing existing secured debt balance down to $138m and total debt to $210m.  For refinancing needs I've assumed $215m funded debt and a seasonal revolver.  This represents 3.5x leverage.

Arctic Glacier Cash from Ops (adj. for legal expenses)
  Q1 Q2 Q3 Q4 Full Year First 2Q Last 2Q
2009 -10.9 4.2     -6.7 -6.7  
2008 -16.9 9.6 41.9 15.3 49.9 -7.3 57.2
2007 -12.2 5.4 49.2 8.9 51.3 -6.8 58.1
2006 -6.8 18.3 31.1 4.2 46.8 11.5 35.3
note: 2006 reflects only partial year of major acquisition      

I expect that Arctic Glacier will have to pay high interest rates even with clarity on DOJ penalties and reasonable 3.5x leverage on a highly cash generative business.  I've assumed $150m sr. secured debt (2.5x leverage, 3.25x leverage at seasonal w/c peak) would be priced around 9% (call it L+700 with a 2% LIBOR floor), and $65m of unsecured debt (3.5x leverage through unsecured) would be priced at 13%.  All-in, this would be a blended interest rate of approx. 10%. 

    December (w/c low)   June (w/c high)
    $$ amt Leverage Pricing $$ Leverage
Secured Debt $150.0 2.46x 9.0% $200.0 3.28x
Unsecured Debt 65.0 1.06x 13.0% 65.0 1.06x
  Total Debt $215.0 3.52x 10.2% $265.0 4.34x

Worst case - if John Hancock forced redemption and Arctic Glacier had to do a dilutive equity offering for the full US$60m maturity at a 15% discount to mkt price (C$1.28/share), this trade would still return 1.9x based on the valuation methodology below.

 

Valuation / Potential Upside:

Normalized EBITDA -- I expect normalized EBITDA from Arctic Glacier of ~$60m going forward.  Arctic Glacier achieved $65m of EBITDA in 2007 (normal to slightly warm weather conditions).  Arctic Glacier has closed ~$32.5m of acquisitions since the 3rd quarter of 2007, adding ~$3-5mm of EBITDA to total $68-70mm of EBITDA on a normalized basis.  However, we reduce EBITDA by 10-15% to reflect the poor consumer spending environment and the assumption Arctic Glacier will lose the benefits of historical anti-competitive activity.  This results in estimated steady state EBITDA of ~$60m under normalized weather conditions.  Note: expect 2008 was a period of ramped up competition between ice makers as they were careful to avoid any ongoing collusion while under DOJ investigation.

  

Summer weather patterns in US

(Arctic Glacier covers California, Northern half of US + into Canada)

2009 - Very Cool

2008 - Unseasonably Cool

2007 - Normal to Slightly Warm

 

 

  

Arctic Glacier Footprint and manufacturing/distribution sites

Note - seasonal climate charts won't paste into VIC -- but you can see for yourself at http://www.ncdc.noaa.gov/sotc/?report=national

 

Shows that 2007 was approximately normal, 2008 was cool in Arctic's major seasonal markets, 2009 is VERY cool in Arctics seasonal markets.

 

* Company does not report regional sales, but based historical analysis of acquisitions, expect split is roughly:

   - 44% California

   - 22% Northeast

   - 18% Canada

   - 10% Midwest

   - 7% Unknown (NEast/MidW/Texas)

Note: California sales less sensitive to the summer temperature maps above as ice sells on a year round basis

 

Valuation - So once uncertainty on antitrust fines and refinancing are behind Arctic Glacier, what's it worth?

Keeping it Simple - EBITDA multiples

These are simple low growth, steady high cash flow businesses.  In the roaring 2000s, they spent most of their time around 10-12x TEV/EBITDA.  In fact, following Reddy's 130% stock market run up in the past few days, Reddy Ice is now at ~7.4x EBITDA now before any antitrust penalties.  On a go-forward basis I expect 8x EBITDA, post payment of antitrust fines, is a reasonable trading level and fair value for Arctic Glacier. 

Packaged Ice Industry EBITDA Multiples

 Again, chart won't paste into VIC - but go to CapIQ to take a look.

For past 5 years, EBITDA multiples in the 10-12x range until the antitrust suits hit 

I use the simplifying assumption that DOJ/private lawsuit penalties are all paid immediately - in reality these payments will be structured over 5+ years and paid out of cash flow.   At an 8x valuation, as shown below, expected equity return is 3x.  Actual DOJ fines could be 3x higher than the Professors' calculations and the investment would still return your money at an 8x stabilized EBITDA multiple.

Assumed Fines   Valuation
DOJ antitrust fine (est.)        25.0   EBITDA   $60.0  
Other lawsuits          43.8     Multiple   8.0x  
   Expected fines/lawsuits $68.8   TEV   $480.0  
                Price
Multiplier for conservatism 1.0x   Debt (12/31/09E) (214.1) per share
          Fines/lawsuits (68.8) ($CAD)
   Assumed fines/lawsuits $68.8     Mkt Cap post DOJ $197.1 $5.40
   Payment/year (5 years) $13.8          
          Current Mkt Cap ($US) $62.8 $1.72
            Gain   3.1x  
                 
    Equity Returns Sensitized  
      EBITDA Multiple  
      6.0x 7.0x 8.0x 9.0x 10.0x  
  Assumed  0.5x 1.8x 2.7x 3.7x 4.6x 5.6x  
  Fines 1.0x 1.2x 2.2x 3.1x 4.1x 5.1x  
  (mult. of 1.5x 0.7x 1.6x 2.6x 3.5x 4.5x  
  expected 2.0x 0.1x 1.1x 2.0x 3.0x 4.0x  
  fines) 2.5x -0.4x 0.5x 1.5x 2.5x 3.4x  
    3.0x -1.0x 0.0x 0.9x 1.9x 2.9x  

 

Confirming - Discounted Cash Flow to Equity

Because this situation takes into account a few moving pieces: refinancing at higher interest rates; the Company becoming a cash taxpayer due to change in Canadian Income Trust law; DOJ penalties and private lawsuit settlements paid out over time -- we checked this outcome against a simple DCFE as well.

