Tabcorp's issue a safe bet

With the ink barely dried on last week's interim results, Tabcorp has rushed out a prospectus for a $200 million-plus issue of subordinated debt to get in early in what is expected to be an avalanche of similar issues as the reporting season continues.

The significance of the issue isn't in its size – Tabcorp apparently plans to limit it to $300 million at most – but in the expectation that a queue of big corporates is forming to tap a new source of long-term funding in the wake of the success of similar issues by Woolworths and Origin Energy last year.

Woolworths and Origin significantly increased the size of their issues after being overwhelmed by the demand – Woolworths ended up raising $700 million and Origin $900 million – but still left some investors unhappy.

The appeal of the kind of note issues they made, and the Tabcorp offer is almost identical in structure, is that it enables them to diversify their funding and tap into a source of very long-term funding – the Tabcorp issue has a 25-year duration.

There aren't many sources of funding that long-dated and it helps the companies reduce their reliance on offshore debt markets and bank borrowings at a time when there is a question mark over access to both.

The target market for these issues is largely retail investors and DIY superannuation funds in particular. With the yield curve being forced down by the Reserve Bank and, despite the competition among the banks for deposits, depositors suffering disproportionately because of the politics around home loans, there is a window of opportunity for the companies.

Ironically, there is an expectation in the market that among the bigger issuers this year will be the banks themselves as they seek to further reduce their reliance on wholesale funding.

The Tabcorp issue is nominally a $200 million offering of unsecured subordinated and cumulative 25-year notes which will initially be offered to investors via a book-build, with a subsequent offer to shareholders and holders of the unsubordinated bonds the group issued in 2009 in what was at the time the first vanilla issue of corporates bonds in memory.

That issue was very successful, with the $100 bonds never trading below $102. The notes, which carry a margin of 425 basis points over bank bills, are trading at an implied margin of 230 basis points, so the original investors are sitting on material capital gains as well as the 4.25 per cent margin over bills.

The new issue is of subordinated debt – it ranks behind senior debt – and is expected to carry a margin of between 400 and 450 basis points over bills, which would produce a yield in today's market between about 8.4 per cent and 8.9 per cent.

The notes, which will be listed on the ASX, are pure debt instruments, with no conversion rights. Tabcorp will have the right to redeem them in 2017 at its own discretion.

The beauty of the notes from Tabcorp's perspective – and it explains why it isn't seeking to pull in as much funding as it can – is that Standard & Poor's treats these issues as equity until the redemption window arrives.

The issue, with its dividend reinvestment plan, will enable Tabcorp to finesse its capital structure for ratings purposes, minimise dilution of its performance statistics and ensure it protects its investment grade rating and can fund maturing debt without materially impacting its funding costs.

It also, of course, adds another tier to its funding structure that will, if the issue is deemed a success, give it another funding option in future.

Interestingly, given the relatively modest size of the offering, Tabcorp has three joint lead managers to the offer – UBS, which advised on its structure, Macquarie and Westpac. That kind of distribution clout suggests Tabcorp wants to take out insurance that it gets the offer away in the expectation that there could be very significant competition for investors from other big issuers.

The financial crisis, the teetering of the eurozone and the deep risk aversion of investors large and small is creating a market for listed debt that previously didn't exist.

It would get another significant kick along if Wayne Swan follows through on his commitment to facilitating the trading of Commonwealth government securities on an exchange, which would then provide a benchmark against which corporate issues could be more easily referenced. Late last year Swan released a discussion paper on reforms to help develop a listed market for corporate debt.

Even without a retail market for Commonwealth debt securities, the hunger of retail investors for yield and their willingness to accept paper from highly-rated companies with resilient cash flows – and Woolworths, Origin and Tabcorp fit that bill – is creating the foundations for a market with some depth. If there were some significant issues of big bank paper, that would be another significant step forward.