PORTFOLIO POINT: The value of having institutional investors participating alongside retail investors was underscored in the failed Seek notes issue.
Two weeks ago, Seek announced a A$125 million “subordinated note” issue aimed at retail investors.
Last Wednesday, Seek pulled the issue and lost up to A$0.5 million in the process. This is how much the legal due diligence involved in the preparation of a 124-page full prospectus is likely to have cost (not including management time).
A tersely worded statement to the ASX simply said that Seek would not be proceeding with the issue announced to the market on 4 June 2012. The statement read in part: “Seek was not satisfied that it would achieve acceptable terms at this point in time and believes that it is not in the best interests of shareholders to proceed.”
In other words the book-build for the subordinated notes failed. But why did it fail?
A book-build is the process undertaken by issuers and their advisors prior to opening security offers to the public. Institutional investors and brokers are invited to indicate the price they are prepared to pay for the security being offered and how much they will take. The process is intended to ensure a successful issue before it opens.
A common excuse given for the failure of a book-build is market conditions. This explanation can sometimes be hard to dispute, but more often than not the true reason for failure lies with the issuer or the structure of the issue.
Seek itself is unlikely to have been cause for concern. Its online businesses are sufficiently well diversified in terms of geography and sector and should not give rise to concern.
Moreover, its recent performance has been strong and improving. This is reflected in its share price, which started the year at around A$5.70 and closed ahead of the cancellation of the offer at A$6.66.
The structure of an issue is reflected in the terms and conditions and the pricing. That the issue was the highest yielding to come to the market so far this year should have rung alarm bells.
It was also the most aggressively structured issue yet seen. To call the securities being offered subordinated notes was misleading, maybe even grossly so.
These securities were definitely hybrid securities with all the risks of equity and none of the upside. The only 'debt-like’ features were the potential for a fixed coupon payment to be made and the possibility that the securities may be redeemed at face value after five years.
But the payment of coupons and the repayment of principal were to be at the sole discretion of Seek. And unlike the other hybrid issues that have come to the market this year, there was no time limit on the recognition of 'equity credit’.
The major credit rating agencies will give full or partial 'equity credit’ to deeply subordinated debt. This makes the issuer’s debt service ratios look stronger than they really are and allows their senior debt credit rating to be either maintained or increased.
But there is a time limit on how long this equity credit will be recognised. Once this limit is reached the issuer has an incentive to redeem what is by then, simply expensive debt.
For Seek the 'equity credit’ obtained from its auditors and bankers would be perpetual. This would have been the ideal equity to raise, when not raising equity.
It seems most likely that the aggressive structure of the issue was recognised by institutional investors and maybe even the brokers that would have sold it to their retail clients. Perhaps once more, the value of having institutional investors participating alongside retail investors has been underscored. It is also possible that the limit of the investors’ appetite for what are truly high yield junk bonds has been reached.