Key assumptions include:

  • Sub-normal 2H09 cash generation (antitrust costs, poor weather)
  • $60m stabilized EBITDA in '10, growing 3% a year
  • No cash contribution from w/c (consistent source of cash historically)
  • Full 35% Canadian tax load (actual taxes likely less)
  • Expected DOJ fine of $25m and civil lawsuits settlement of $43.8m per the Professor
  • 12.5% normalized equity required return (after DOJ and refinancing issues pass)
  • 10% cost of debt (9% on sr. sec. at 2.5x leverage, 13% unsecured at 3.5x leverage as per above)

This valuation produced a similar >3x return on the stock.  Key assumptions (equity discount rate, average cost of debt, multiples of expected DOJ fine & private lawsuit settlements) are sensitized below.

                    Terminal 
      2H09 2010 2011 2012 2013 2014 2015 Value
EBITDA     40.0 60.0 61.8 63.7 65.6 67.5 69.6  
  Capex     (7.5) (15.0) (15.3) (15.6) (15.9) (16.2) (16.6)  
  Tax (pre-interest shield) 0.0 0.0 (10.4) (10.7) (11.1) (11.4) (11.7)  
  w/c     20.0 0.0 0.0 0.0 0.0 0.0 0.0  
FCF pre-debt, settlement 52.5 45.0 36.1 37.3 38.6 39.9 41.3  
  Interest     (8.9) (24.4) (23.7) (22.9) (21.9) (20.8) (19.4)  
  Antitrust fines/private lawsuits   (13.8) (13.8) (13.8) (13.8) (13.8)    
  Tax shield on above(1) 0.0 0.0 9.5 9.2 8.9 8.5 6.8  
FCF to equity   43.6 6.8 8.1 9.9 11.8 13.9 28.7 301.7
                     
   FCF to equity (ex. antitrust) 43.6 20.6 21.8 23.6 25.5 27.6 28.7  
                     
Net debt (start)   257.7 214.1 207.3 199.2 189.4 177.6 163.7  
  Debt raise/(repayment) (43.6) (6.8) (8.1) (9.9) (11.8) (13.9) (28.7)  
Net debt (end)   214.1 207.3 199.2 189.4 177.6 163.7 135.1  
  Avg. Cost of Debt   5.80% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%  
  Year End Leverage     3.46x 3.22x 2.97x 2.71x 2.42x 1.94x  
                     
Equity Disc. Rate   12.5% <<Post DOJ clarity          
Equity NPV (mkt cap)   $199.5              
  Return on investment 3.18x              
 

    Equity Returns Sensitized
                DOJ Fine            
    Avg. Cost of Debt   & Lawsuit Avg. Cost of Debt
  9.0% 10.0% 11.0% 12.0% 13.0%   Settlements 9.0% 10.0% 11.0% 12.0% 13.0%
  10.0% 4.8x 4.4x 4.1x 3.7x 3.3x   $34.4 0.5x 3.9x 3.7x 3.5x 3.3x 3.0x
Equity 12.5% 3.4x 3.2x 2.9x 2.7x 2.3x   $68.8 1.0x 3.4x 3.2x 2.9x 2.7x 2.3x
Discount 15.0% 2.6x 2.5x 2.3x 2.1x 1.8x   $103.1 1.5x 2.9x 2.6x 2.3x 2.0x 1.6x
Rate 17.5% 2.2x 2.0x 1.9x 1.7x 1.5x   $137.5 2.0x 2.4x 2.1x 1.7x 1.3x 0.7x
  20.0% 1.8x 1.7x 1.6x 1.4x 1.2x   $206.3 3.0x 1.3x 0.8x 0.2x -0.4x -1.0x
DOJ Fine                            
& Lawsuit   Equity Discount Rate                
Settlement 10.0% 12.5% 15.0% 17.5% 20.0%                
$34.4 0.5x 5.1x 3.7x 2.9x 2.4x 2.1x                
$68.8 1.0x 4.4x 3.2x 2.5x 2.0x 1.7x                
$103.1 1.5x 3.8x 2.6x 2.0x 1.6x 1.4x                
$137.5 2.0x 3.1x 2.1x 1.5x 1.2x 1.0x                
$206.3 3.0x 1.5x 0.8x 0.5x 0.3x 0.2x                

Key Risks:

