The issues with Bendigo's issue

PORTFOLIO POINT: Ordinary shareholders in Bendigo and Adelaide Bank get a better yield, and have more upside potential, than those who take up the bank’s new convertible preference share offer.

I hope that I will not embarrass any of my fund manager peers by stating that I do not believe that any professional equity manager helped design the terms for the new Bendigo and Adelaide convertible preference share offer. 

I have previously mentioned in this column, in what now appears as the distant past, (when I was an institutional fund manager at NRMA), that I was often asked to respond or comment on the proposed terms of a new capital raising.

Simply put, a broker would seek the support (underwriting or otherwise) of the NRMA so that an issue could go confidently forward. Often we were asked because we were a major shareholder of the issuing company.

Our rules regarding an underwriting were simple. Was the new issue a worthy investment so that if there was a 100% shortfall, we would be happy to take up our full underwriting exposure? An underwriting fee was never enough to compensate for a poorly structured investment.

Now, if I were a potential underwriter of the current Bendigo issue I would gracefully decline the opportunity. I have nothing against this bank and have invested in it on behalf of clients for decades – indeed from its earliest days as a public company. However, the terms of this issue are convoluted and the yield is inadequate on a key comparative basis – compared to its ordinary shares. 

In any case, this issue could not be underwritten because the issuer doesn’t know how much they want to raise. Is it $125 million or less, or more?

Let’s be frank. This is an equity raising with the virtual downside risk of an ordinary share (loss exposure below about 50% of the current share price) without the capital growth potential of an ordinary share (actually virtually no upside).

For this, an investor gets a preferential dividend (hopefully) but at a pre-tax yield below that which is currently paid on the ordinary shares. The current ordinary pre-tax yield is 60 cents franked on $7.80 (7.7% franked or 11% pre-tax) and the pre-tax yield on these “preference” shares is between 8.53% and 9.03%.  

The giveaway statement is on the first page of the CPS Summary Offer Statement. These new shares are “Perpetual convertible preference shares with discretionary dividends which can be non-cumulative” Further reading also discloses that these notes “may be redeemed at the issue price”.

If you have a pen and paper, go to page 19 and check out the “Mandatory Conversion” terms and don’t forget the “Capital Trigger Event” or the “Optional Exchange” or the potential to be “redeemed for cash” or “the Non-Viability Event”.  The latter is in my view most critical because it appears that not even APRA can provide guidance as how to determine “Non-Viability”.  Do you need a financial advisor or a lawyer?

So I am left wondering why companies construct issues that are so darn hard to understand. What is wrong with a simple and traditional converting preference share which is issued at a premium to the ordinary shares but pays preferred dividends?

For instance, why doesn’t BEN simply issue a five to seven-year mandatory converting preference share (at say $10) and which pays a fixed 7% to 8% fully franked dividends on a quarterly basis? The preference shares could be cumulative, non-discretionary and non-redeemable. They would rank as Tier 1 capital. They would convert at 20% premium to the current ordinary share but they would rank ahead of same for dividends and capital.

Conversion can be at the option of the holder if they want to convert early. Rather than a redemption right, the company can retain the right to buy them back on the market if it is flush with capital. Upside in the ordinary shares above 20% is to the benefit of the preference owner. The investor is treated on the basis that he has equity risk and the terms or risks are easily understood. 

Common sense with no convoluted term sheet and no tricky terms! Maybe the newly proposed ASX book build system could also be constructed so that investors can input their own sensible terms for an issue when they bid!

QR National

On the subject of common sense, I was intrigued to read some updated broker research this week on QR National (ASX: QRN). Now this is an interesting company, not least because it is owned 30% by the Queensland government, who surely must be considering the sale of their shareholding.

The pressing fiscal predicament of the Sunshine State would suggest nothing else. However, the recent Queensland budget gave no hint of a sale or even a note of a magical $2.5 billion inflow to balance the books. The QRN share price maintains an eerie stability that belies the overhang. Noteworthy is that it is supported by a buyback.

Be that as it may, I was attracted to this unnamed broker research because it noted the potential for disappointing coal movement volumes in the coming year and the risk of wage cost increases.

Anyway I perceive that investors in this stock must still have a healthy expectation of dividend increases in coming years given the current poor yield.

One thing the BEN issue does suggest is that there continues to be an unsatisfied demand for high “constructed” yield, and so it is interesting to compare QRN to my favoured “solid” yield stock – Telstra.

Let’s compare their projected three-year dividends:

Over three years it is projected that QRN will return 10% of its current share price in dividends (plus franking) whilst TLS will return 22% (plus franking).

I can hear the analysts shouting “QRN is a long-term growth story and TLS is unknown and ex growth”. Really! Does anyone actually know what is going to happen in 2020? Anyway, I think both companies will be still around then and TLS will still have a higher dividend per share then QRN. The current difference in share price is inadequate, but it has been since QRN listed.

The benefit of being a patient investor who chooses to invest in a limited number of companies and securities is that direct comparisons can be made between possible investments. I simply do not need to invest all the time or buy everything that comes along.

Indeed I suggest that all of us take our time in this market and wait for the opportunities. For every bad investment offer a good one is created by the selling of rotating investors. These investors, whom are advised by commission agents, sell and buy with value being a secondary concern.

For the record, TLS stays in our income portfolio, QRN does not get close and the BEN preference shares are to be reviewed by my Martian Lawyer. Maybe he can me make sense of it!

John Abernethy is the chief investment officer at Clime Investment Management. Utilise MyClime to identify high yielding equities to enhance income returns for your portfolio.

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Clime Income Portfolio - Prices as at close on 27th September 2012