Getting down to simpler issues

Many of the issues being taken to market are just too complex. Simpler convertible structures are warranted.

PORTFOLIO POINT: Companies can cash in on the ongoing appetite by investors for issues in stocks with a good yield and potential for capital growth.

The recent reviews in Eureka (refer to Mondays column) concerning the now defunct issue of Seek Limited hybrid securities have adequately covered the investment shortfalls of its terms. The good news is that the market saw through the structure and declined to support it as a listed security.

The Seek issue was a peculiar one, not least because it complicated what should have been a fairly vanilla convertible note issue. As a “veteran” fund manager with some 30 years experience in capital markets, I constantly agonise as to why investment bankers and company advisors persist in proposing securities which are confusing, poorly priced and unfair to investors.

Back in my early days at NRMA Investments, in the 1980s, investment managers were spoilt for choice in allocating patient capital. Not only was there a widespread choice of companies across a multitude of industries, but the choice of securities was broad as well. Further, when capital was to be raised from the market, the advising brokers often consulted with the major shareholders or investors on the structuring, the price, the terms and even the underwriting fees to be paid. In those days, the advisers were brokers and they had no balance sheet to underwrite an issue. The balance sheets of the big mutuals such as AMP, National Mutual and NRMA were often used to secure the success of an issue.

The beauty of the market then was that the large institutions determined a price and the terms which they believed would give them and their members an adequate return for the risk of allocating their mutual investment reserves. The emergence in Australia of the big international Investment banks, the growth in mandated superannuation funds managed by banks, and the demutualisation of some of Australia’s largest investment entities have paved the way for a market that now abounds in confusion.

These developments led me to the conclusion that the capital market is not operating efficiently to direct capital to those businesses that can generate high returns and thereby grow the wealth of the country. The development of index investing has also had an undesirable effect on the direction of capital. It is surely an embarrassment that today’s Australian share market capitalisation approximates its level of 2005. Seven years of economic growth have not created a rise in the value of Australian shares – so what is that doing to the retirement intentions of many investors?

To emphasise the point of poor capital management by Australian capital providers, we need only to reflect on the terms (or lack of terms and conditions) that accompanied most of the $120 billion of capital raised during 2008-09. You will recall the panic that reigned amongst many listed corporations who feared a debt meltdown. Aided by investment banks, massive amounts of capital were raised without thought, or indeed much process. Many issues were rushed through and smaller shareholders were disenfranchised. We can now see that what then looked like well-priced deals, based on market discounts, have actually turned out to be poorly structured recapitalisations. Think Fairfax, TEN, Westfield, QBE, Onesteel and Bluescope amongst many other capital raisings that could and should have been structured as high yielding convertible notes.

Had these companies raised convertible debt then the board and management of these companies would have been confronted with the reality of servicing capital and not abusing it. The investors would have been protected by a redemption term and a solid yield. Success would have been measured by the ability of the share price to increase above the conversion price before redemption. This success would occur when the issuing company achieved returns on the capital far greater than the cost of debt.

Figure 1: Value of $1
Source: IRESS Data

Long-time investors might remember the convertible notes that existed in the Australian market during the 1980-90 period. They were issued by names such as Pioneer Concrete, CSR, TNT, Ampol, Brambles, Mayne Nickless, ANI, BTR Nylex, Clyde Industries, News Corporation, ICI and ACI. Generally the terms were simple for the issuer and easy to understand for the investor. They were unsecured notes, with a set yield and a redemption/conversion term at a premium to the market. These structures were similar to those proposed and actioned by Berkshire Hathaway in its 2008 investments into Goldman Sachs and GE Capital Inc. The terms were also similar to those undertaken by the listed investment company Australia Foundation Investment Company Limited.

So the message is simple for companies and their advisors. Please consider simple convertible structures for raising capital if you believe that the cost of equity is too high at present. There is a growing investor appetite for solid investments that offer a reasonable yield with the potential for capital growth. The developments in the structuring of hybrids has become too complicated and the market is correctly responding by saying no to issues such as that proposed by Seek.

Clime Investment Management is one of Australia’s top performing fund managers specialising in income and value growth portfolios for wholesale and sophisticated investors, particularly self-managed super funds.

The Income Portfolio

Start Value: $120,000.00
Current Value: $117,963.80

-Hybrids/Pseudo Debt Securities
CompanyASX
Market Price
($)
Margin over BBSW (%)
Running Yield
(%)
Franking
(%)
Total Return
(%)
ANZ NoteANZHA
100.00
2.75
6.29
0
-0.89
Multiplex SITESMXUPA
74.55
3.90
9.98
0
-2.55
Australand
ASSETS
AAZPB
90.75
4.80
9.19
0
-1.36
Macquarie Group
Floating Rate Note
MBLHB
60.00
1.70
8.73
0
-10.45
NAB Floating Rate
Note
NABHA
68.20
1.25
7.02
0
-7.44
Seven Group
TELYS4
SVWPA
78.25
4.75
10.56
100
-6.61
Woolworths
Notes II
WOWHC
103.85
3.25
6.54
0
0.66
Ramsay Health
Care CARES
RHCPA
100.80
4.85
8.29
100
-0.93
-High-Yielding Equities
CompanyASX
Market Price
($)
Dividend
($)
GUDY
(%)
Franking (%)
Total Return (%)
Telstra CorpTLS
3.60
0.28
11.11
100
2.56
Ardent Leisure
Group
AAD
1.35
0.12
8.92
0
8.47
Commonwealth
Bank
CBA
51.78
3.29
9.08
100
0.23
Westpac Banking
Corp
WBC
20.98
1.56
10.62
100
-3.84
Average
8.86
Weighted
-1.70
Yield
Portfolio Return

Clime Investment Management is one of Australia’s top performing fund managers specialising in income and value growth portfolios for wholesale and sophisticated investors, particularly self-managed super funds.

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