  • Higher than expected DOJ antitrust penalties and private market lawsuits - these numbers are difficult to predict. However, the Company could sustain up to 3x the Professor's expected fines and still be fairly valued at today's price.
  • Arctic Glacier unable to refinance debt and forced into dilutive equity offering to retire $60m debt due in Jan '10 - I expect that either the DOJ case will be settled by this maturity (as evidenced by insider buying in Reddy Ice and comments from mgmt), or that Arctic Glacier will be able to extend the maturity on the $60m notes.
  • o The notes are held entirely by the John Hancock, the insurance company, which to my knowledge does not tend to be aggressive with borrowers. Further sr. secured debt is sufficiently covered -- 1.0x tangible assets coverage at w/c trough, 1.25x at year-end. ~2.3x sr. sec. leverage at year-end.
  • o If Arctic was forced to do a dilutive offering to retire the $60m maturity at ~15% discount to today's stock price, trade generates an expected 1.9x return
  • 2009's Q3 will be very poor, last thing this company needs as it tries to refinance debt. It has been unusually cold throughout the Northern US. Prior year comp is light already due to a cold season last year, I expect full year EBITDA ~$55m in 2009.

Overall - this is a high risk trade.  Pending DOJ fines, customer lawsuits and refinancing risk in this environment should not be brushed aside.  However, in my view the lucrative potential upside, and the cushion at this valuation to absorb adverse outcomes on fines and interest rates provide enough margin of safety to take a real look.  But be prepared for a bumpy ride.

A Note on Reddy Ice:

Reddy Ice (NYSE:FRZ) was my initial focus in this analysis.  Reddy has slightly larger scale, higher levels of insider buying, 4x the daily trading volume and no debt maturities until 2012.  Further, Reddy was able to attract CEO Gil Cassagne (a very capable and intelligent exec from Cadbury I've had the pleasure of working directly with in a prior life) after the antitrust lawsuit was already public - a real demonstration of confidence from Gil that the DOJ situation will be manageable.  Valuation aside, I prefer Reddy Ice.

However, the 130% price runup over the past 9 days has taken the juice out of Reddy's upside (trading at 7.5x BEFORE accounting DOJ/private lawsuit fines).  Either something bigger is going on here or the public markets are being their usual silly selves - 130% price response and a week of $10-15mm/day volume in a stock that usually does $400k/day is quite an outsized response to a 10b5 plan filing with no details.  If any of you can get past the crazy trading patterns and have the wherewithal to short Reddy or do a pair trade, by all means do it -- I can't short in my PA and FRZ may not be easy to borrow.  However, if Reddy starts drifting down to the $2.50 level again it would be an interesting buy. 

Catalyst

 Plea agreement with the DOJ - expect by year end. Settlements with customer/shareholder lawsuits - expect shortly thereafter.

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    Description

    Date: 8/24/09

    Idea: Long Arctic Glacier Income Trust (TSX: AG-U CN Equity)

    Price: CAD$1.72 (US$1.61)

    Mkt Cap: CAD$67m (US$63m)

    P/E: 3.7x

    TEV/EBITDA: 5.3x (4.5x normalized for seasonality)

     

    Arctic Glacier offers the opportunity to purchase a highly cash generative business with steady end-market demand at a cheap valuation owing to uncertainty over an industry anti-trust investigation and refinancing risks.

    This is an idea for PAs only - mkt cap ~US$60m, trading volume ~$125k/day.  Nonetheless I'm writing up for VIC as I've dug up some interesting proprietary information.  I believe the idea offers ~3x upside with limited downside.

    Investment Thesis:

    Company Description:

    Arctic Glacier (US$1.61/share, 3.7x P/E, 5.3x TEV/EBITDA) is a leader in the packaged ice industry in North America.  The company markets its packaged ice under Arctic Glacier Premium Ice brand name to retail customers, such as supermarket grocery stores and convenience stores, as well as to various commercial users, including airlines, bakeries, and meat and poultry processors. The company also sells its ice in bulk quantities to various industrial users, including the food processing, construction, chemical manufacturing, and commercial fishing industries. In addition, Arctic Glacier sells other products, such as bottled water, dry ice, packaged wood, and rock salt, as well as sells and leases ice-making and dispensing equipment in certain markets.

    The Company is a Canadian Income Trust and historically has not paid corporate level taxes.  Due to a change in law in 2006, all Canadian Income Trusts will lose this favorable tax treatment beginning in 2011, (assumed full Canadian tax load in all analysis).

    Industry Overview:

    Packaged Ice industry is dominated by 2 large players - Reddy Ice (35-40% mkt share, concentrated in southern half of US) and Arctic Glacier (~25-30% mkt share, concentrated in northern half of US & Canada).  The remainder of the market is made up of a few smaller regional players and mom & pop outfits, the market is regionalized due to transportation costs.  The two leaders have been aggressively consolidating for the past 5 years.  Aggregate demand for ice is steady on the whole - volume growth of 1-3%, pricing growth roughly at cost inflation.  Cash flow is highly seasonal for both companies - 1st half is typically cash flow negative with the full year's cash generation coming in the 2nd half.

    Anti-Trust Investigation:

    Background:

    Sizing DOJ fine & related lawsuits:

    I found a number of research papers put out over the past 10 years from an economics professor who is a thought-leader on optimal deterrence theory and sizing of DOJ and European antitrust fines in practice (I'll refer to him just as "The Professor" so he doesn't get incoming calls on this).  The Professor has a database of >100 DOJ fines for domestic companies and has cut & diced the database to produce a regression with strong explanatory power (R2= 71%).  In my discussions with him, he was kind enough to take on this project to use his historical regressions for predictive purposes.  As an aside, I'm trying to help the Professor find a way to commercialize the academic work he's done.  If any members of VIC community need anti-trust fine expertise please get in touch with me and I'll introduce you. 

