Seven's Telys hybrids and the Stokes factor

PORTFOLIO POINT: Any move by Kerry Stokes against Consolidated Media could augur badly for Seven’s Telys hybrids.

KERRY STOKES just couldn’t help himself. When the opportunity arose for him to land a body blow on long-time corporate rivals the Packer clan, he seized the chance.

Last week Seven Network, of which Stokes is the majority shareholder, acquired 13.5% of Consolidated Media Holdings – otherwise known as James Packer’s media plaything – in a $234 million raid. Combine this with an existing stake of about 4.8% and Seven has now emerged with a total holding of 18.3% of Consolidated Media, worth $335 million. It now remains to be seen whether Seven is content to sit patiently as a minority shareholder – or if a full blooded takeover tilt is on the cards.

Stokes’ corporate aspirations for Consolidated Media may or may not eventually be a positive for Seven shareholders but it augurs poorly for the latter’s hybrid (Seven Telys) investors. The company is currently essentially a listed cashbox and investment company, and any moves to reduce the cash on hand increases the risk that Seven won’t redeem the hybrids at the first opportunity on May 31, 2010.

That is our biggest concern about the Seven Telys as an investment. While Seven is technically an independently run listed company, we’ve long suspected (and there is ample evidence to support our position) that it is run as Stokes’ personal fiefdom.

The prime example of Stokes’ control of the board was the C7 legal battle. Seven spent an estimated $200 million on legal fees in what ended up being a fruitless pursuit with many speculating that the action was fuelled more by a personal vendetta than economic considerations.

Even after this recent splurge, though, Seven is still in a remarkably strong financial position. The company still has cash of almost $1 billion on its books, a listed investment portfolio of just under $1 billion and no debt.

So assuming that Seven just sits on its hands for the next year, it is a no-brainer that the company will redeem the Seven Telys in May next year. If the company doesn’t redeem the securities then it will be forced to pay a step-up of 2.25%, bringing the total margin on the Seven Telys to 4.75% over 90-day bank bill swap rate (BBSW).

It wouldn’t be a particularly smart idea to pay such exorbitant rates when there is a cash stock pile on the books earning considerably less.

However, the risk, which has just substantially increased, is that Seven will make an acquisition that will chew up this hoard of cash and potentially force it to take debt on to its books. If this were to occur, the 4.75% margin on the Seven Telys might actually be an attractive source of funding and tempt the company into not redeeming the securities.

Admittedly, this wouldn’t be a complete disaster for Seven Telys investors. They would then still be earning a healthy perpetual coupon based on the $100 face value on the notes. Considering the securities are currently only trading at around $88 this translates to a margin of approximately 5.40% over BBSW on a perpetual basis.

Of course, redemption is still the preferred option. When the prospect of a $12 capital gain and a couple of coupon payments in less than a year are taken into account, the current annualised yield to call date of the Seven Telys is close to 20%.

The following chart illustrates the price movement of the Seven Telys over the past year. From lows of just over $74 in December 2008, the stock has rallied strongly.

Source: Bloomberg

While the Seven Telys still look like a reasonable opportunity at these levels, the compelling value that was available late last year has dissipated. Not only has the price risen significantly taking away a large portion of the potential capital gain, but the prospect of the securities being redeemed at the first opportunity on May 31, 2010, has declined with Seven’s raid on Consolidated Media.

Jim Stening is managing director of FIIG Securities.