Bonds, Bowie and big tobacco

PORTFOLIO POINT: Singer David Bowie and US tobacco companies could prove useful in the NSW government’s plan to securitise its lotteries revenue.

Last month NSW Treasurer, Mike Baird, appointed Macquarie Capital to investigate the viability of monetising part of the NSW lottery revenue duties received by the state.

The lotteries business was sold to Tatts Group in 2010 but the state receives annual duties that are expected to amount to $321 million this financial year, and should increase to around $355 million in 2015-16.

What is being considered now is an effective securitisation of these revenues, the proceeds of which would be used to fund infrastructure development. If Macquarie Capital determines a viable means for securitising the revenues, work on the process could begin early next year.

Securitisation of a constant $300 million revenue stream in perpetuity would be worth more than $6 billion.

No doubt Macquarie Capital will find that the monetisation of NSW lottery revenue duties is viable. There is nothing new in the securitisation of dedicated revenue streams; this is what is done with mortgage repayments to create residential mortgage-backed securities (RMBS).

But more comparable examples in this case are Bowie Bonds and Tobacco Bonds.

In 1997, David Bowie raised US$55 million by selling bonds that securitised future royalties to be received from 25 albums recorded prior to 1990. This is considered to be the first securitisation of intellectual property rights and was later emulated by a number of artists, including Michael Jackson.

Tobacco Bonds have been issued by many US states and are a securitisation of payments agreed to be made by the four largest tobacco companies in the US, at the time. The payments are made to 46 US states under the Tobacco Master Settlement Agreement, entered into in 1998, and are compensation for health care costs incurred as a result of their residents smoking.

The tobacco companies agreed to pay a minimum of US$206 billion over the first 25 years of the agreement. Many states took the opportunity to securitise these future income streams to receive a lump sum that could be used to repay existing debt or, more commonly, be spent elsewhere.

While the process of monetising or securitising future revenue streams is well understood, it may not result in a clean sale for New South Wales. Both the Bowie Bonds and many of the Tobacco Bonds required additional guarantee support.

The Bowie Bonds came with a guarantee from Bowie’s record label, EMI Records, and many of the Tobacco Bonds also have guarantees from the states selling the bonds, to ensure that the cash flows securitised eventuate.

However, a securitisation utilising a tranching structure, like that used in RMBS, may work.

Philip Bayley is a former director of Standard & Poor’s and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.