    Assuming 100% of each company's sales are "affected sales" (affected by anticompetitive cartel activity), he expects anti-trust fines of $45m for Reddy Ice and $25m for Arctic Glacier, with private market settlements (customers, shareholders etc.) approx. 1.75x the size of the anti-trust fines.  Using the high end of these numbers, that means approx. $125m for Reddy Ice and $70m for Arctic Glacier. 

    It's important to note that Home City Ice has already entered a plea agreement that suggested $24-48m of DOJ fines.  It is my understanding however that this is Home City's "pre-discount" number (headline guidance, but real numbers come in much lower).  The Professor expects the final DOJ fine to be approximately $2-5m for Home City.  It is also important to note the DOJ takes "ability to pay" into account when assessing fines and generally tries not to put companies into bankruptcy.

    Upcoming Debt Maturities:

    Arctic Glacier has a $60m 5.35% note due January, 2010.  Unless the DOJ situation is resolved prior thereto, it will be difficult to refinance this debt.  I expect Arctic Glacier will be able to reach a settlement in Q3 or Q4 this year, given the time that has elapsed since the DOJ received it's first plea from Home City Ice.  However, it is difficult to anticipate DOJ timing with conviction.

    Assuming the DOJ settlement remains unresolved in January, I expect Arctic Glacier can extend the maturity on this debt for a fee -- perhaps 300bps ($1.8m) and an upward revision in interest rates.  The debt is 100% owned by John Hancock, the insurance company.  I haven't been able to reach the right portfolio manager, but speaking with a few bank desks I understand they don't have a reputation for being particularly harsh on borrowers.  I expect they still feel safe in their senior secured note - total senior secured debt is covered by tangible assets (1.0x 6/30 at seasonal peak, 1.25x at year end) and sr. sec. debt / EBITDA is 3.1x at 6/30, 2.4x at year end. 

    The remainder of Arctic Glacier's debt comes due in 2011 - the $161m L+175 revolver ($128m drawn at 6/30 w/c peak) is due in May, 2011.  C$100m of 6.5% subordinated converts are due in July 2011.  Arctic Glacier will have to refinance all this debt at once and face today's interest rates once the DOJ fines are known.  I've assumed they do this at the start of 2010.

    The Company will generate ~$50m of cash between June and Dec (per table below, est. $57-58m cash from ops, $7.5m capex), bringing existing secured debt balance down to $138m and total debt to $210m.  For refinancing needs I've assumed $215m funded debt and a seasonal revolver.  This represents 3.5x leverage.

    Arctic Glacier Cash from Ops (adj. for legal expenses)
      Q1 Q2 Q3 Q4 Full Year First 2Q Last 2Q
    2009 -10.9 4.2     -6.7 -6.7  
    2008 -16.9 9.6 41.9 15.3 49.9 -7.3 57.2
    2007 -12.2 5.4 49.2 8.9 51.3 -6.8 58.1
    2006 -6.8 18.3 31.1 4.2 46.8 11.5 35.3
    note: 2006 reflects only partial year of major acquisition      

    I expect that Arctic Glacier will have to pay high interest rates even with clarity on DOJ penalties and reasonable 3.5x leverage on a highly cash generative business.  I've assumed $150m sr. secured debt (2.5x leverage, 3.25x leverage at seasonal w/c peak) would be priced around 9% (call it L+700 with a 2% LIBOR floor), and $65m of unsecured debt (3.5x leverage through unsecured) would be priced at 13%.  All-in, this would be a blended interest rate of approx. 10%. 

        December (w/c low)   June (w/c high)
        $$ amt Leverage Pricing $$ Leverage
    Secured Debt $150.0 2.46x 9.0% $200.0 3.28x
    Unsecured Debt 65.0 1.06x 13.0% 65.0 1.06x
      Total Debt $215.0 3.52x 10.2% $265.0 4.34x

    Worst case - if John Hancock forced redemption and Arctic Glacier had to do a dilutive equity offering for the full US$60m maturity at a 15% discount to mkt price (C$1.28/share), this trade would still return 1.9x based on the valuation methodology below.

     

    Valuation / Potential Upside:

    Normalized EBITDA -- I expect normalized EBITDA from Arctic Glacier of ~$60m going forward.  Arctic Glacier achieved $65m of EBITDA in 2007 (normal to slightly warm weather conditions).  Arctic Glacier has closed ~$32.5m of acquisitions since the 3rd quarter of 2007, adding ~$3-5mm of EBITDA to total $68-70mm of EBITDA on a normalized basis.  However, we reduce EBITDA by 10-15% to reflect the poor consumer spending environment and the assumption Arctic Glacier will lose the benefits of historical anti-competitive activity.  This results in estimated steady state EBITDA of ~$60m under normalized weather conditions.  Note: expect 2008 was a period of ramped up competition between ice makers as they were careful to avoid any ongoing collusion while under DOJ investigation.

      

    Summer weather patterns in US

    (Arctic Glacier covers California, Northern half of US + into Canada)

    2009 - Very Cool

    2008 - Unseasonably Cool

    2007 - Normal to Slightly Warm

     

     

      

    Arctic Glacier Footprint and manufacturing/distribution sites

    Note - seasonal climate charts won't paste into VIC -- but you can see for yourself at http://www.ncdc.noaa.gov/sotc/?report=national

     

    Shows that 2007 was approximately normal, 2008 was cool in Arctic's major seasonal markets, 2009 is VERY cool in Arctics seasonal markets.

