Why is Ontario getting into interest free corporate lending?

You might have missed it, but budding Wimax concern Redline Communications (RDL:TSX) tapped the Ontario Ministry of Economic Development for a $10 million interest free loan a few weeks ago. Redline’s December Q4 showed revenue of about $10.6 million, down from $12.8 million in 2007. Cash on hand at the end of December was $4.4 million, and the company burned $4.5 million during Q4.

Having sought the greener pastures of an AIM listing in London, England, Redline is back home now. Things haven’t gone as planned, and the taxpayer of Ontario has to come to the rescue. Redline has lost more than $115 million so far, and this last $10 million injection comes at a difficult time for Wimax buildouts.

The details of the Ontario government loan are sketchy, and few even knew that such a program even existed, but according to GMP’s equity research team they sound very borrower friendly:

The highlight of the quarter is that Redline signed a term sheet for a C$10 mm loan from the Ontario Government, which is expected to be made available in Q2/09 retroactive to last December and dispersed over 24 months. The loan is expected to be dispersed linearly (~C$417k per month) with a larger sum provided in Q2/09 for the retroactive portion. The agreement is still subject to negotiation, on which management would not provide further colour, but the loan is expected to be interest-free for up to 5 years if the company meets certain conditions. This loan is a positive development as it should provide the company with low-cost capital to help it reach EBITDA break-even.

This deal gives new meaning to the phrase “low-cost capital”. But does a company that lost $25 million in 2008, and burned half of their remaining cash during the prior quarter, deserve low cost taxpayer capital? And what due diligence was done by the Ontario government to ensure that the program-maximum $10 million would be enough? According to GMP’s equity research analyst, the business won’t likely be breakeven this year without a jump in revenue growth, which means either i) more money from the government will be required (although the program is capped at $10MM per company), ii) an equity offering will be needed, or iii) layoffs or worse….:

We continue to see significant risk with this story, but note that the expected Ontario Government loan and working capital improvements appear to have stabilized its cash issue for the time being. Under our current forecast, we believe the company has sufficient cash to reach EBITDA break-even, but we think it will be tough to get there without a stronger ramp in revenues and/or stronger gross margins of 50%. We continue to see inherent risks in the sales ramp of Redline’s WiMAX equipment.

Clearly this isn’t being driven by the folks who run the innovation agenda at the Ministry of Research and Innovation (MRI), given that Redline is a public company with ready-access to capital and MRI is trying to solve the plight of the start-up and venture capital industries.

And one has to wonder; weren’t the government’s lawyers concerned about a NAFTA challenge by any of the U.S.-based venture debt firms on those terms?

But, in the meantime, for the rest of you in corporate Ontario, the wicket is open at Queen’s Park. And the money’s free. The politicians’ speech line was once “a chicken in every pot”; now its “Wimax on every telephone pole”.

Capitalism is dying in Canada, and we have no one to blame but ourselves.

MRM