BMWs, Datsuns and IAG

Is the BMW 7 series a 'like for like' car with the Datsun Sunny?

I found myself pondering this question recently after receiving a copy of the following email from a member (redacted/emphasis added):

Whilst no great car enthusiast I always figured that the 2012 BMW 7 Series and the old Datsun Sunny from my childhood were, well, different, in some fairly significant ways.  I'd certainly never classified them as pretty much 'like for like'.

But having seen this analysis of the IAG CPS offer I may have to re-think matters. Both do have wheels, doors, windows and an engine after all.

Those who have read Gareth Brown's review of the new IAG CPS offer will know we are not fans. There is not enough return to justify the downside equity risk being taken.  Of course others are free to take alternative views: 2% or so additional margin (compared to a term deposit) for; Giving up a Federal Government Guarantee; Allowing the issuer to skip payments; Exposing yourself to share price risk on conversion; And mandatorily converting to ordinary shares as the issuer heads towards insolvency; might be an attractive proposition for some.

But somewhere along the road to a pitch to the retail investor these 'hot points' get skipped.  And you have to wonder how many of these securities are being lapped up because punters are being told 'Yeah, they're just like for like with the stuff you've already got. Ship it in for the yield', rather than having the key risk considerations pointed out to them?

So is the new IAG offer 'like for like' with the old hybrid?

Certainly they are both preference shares paying dividends: So that's a match. And both are offered under a nice thick PDS carrying the IAG logo. In truth they are alike on many measures: Except the important ones.

The old IAG hybrid (and older hybrids generally) were designed to be largely debt-like securities, dressed up to look like equity so that APRA would treat them as regulatory capital. Whilst they converted to ordinary shares, they did so at a generous discount (to make sure you got your money back). And if the issuer hit trouble then no conversion occurred:  You stayed as preference shares (or subordinated debt) and got paid ahead of ordinary shareholders rather than converting to ordinary shares and absorbing losses.

But APRA is on to this and the old game is up. Today's hybrids must incorporate true equity features is they are to be given the regulatory capital green light. So no catching up on unpaid dividends and, if the issuer hits rough times, hybrid owners automatically become ordinary shareholders to absorb losses.

On the important issues and, in particular, the question of 'Will I get my money back?', the modern day hybrids are 'not at all like' the old incarnations. Investors take a lot more risk.

Which brings us back to the 'email analysis', the pitch to investors and my residual questions.

How many of these hybrids have been sold to investors off the back of analysis which glosses over the risks involved? In fact how many investors would even look at the PDS once they have been told by a research house or advisor that it is 'arguably like for like' with what they already own?

And how many investors would be piling into these things if emails like this instead said 'the new offer is very different to the existing investment' (with some post-it notes to highlight the key PDS pages)?

Advising and selling at the same time. Great for keeping our financial institutions well capitalized with cheap equity. But a potential disaster for investors.