     

    * Company does not report regional sales, but based historical analysis of acquisitions, expect split is roughly:

       - 44% California

       - 22% Northeast

       - 18% Canada

       - 10% Midwest

       - 7% Unknown (NEast/MidW/Texas)

    Note: California sales less sensitive to the summer temperature maps above as ice sells on a year round basis

     

    Valuation - So once uncertainty on antitrust fines and refinancing are behind Arctic Glacier, what's it worth?

    Keeping it Simple - EBITDA multiples

    These are simple low growth, steady high cash flow businesses.  In the roaring 2000s, they spent most of their time around 10-12x TEV/EBITDA.  In fact, following Reddy's 130% stock market run up in the past few days, Reddy Ice is now at ~7.4x EBITDA now before any antitrust penalties.  On a go-forward basis I expect 8x EBITDA, post payment of antitrust fines, is a reasonable trading level and fair value for Arctic Glacier. 

    Packaged Ice Industry EBITDA Multiples

     Again, chart won't paste into VIC - but go to CapIQ to take a look.

    For past 5 years, EBITDA multiples in the 10-12x range until the antitrust suits hit 

    I use the simplifying assumption that DOJ/private lawsuit penalties are all paid immediately - in reality these payments will be structured over 5+ years and paid out of cash flow.   At an 8x valuation, as shown below, expected equity return is 3x.  Actual DOJ fines could be 3x higher than the Professors' calculations and the investment would still return your money at an 8x stabilized EBITDA multiple.

    Assumed Fines   Valuation
    DOJ antitrust fine (est.)        25.0   EBITDA   $60.0  
    Other lawsuits          43.8     Multiple   8.0x  
       Expected fines/lawsuits $68.8   TEV   $480.0  
                    Price
    Multiplier for conservatism 1.0x   Debt (12/31/09E) (214.1) per share
              Fines/lawsuits (68.8) ($CAD)
       Assumed fines/lawsuits $68.8     Mkt Cap post DOJ $197.1 $5.40
       Payment/year (5 years) $13.8          
              Current Mkt Cap ($US) $62.8 $1.72
                Gain   3.1x  
                     
        Equity Returns Sensitized  
          EBITDA Multiple  
          6.0x 7.0x 8.0x 9.0x 10.0x  
      Assumed  0.5x 1.8x 2.7x 3.7x 4.6x 5.6x  
      Fines 1.0x 1.2x 2.2x 3.1x 4.1x 5.1x  
      (mult. of 1.5x 0.7x 1.6x 2.6x 3.5x 4.5x  
      expected 2.0x 0.1x 1.1x 2.0x 3.0x 4.0x  
      fines) 2.5x -0.4x 0.5x 1.5x 2.5x 3.4x  
        3.0x -1.0x 0.0x 0.9x 1.9x 2.9x  

     

    Confirming - Discounted Cash Flow to Equity

    Because this situation takes into account a few moving pieces: refinancing at higher interest rates; the Company becoming a cash taxpayer due to change in Canadian Income Trust law; DOJ penalties and private lawsuit settlements paid out over time -- we checked this outcome against a simple DCFE as well.

    Key assumptions include:

    This valuation produced a similar >3x return on the stock.  Key assumptions (equity discount rate, average cost of debt, multiples of expected DOJ fine & private lawsuit settlements) are sensitized below.

                        Terminal 
          2H09 2010 2011 2012 2013 2014 2015 Value
    EBITDA     40.0 60.0 61.8 63.7 65.6 67.5 69.6  
      Capex     (7.5) (15.0) (15.3) (15.6) (15.9) (16.2) (16.6)  
      Tax (pre-interest shield) 0.0 0.0 (10.4) (10.7) (11.1) (11.4) (11.7)  
      w/c     20.0 0.0 0.0 0.0 0.0 0.0 0.0  
    FCF pre-debt, settlement 52.5 45.0 36.1 37.3 38.6 39.9 41.3  
      Interest     (8.9) (24.4) (23.7) (22.9) (21.9) (20.8) (19.4)  
      Antitrust fines/private lawsuits   (13.8) (13.8) (13.8) (13.8) (13.8)    
      Tax shield on above(1) 0.0 0.0 9.5 9.2 8.9 8.5 6.8  
    FCF to equity   43.6 6.8 8.1 9.9 11.8 13.9 28.7 301.7
                         
       FCF to equity (ex. antitrust) 43.6 20.6 21.8 23.6 25.5 27.6 28.7  
                         
    Net debt (start)   257.7 214.1 207.3 199.2 189.4 177.6 163.7  
      Debt raise/(repayment) (43.6) (6.8) (8.1) (9.9) (11.8) (13.9) (28.7)  
    Net debt (end)   214.1 207.3 199.2 189.4 177.6 163.7 135.1  
      Avg. Cost of Debt   5.80% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%  
      Year End Leverage     3.46x 3.22x 2.97x 2.71x 2.42x 1.94x  
                         
    Equity Disc. Rate   12.5% <<Post DOJ clarity          
    Equity NPV (mkt cap)   $199.5              
      Return on investment 3.18x              
     

