A flutter on Tabcorp Notes?
The success of the recent Woolworths and Origin Energy income security offers has caught the eye of other capital-hungry companies. Step up, please, Tabcorp Holdings, an altogether different proposition.
In the first of many ‘me too’ issues in coming months (we'll cover similar offers from ANZ and Colonial over the next few days), Tabcorp this week launched its Subordinated Notes offer. The company is seeking $200m but reserves the right to raise more, and is no doubt keen to do so for reasons which will become self-evident.
You may have already received an offer from your broker, perhaps with a tight acceptance deadline, in which case you’ll find this review timely. It may also be of some use if you’re thinking of participating in the less–hurried shareholder or general offers set to close on 14 March.
Key Points
- Margin of 4.0-4.5% over 3-month bank bill rate
- Miserly step up of just 0.25% in 2017
- With large debts and an assured hit to earnings, Avoid
While the likely ASX code of TAHHB is only one letter removed from the Tabcorp Bonds (ASX code TAHHA) issued in 2009, this is an altogether different proposition. The Subordinated Notes are a riskier, lower-ranking security akin to the recent Origin Energy Notes offer.
Structure
As with Origin Notes, Tabcorp’s new security is subordinated. In the event of insolvency noteholders sit before ordinary shareholders but behind all unsubordinated creditors, including bank lenders and Tabcorp Bond owners.
Tabcorp Notes will pay cash distributions (no franking credits) on a quarterly basis at a rate equal to the 3-month Bank Bill Rate plus a margin of between 4.0% and 4.5%, to be finalised via next week’s bookbuild.
TAHHB | ORGHA | |
---|---|---|
Official ranking | Unsecured, subordinated | Unsecured, subordinated |
Risk characteristics | Debt-like | Debt-like |
Distribution rate | 3 month BBR 4-4.5% | 3 month BBR 4% |
Distribution type | Cash only | Cash only |
Compulsory distributions? | No-deferrable up to 5 years | No-deferrable |
Cumulative? | Yes | Yes |
Principal repayment | Cash | Cash |
Step-up date | 22 Mar 17 | 20 Dec 36 |
Step up increase | Margin increased by 0.25% to 4.25-4.75% | Margin increased by 1.0% to 5% |
Maturity date | 22 Mar 37 | 20 Dec 71 |
Distributions must be deferred if Tabcorp’s finances deteriorate beyond a point as set out in the prospectus (see page 30) but any deferred distributions accrue interest and must be repaid within five years.
The security matures in 2037—a 25-year term—with a step up date in 2017. Tabcorp can redeem the security at that point or on any interest payment date thereafter.
But, and we think this is a very important point, there’s a higher probability of Tabcorp Notes ‘going the full term’ than similar recent offers (see below). If so, noteholders have no right to demand early redemption, except under a change of control, a takeover for example.
In the Origin Notes float review, we warned of a process of deterioration in the fine print of each new offer ‘until investors tighten up their wallets and the game moves on’. That effect is most obvious in the step up features of Tabcorp Notes.
On a step up date, the interest on a security ‘steps up’ by a predetermined amount. This is an important safety feature for investors. Threatened by the stick of higher borrowing costs, management is incentivised to seek funding elsewhere and repay on the step up date if at all possible. If the company can’t find cheaper funding, investors are compensated with higher interest payments for the remaining life of the security.
In previous generations of subordinated notes, it was not uncommon to see step ups of 2.5% (see Australand ASSETS, for example). Recently-listed notes from Woolworths and Origin have a smaller step up of 1.0% but that’s still an incentive to redeem.
In 2017, Tabcorp faces a miniscule step up of just 0.25%—it’s really a step up in name only. And while we’d be hesitant to accuse anybody of obfuscation, this feature might lull investors into thinking the notes are likely to be a five year security while the company might actually be keenly seeking the option of 25-year funding. This is potentially a landmark shift (by which we mean deterioration) in the income security market.
Perhaps in five year’s time cheaper credit will be available elsewhere but if not, there’s not much incentive for the company to redeem. If you’re thinking of purchasing Tabcorp Notes, you need to be willing and able to own a 25-year security.
Tabcorp Notes trump the Origin offering with a shorter period until step up date (2017 versus 2036) and shorter maturity (2037 versus 2071) but that’s no clear endorsement. More significant threats lurk, too.
Financial strength
The financial strength of Tabcorp is even more crucial than the fine print conditions of this offer. And here we have deep concerns.
As explained on 29 Jan 10 in Tabcorp’s year of living dangerously (Hold - $7.03), the company is on the verge of losing its most profitable cash cow; its Victorian poker machine duopoly. From August 2012, licences will be owned directly by venues.
Tabcorp has responded by developing machine supply, consulting and support services to pitch to the new owners, although this new business will be but a shadow of the old one.
Bookbuild to determine margin | 21 Feb |
Announcement of margin | 22 Feb |
Opening date | 22 Feb |
Closing date (shareholder and general) | 14 Mar |
Closing date (broker firm offer) | 21 Mar |
Begin trading (deferred settlement) | 23 Mar |
Normal trading | 27 Mar |
First interest payment | 22 Jun 12 |
First call date | 22 Mar 17 |
Maturity date | 22 Mar 37 |
In 2011, the gaming division delivered $241m of earnings before interest and tax (EBIT), 43% of Tabcorp’s total of $563m. For the 12 months following the licence change, EBIT from the division is forecast to fall to $22m (see page 63 of the prospectus), down more than 90% from 2011. More than a third of Tabcorp’s entire earnings power will disappear overnight.
The company’s other major business—wagering—is also challenged. Having recently renewed its Victorian wagering licence out to 2024 at a cost of $410m, this business faces a strategic threat from online gaming.
Recent results have been more resilient than we expected. But the internet has revolutionised the way savvy punters bet. Betting exchanges like Betfair and online bookmakers such as Centrebet, Sportsbet and Sportingbet usually offer better odds than the incumbent totalisers. Technology is revolutionising the industry, often at Tabcorp’s expense.
Punters will still want to place bets in TABs, pubs and clubs, but the bigger, more profitable punters are turning elsewhere. It’s a major threat to Tabcorp’s wagering profitability.
Given these longer term threats, and a possibility of a 25-year security life, potential investors in Tabcorp Notes need to know that the company’s financial position is bullet proof. Unfortunately, it’s anything but.
Accounting for the $410m licence payment to the Victorian Government in January, the company has about $1.2bn of net debt, excluding the debt to be raised in this offer. This compares with about $1.3bn of equity. With fully three-quarters of the company’s debt facilities due to expire before the end of 2014 (see page 67 of the prospectus), Tabcorp is no financial fortress.
Awash with debt and with earnings about to fall, lending money to Tabcorp for a margin of 4.5% or less doesn’t stack up. In the end, this is an easy decision. AVOID Tabcorp Subordinated Notes.