|Summary: The Healthscope Subordinated Notes II are high-yield, junk bonds with commensurate risks attached. But the structure of the notes is more bond-like than hybrid-like.|
Key take-out: The coupons are not franked, so the full, cash value is received up front. The coupons are also fixed, with 10.25% to 10.75% per annum being offered.
Key beneficiaries: General investors. Category: Income.
Danger, Will Robinson! Danger!
Among those of us who remember those words are the investors at which the latest retail note issue is aimed. And the warning is appropriate.
The Healthscope Subordinated Notes II are high-yield, junk bonds with commensurate risks attached. And they are really only suitable for those investors who have closely studied the prospectus and can hold the notes in a well-diversified investment portfolio.
That said, the notes have some attractions, certainly relative to the many hybrid notes that have been sold in recent times, and relative to the MYOB subordinated notes, with which they most closely compare.
The structure of the notes is more bond-like than hybrid-like.
The coupons are not franked, so the full, cash value is received up front. What’s more, the coupons are fixed, with 10.25% to 10.75% per annum being offered. And while coupons can be deferred if senior debt covenants are breached, the coupons are cumulative and a further 2% penalty interest is payable.
Furthermore, the term to maturity is just five years. The notes are not perpetual, nor do they a have a term to maturity of 60 years, which may as well be perpetual.
As for the comparison with the MYOB notes issued late last year; this is another private equity mezzanine financing transaction. The Carlyle Group and TPG took Healthscope private in 2010 and issued $200 million of Healthscope subordinated notes at the time, as part of the financing.
But, unlike the MYOB transaction, this is a second issue of subordinated notes of which $150 million plus is being sought. The advantage for investors this time around is that the transaction has a track record – and so far so good.
The original Healthscope notes are trading on the ASX at more than $105, compared with a face value of $100. That is because none of the 11.25% per annum coupons have been missed.
The MYOB notes only traded above their $100 face value upon listing and are currently trading close to their low of $95.
Also, unlike the MYOB transaction, the proceeds from the note issue are not going back to the private equity investors but will be used to pay down senior debt. So the transaction is not being further leveraged, albeit temporarily.
Healthscope discloses that this repayment will allow flexibility for further senior borrowings later.
And, lastly, Healthscope has some tangible assets over which noteholders will have a second ranking charge. But while the tangible assets amount to almost $1.5 billion, the senior and subordinated debt combined totals $1.6 billion, according to the pro-forma December 31, 2012 accounts.
Thus, in any liquidation of Healthscope, noteholders could expect to lose a fair portion of their investment. But this is better than what MYOB noteholders could expect, given that MYOB has no tangible assets to speak of.
Nevertheless, this deal is about the ongoing profitability of one of Australia’s largest private health care services providers and the cash flow that it generates. Both are critical to Healthscope’s ability to continue to meet the progressively tightening financial covenants attached to the $1.26 billion of senior debt.
And both profitability and cash flow may be challenged in a rising interest rate environment and by any further changes to health insurance rebates that the Commonwealth government may make.
To illustrate the vulnerability that exists, Healthscope took a $120 million goodwill impairment charge in the first-half of the current fiscal year. Clearly, The Carlyle Group and TPG have recognised that the nearly $2 billion of goodwill paid on acquisition was too much, and future cash flows are not going to be as great as was expected.
Fortunately the senior debt agreement allows for covenant breaches, if they occur, to be rectified through the injection of more equity into the transaction. With $962 million of equity currently invested, there is a reasonable chance that more equity will be found to rectify a covenant breach.
Lastly, as is the norm with deals of this sort, noteholders will have to opportunity to roll over their investment into any IPO of Healthscope, at a 2.5% discount on the share price. That is, if there is an IPO.
The current noteholders were expecting the announcement of an IPO now, not a new note issue.
The bookbuild for the Healthscope Subordinated Notes II commenced on March 4, and the coupon setting and the value of commitments received will be announced on Wednesday. Investors using the paper application form must submit it by March 19 and those applying online have until close of business on March 25 to do so.
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.