        Equity Returns Sensitized
                    DOJ Fine            
        Avg. Cost of Debt   & Lawsuit Avg. Cost of Debt
      9.0% 10.0% 11.0% 12.0% 13.0%   Settlements 9.0% 10.0% 11.0% 12.0% 13.0%
      10.0% 4.8x 4.4x 4.1x 3.7x 3.3x   $34.4 0.5x 3.9x 3.7x 3.5x 3.3x 3.0x
    Equity 12.5% 3.4x 3.2x 2.9x 2.7x 2.3x   $68.8 1.0x 3.4x 3.2x 2.9x 2.7x 2.3x
    Discount 15.0% 2.6x 2.5x 2.3x 2.1x 1.8x   $103.1 1.5x 2.9x 2.6x 2.3x 2.0x 1.6x
    Rate 17.5% 2.2x 2.0x 1.9x 1.7x 1.5x   $137.5 2.0x 2.4x 2.1x 1.7x 1.3x 0.7x
      20.0% 1.8x 1.7x 1.6x 1.4x 1.2x   $206.3 3.0x 1.3x 0.8x 0.2x -0.4x -1.0x
    DOJ Fine                            
    & Lawsuit   Equity Discount Rate                
    Settlement 10.0% 12.5% 15.0% 17.5% 20.0%                
    $34.4 0.5x 5.1x 3.7x 2.9x 2.4x 2.1x                
    $68.8 1.0x 4.4x 3.2x 2.5x 2.0x 1.7x                
    $103.1 1.5x 3.8x 2.6x 2.0x 1.6x 1.4x                
    $137.5 2.0x 3.1x 2.1x 1.5x 1.2x 1.0x                
    $206.3 3.0x 1.5x 0.8x 0.5x 0.3x 0.2x                

    Key Risks:

    Overall - this is a high risk trade.  Pending DOJ fines, customer lawsuits and refinancing risk in this environment should not be brushed aside.  However, in my view the lucrative potential upside, and the cushion at this valuation to absorb adverse outcomes on fines and interest rates provide enough margin of safety to take a real look.  But be prepared for a bumpy ride.

    A Note on Reddy Ice:

    Reddy Ice (NYSE:FRZ) was my initial focus in this analysis.  Reddy has slightly larger scale, higher levels of insider buying, 4x the daily trading volume and no debt maturities until 2012.  Further, Reddy was able to attract CEO Gil Cassagne (a very capable and intelligent exec from Cadbury I've had the pleasure of working directly with in a prior life) after the antitrust lawsuit was already public - a real demonstration of confidence from Gil that the DOJ situation will be manageable.  Valuation aside, I prefer Reddy Ice.

    However, the 130% price runup over the past 9 days has taken the juice out of Reddy's upside (trading at 7.5x BEFORE accounting DOJ/private lawsuit fines).  Either something bigger is going on here or the public markets are being their usual silly selves - 130% price response and a week of $10-15mm/day volume in a stock that usually does $400k/day is quite an outsized response to a 10b5 plan filing with no details.  If any of you can get past the crazy trading patterns and have the wherewithal to short Reddy or do a pair trade, by all means do it -- I can't short in my PA and FRZ may not be easy to borrow.  However, if Reddy starts drifting down to the $2.50 level again it would be an interesting buy. 

    Catalyst

     Plea agreement with the DOJ - expect by year end. Settlements with customer/shareholder lawsuits - expect shortly thereafter.

    Messages


    SubjectCLARITY ON DOJ
    Entry10/14/2009 10:31 AM
    MemberPGTenny

    Gi - Yes - this is a GREAT outcome.  Fine was less than the professor's estimate - Think the divergence driven by the limited scope of the DOJ fine - focused only on some midwestern states.  I had assumed witht he professor 100% of sales were effected by anti-trust activity, to be conservative and to account for the random investigations popping up in FLA, CA.

    I would caution the remaining risks are fines in Canada - not settled with the DOJ, but given competitive dynamics up there (no other players the size of home city, reddy to conspire with), I think there is a low likelihood of major adverse effect.  Further, lawsuits from customers/shareholders still on the come. 

    But with this stick in the ground as a benchmark, think this contains the risk significantly.  I have added to my position.  Fair value well above the $4/share it's trading at now, based on some quick calcs, I'm getting $6.50/share based on conservative valuation metrics, I think my underlying assumptions (10-15% down EBITDA when anti-competitive behavior corrected) are likely still too harsh based on the limited scope of the behavior, so expect there is even more upside.

    Thanks for following this Gi, sorry for the slow response, added to my position this AM before responding.


    SubjectRE: CLARITY ON DOJ
    Entry10/14/2009 11:50 AM
    Memberhbomb5

    PGT:

    Thoughts on Reddy, at the current quote?  Will they be able to settle?  How is their position in Canada?  Any risks on this name?


    Thanks


    SubjectRE: RE: CLARITY ON DOJ
    Entry10/15/2009 03:27 PM
    MemberPGTenny

    I passed on Reddy -- I think the risk/reward is better on AG - I've been buying more AG at current levels.

    I think Reddy is interesting, and like I said was the original focus of my analysis, but back when it was ~$2.50 per share.  I'm inclined to think that Reddy may escape with no penalties whatsoever, given that the DOJ restricted it's final settlement to Michigan only (where Reddy has no presence to my knowledge).  They've been the target of investigations in other regions, mainly around an alleged agreement with AG not to enter eachother's territories on a regional basis.  It seems the DOJ investigation did not support these allegations, though there could still be risks from private lawsuits which are held to a different standard.

