PORTFOLIO POINT: The MYOB subordinated notes issue has an attractive fixed coupon rate, however retail investors will rank behind other lenders.
Retail investors have soaked up more than $12 billion of debt so far this year, most of it in the form of high-yielding, but very high-risk, hybrid notes.
Adding to the list is the $125 million five-year subordinated notes issue announced today by accounting software producer MYOB via its private equity owner Bain Capital. The MYOB issue will be high-risk too, but of a different sort.
The five-year notes will pay a floating interest rate of between 6.7 and 6.9 percentage points over the bank rate, at an initial minimum of 10%. The payments will be made in quarterly instalments. The issue price is $100 per note and the minimum is $5000. In the current low interest rate environment, a fixed coupon in this range is very attractive.
However, a high coupon is being offered because the notes will rank as subordinated or mezzanine debt. The unsecured notes will rank behind the secured bank lenders that provided the senior debt used by Bain Capital to acquire MYOB in the first place.
This type of deal is not unusual but has had its successes and failures. The notable success was the Myer notes issued in 2006, also with a 10% per annum fixed coupon.
However, while the note issue itself was successful, those noteholders that took the opportunity to participate in the subsequent listing of Myer on the ASX will still be regretting that decision.
As with the Myer notes, investors that take up the MYOB bonds are likely to be offered the opportunity to acquire shares in MYOB at a discount when the company is eventually relisted on the ASX. However, acquiring shares in companies that private equity investors are exiting has often proved to be a poor investment.
Myer is the stand-out example of this.
Healthscope, owned by TPG and The Carlyle Group, issued $200 million of convertible notes in 2010. The notes are still listed on the ASX and are trading at a premium to face value, but Healthscope is yet to re-list.
The notable failure, when it comes to buying mezzanine debt issued by private equity owned companies, is Nine Network. Just about everyone involved in taking Nine Network private lost their money – the private equity investors, the mezzanine debt investors and most of the senior lenders. The only investors to make money were the distressed debt investors who progressively bought-out the senior lenders, before undertaking a capital restructure.
Interestingly, in this case, the mezzanine debt investors were funds run by Goldman Sachs and not retail investors. This goes to show that even professional investors can get it wrong, but it also highlights the level of risk being taken by retail investors.
Unlike recent hybrid note issues, the bonds to be offered by MYOB should have regular coupon payments with no option to defer. There should be a relatively short term to maturity, probably no more than five years, and there should not be any mandatory conversion into equity, if MYOB’s capitalisation falls to a non-viable level.
However, retail investors are being asked to assess the credit risk of MYOB; the risk that MYOB may prove to be another Nine Network and not a Myer.
As usual, the notes will not be rated and retail investors will be at a distinct disadvantage in trying to assess and monitor the credit risk of MYOB. Most retail investors are unlikely to have the skills to assess credit risk and, even if they do, the information flow needed to monitor that credit risk is likely to be restricted.
Investors will have to rely on business media and announcements made to the ASX. It is unlikely that there will be any investment analyst coverage of MYOB.
The issuers of hybrid notes are typically well covered by investment analysts.
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.