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AFIC notes look good close up

Venerable listed investment firm Australian Foundation Investment Company is looking to raise $200 million - and perhaps more - via an unsecured convertible note offer.

Venerable listed investment firm Australian Foundation Investment Company is looking to raise $200 million - and perhaps more - via an unsecured convertible note offer.

There's no general public offer so it's really of interest to existing AFIC shareholders and those offered an allocation by their broker. Worry not if that doesn't include you.

If the stock lists, or at some stage trades, at less than $100 a share, it could be a good buy.

The offer is implicitly pitched to investors that want the security and return of a term deposit or bond with some upside potential.

In that sense, the notes are best considered a potential part of the fixed-income and cash component of your portfolio, not as equity. Looked at that way, it's an attractive offer.

AFIC notes secure

The convertible notes are being issued at $100 per security. Should noteholders choose not to convert them into ordinary shares (a matter we'll get to), they'll be redeemed

for $100 cash in just over five years (see table).

Interest is paid twice yearly at a fixed rate of 6.25 per cent a year.

If interest rates rise or markets crash, the price at which the notes trade might fall. That may be a problem if you need to sell before maturity but if you can hang on for the full term, it won't be a concern.

Remember also that your six-monthly returns are interest payments, not dividends.

Franking credits do not apply.

These slight disadvantages are more than offset by a range of very attractive features, including the fact most income security instruments allow the issuer to defer an interest payment, or not pay it at all. These don't.

AFIC notes are also very secure. Assuming AFIC raises just $200 million in this issue, the sharemarket could fall 90 per cent next year and AFIC would still be solvent. It's not Armageddon-proof but it gets close.

Adding to the security is the fact that, while the notes are technically unsecured, unsubordinated debt, AFIC doesn't have any senior debt.

Also, a so-called negative pledge in the fine print ensures the company can't pledge assets to any other lender without first setting aside security for noteholders or gaining their approval through a vote (which would almost certainly be rejected).

Together with two financial covenants, including one preventing too much debt being taken on, these notes offer a high degree of financial protection.

But what's really special about them is the free option.


If AFIC shares rise by more than 25 per cent over the five-year life of this security, noteholders will share in any further upside.

Let's assume AFIC's current share price of $4.05 holds for the five days up to December 19. That means noteholders can convert their investment into ordinary shares at a fixed price of $5.18 (including the 25 per cent premium) on any interest payment date.

If, say, four years from now, the stock is trading below that fixed price, there's no reason to convert. But if AFIC shares are trading at, say, $7, then you may well convert before the expiry date because you can buy $100 worth of shares at $5.18 each, which can then be immediately sold for $7.

In this example, you would enjoy a capital gain of 35 per cent.

A lot can happen in five years but AFIC wouldn't be raising money to expand its portfolio if it thought stocks were expensive.

AFIC convertible notes offer a competitive return on a very safe security with negligible downside risk, provided you hold them for the full term. Plus, there's potential upside that you don't pay for.

Nathan Bell is the research director at Intelligent Investor, This article contains general investment advice only (under AFSL 282288).

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