    Overall, I'd consider Reddy at $5.40 close to fair value I don't think there is a ton of upside from here, it's about 8x EBITDA, I'd estimate you own at a sub 10% cash flow to equity yield (remember to take into account their old PIK notes going cash pay, this artificially pumped up cash flow for a long time now).

    Reddy's got no Canada exposure.


    SubjectAdditional Questions
    Entry10/19/2009 02:40 AM
    Memberbriarwood988

     

    PGT, thanks for the great comment thread.

    1. On the issue of post DOJ normalized EBITDA, does the Professor have any expertise based on historical examples on evaluating what type of impact these suits have on future EBITDA? I am sure it is case specific but I am sure there are examples where due to geography/transportation costs it would seem that the impact would be small. It would be interesting to see if that was actually the case.

    2. In your post you indicated pricing with inflation - wouldn't this business have at least some pricing power? Have you seen any of this historically from FRZ or AG?

    3. Do you (or someone else in the thread) have a sense for what FRZ and AG debt yields are now post DOJ? Do they lend evidence to being able to roll-over at 10%?

    4. While I agree with you that the impact from the DOJ ruling on normalized EBITDA will be little, there is still uncertainty here which may be enough to scare off banks in this credit environment and block a refinancing even at your rates. Curious to hear your thoughts here.

    5. One thing I couldn't tell from your write-up is how many ice players there are in the average local market. So say AG has a plant in Minnesota which serves some large town there - how many other mom and pops are likely to be there and do these players prevent this from being a good business with pricing power? I just checked FRZ very briefly and saw them earning only 10% levered returns on equity in 2006 which I am assuming is a year before all the legal expenses.

    Thanks and sorry for the multiple questions -


    Briarwood


    SubjectRE: Additional Questions
    Entry10/19/2009 11:39 AM
    MemberPGTenny

    No problem Briarwood - a few thoughts on your questions below: 

    1. On the issue of post DOJ normalized EBITDA, does the Professor have any expertise based on historical examples on evaluating what type of impact these suits have on future EBITDA? I am sure it is case specific but I am sure there are examples where due to geography/transportation costs it would seem that the impact would be small. It would be interesting to see if that was actually the case. 

    A: The Professor doesn't have any data on this.  I think it is very case-specific and depends on the type of collusion.  Qualitatively, it seems that the DOJ determined it was a very limited area of their business (southern Michigan/Detroit area only), I estimate based on an old reporting of geographical focus and the acquisitions they've made that the entire midwest is only about 10% of AG sales, so assuming that is the only affected piece, I'd say the 10-15% est. decline in EBITDA embedded in the nums is conservative.  But it will be important to see the actual outcome.  I think it will take a while to get a clear read on it: this quarter is going to be pretty miserable based on the unseasonably cold summer in most of their area (again, I couldn't paste the chart into VIC, but look here to see climate charts: http://www.ncdc.noaa.gov/sotc/?report=national), but, assuming you want to keep this a year for cap gains treatment, there should be enough time for full value to be displayed.  And even if the new reality is more drastic than I imagine (say $55m EBITDA, weather normalized), you've still got substantial upside on the stock from current levels.

    2. In your post you indicated pricing with inflation - wouldn't this business have at least some pricing power? Have you seen any of this historically from FRZ or AG?

    A: Historically they have been consistently increasing pricing.  There is pricing power in the business, but you don't need to count on it to get a very good return from the C$4.00 level, so I kept it out of analysis for conservatism.

    3. Do you (or someone else in the thread) have a sense for what FRZ and AG debt yields are now post DOJ? Do they lend evidence to being able to roll-over at 10%?

    A: The AG sr. sec. debt (revolver due May '11 and note due Jan '10) don't trade, but the subordinated convertible due July '11 trades.  Pre-DOJ announcement it was trading in the 80s, just over 20% YTM, after the DOJ annoncement it's transacted a few times around 92-93, an 11% Yield to Maturity.  And again, this is the subordinated convert, so the bank debt should trade well inside of that.  Reddy's Sr. Unsec. Debentures are still trading at a 20% YTW, would have expected them to tighten more as it looks like Reddy's has largely dodged the DOJ bullet.

    4. While I agree with you that the impact from the DOJ ruling on normalized EBITDA will be little, there is still uncertainty here which may be enough to scare off banks in this credit environment and block a refinancing even at your rates. Curious to hear your thoughts here.

    A: Yes, this is certainly a negative environment to bring a company with outstanding lawsuits to syndication.  I think the most likely thing that happens is the note due Jan '10 gets amended to extend a year or so but remains due in front of the existing revolver, for a fee and a hit on rates.  This note is sr. sec. so in the worst case scenario it would stand firmly in front of any lawsuit settlements in a BK (don't think this is going BK, but looking at worst case from a lender's point of view).  I think the Subordinated convert trading at 11% is a good marker to allow the Company to keep the rate well below 10%, plus John Hancock not historically a lender who takes punitive actions against borrowers to my knowledge. 

    5. One thing I couldn't tell from your write-up is how many ice players there are in the average local market. So say AG has a plant in Minnesota which serves some large town there - how many other mom and pops are likely to be there and do these players prevent this from being a good business with pricing power? I just checked FRZ very briefly and saw them earning only 10% levered returns on equity in 2006 which I am assuming is a year before all the legal expenses.

