The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Sunday, February 19, 2012

Phil Bayley on Tabcorp's hybrid risks

An excellent summary of the risks of the new Tabcorp hybrids from The Debt Capital Market Review's Phil Bayley (to contact Phil about subscribing email: adcmservices [at] gmail [dot] com):

Tabcorp notes – no thanks

Last week we had not anticipated that Tabcorp would be the next issuer of hybrid notes to come to the market but the rumour mill was accurate to the extent that hybrid issuance was imminent. And unfortunately, the Tabcorp Notes issue comes with all the undesirable features of equity-credit as feared.

To Tabcorp’s credit it has restricted the term to maturity of its notes to ‘just’ 25 years and it has been quite explicit in its prospectus about the risks that investors will be taking on, if they subscribe for the notes. But make no mistake this is an equity investment offering only bond-like returns, provided Tabcorp pays the coupons.

Tabcorp describes the Notes as unsecured, subordinated, cumulative notes. The notes are unsecured and rank only ahead of shareholders and behind all other creditors, in a winding-up of the company.
The coupons to be paid on the Notes are deferrable but must be paid after five years from the date of suspension with compounded interest, assuming Tabcorp is in any financial condition to make the payments at that stage.

The coupons will be deferred if Tabcorp’s leverage ratio exceeds 3.5 times or if its interest coverage ratio falls below 3.0 times on a testing date and will stay suspended until the next testing date at which these ratios are back into order.

Calculation of the ratios is less than straight forward, being determined by the definitions of relevant gross debt, relevant EBITDA, and relevant net interest expense. What is relevant is explained in Appendix A, starting on page 117 of the prospectus.

Tabcorp helpfully points out that as at 31 December 2011, its leverage ratio thus calculated stood at 2.2 times and its interest coverage ratio at 5.3 times. Even more helpfully, Tabcorp provides a sensitivity analysis setting out the deterioration required in each variable for the ratio limits to be breached.

Critically, EBITDA need only fall by 37% for coupon payments to be suspended – not an inconceivable event. Moreover, if the coupons are suspended Tabcorp is under no obligation to also suspend dividend payments, although it does say that it intends to do so.

As is typical of these hybrid issues, the Notes are callable after five years but there is little incentive to call the Notes. The coupon will step-up by 25bps if the Notes are not called but this makes little difference on a coupon that is being marketed at 400bps to 450bps over bank bills.
Tabcorp points-out that one rating agency will cease to give equity credit after five years but goes on to say that it will only redeem the Notes if it can sell new notes that achieve the same or better equity-credit.

Moreover, Tabcorp discloses that it can buy-back the Notes on-market after the call date. What better time to buy-back the Notes when the market price has fallen, presumably below face value, as investors realise they are locked into a 25 year investment.

The Tabcorp Bonds issued to retail investors in April 2009, pay a coupon of 425bps over the bank bill rate. The Tabcorp Bonds are senior ranking debt with a fixed term to maturity of just five years.
The Tabcorp Notes now on offer to retail investors are offering a similar coupon for equity risk. In fact, Tabcorp is hoping to sell the Notes with a coupon of only 400bps, which with a bank bill rate of 4.4% would give an initial coupon of 8.4% per annum.

If investors really want to take on Tabcorp equity risk they should buy Tabcorp shares. The dividend yield is currently 8.6% per annum and the franking credit takes the yield to 12.4%.

But then again, perhaps this says a lot about what the equity market thinks of Tabcorp’s prospects. At least one broker has a sell recommendation on the shares.