    A: I don't know what the average market looks like, but I know the market as a whole is still quite fragmented.  Beyond the two key players (Reddy 35-40% share, AG 25-30% share), there are no major players.  I'm not sure how many mom & pops would be in the average market, I would expect in areas where Reddy & AG are operating there would be at least one more mom & pop.  But this business really thrives on economies of scale, would expect the mom & pops to be at significant cost disadvantages to a large company with scale ice-making and distribution capabilities and national level relationships.


    SubjectRefinancing News
    Entry02/12/2010 02:01 PM
    Memberthrive25

    Any thoughts on the refinancing news?  In conjunction with the maturity extention and credit facility, it also seems they issued some warrants with a $4.00 strike (though not much seems dilutive).


    SubjectInterest Rate
    Entry02/22/2010 01:56 PM
    Memberbriarwood988

    Looks like the interest rate for the US piece is 9% plus LIBOR. Slightly above your expectations but generally in line


    SubjectAny News today?
    Entry05/20/2010 10:39 AM
    Membercam121
    I don't see any... Just a sloppy seller? it was down 40% briefly.

    SubjectRE: Dividend
    Entry05/20/2010 08:10 PM
    MemberPGTenny
    Hey Shoon - didn't see your note, sorry for slow reply.  I don't think they'll be turning it on soon.  They've taken on some pretty expensive debt, I'd guess they focus on repaying that.  would love to see them buy back stock, but I don't get the impression that's their inclination.  But no, I haven't spoken directly to mgmt about it....

    SubjectRE: RE: Dividend
    Entry05/21/2010 08:44 AM
    Membercam121
    They said in the press release that their debt covenants prevent them from paying a dividend until 2014:
     
    The trustees of the Fund do not anticipate paying distributions for the foreseeable future as the lending
    agreements effectively prevent payment of distributions through February 2014. In addition, the
    trustees expect the Fund to convert from an income trust to a corporation during 2011, subject to
    approval from unitholders and other stakeholders.
     
    http://www.arcticglacierinc.com/pdf/news/2010/NR20100511.pdf

    SubjectRE: RE: RE: RE: Dividend
    Entry06/11/2010 05:26 PM
    Memberdoggy835
    I'd also like to hear about in-store icemaking. FRZ has a system to do this and they recently sued someone making a similar system. It seems vastly more cost-effective to have the water company transport the product to the store in their pipes than to pay AG employees to drive it around in refrigerated trucks.

    SubjectAny News?
    Entry07/08/2010 07:16 PM
    Memberthrive25
    This thing continues to get clobbered?  Any idea on how the summer is turning out for their markets in terms of weather / sales trends?

    SubjectFundamentals of Business
    Entry08/10/2010 03:24 PM
    Memberthrive25
    I listened to today's call and it seems AG still has a very long-list of headwinds both legal and operational.  Are there any estimates on what the outstanding legal liabilities could end up costing? 
     
    Do you have any take on the competitive pressures in their western markets - California and Oregon?  The CEO mentioned pricing & margins were deteriorating due to competitive forces and that they are "dealing" with ... which of course is vague and concerning given that it represents such a large chunk of their business, any insight on whether this is material / impacting your thesis?  Are your estimations on normalized EBITDA margins still intact?
     
    The 2011 converts could present challenges.
     
    Assuming fundamentals haven't deteriorated too much and legals costs are kept within reasonable levels, today's price looks pretty attractive.  But I am having trouble managing all the uncertainty with such limited disclosure and communications.  Any thoughts?

    SubjectRE: Reddy Ice bid
    Entry04/13/2012 10:47 AM
    Memberstraw1023
    I took a look in light of Filmon's comments. However, I do not know how to get comfortable with how the as-yet-unknown state-by-state antitrust penalties are going to play out. If I understand, there are significant unknown liabilities out there. Before they filed, I think the argument was that the penalties woudl be set such that they could continue as an operating concern. Fair enough, but with this entity in bankruptcy, why would the state AGs let equity have anything, esp if they sell the assets?
     
    Am I mis-understanding the situation? If not, how are you estimating these liabilities?

    SubjectRE: Anyone following?
    Entry07/10/2012 08:35 AM
    Membercnm3d
     
    Decent read.

    SubjectRE: RE: RE: Anyone following?
    Entry07/30/2012 01:38 PM
    MemberGideonMagnus
    Looks like an amended deal has lopped off $20 million. Looks like this is back down to an estimated equity recovery around $0.20 and that doesn't account for the possibility of taxes (of which I don't have an answer).
     
    http://www.marketwire.com/press-release/arctic-glacier-income-fund-completes-sale-of-its-business-to-hig-capital-cnsx-ag.un-1684809.htm

    SubjectRE: RE: RE: RE: RE: Anyone following?
    Entry07/30/2012 02:14 PM
    MemberGideonMagnus
    Sorry, I was basing that off the $0.27 from the Seeking Alpha article mentioned by JetsFan below. The market seemed to run with that viewpoint and rose about 15% within a couple days before trickling back down until today's big drop.
     
    Here's the article, if you haven't seen it: http://seekingalpha.com/instablog/1403631-saquib/812051-money-to-be-made-in-the-final-chapter-of-arctic-glacier
     
    I decided not to dive deep into this one since I don't understand the tax issue.
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