Neither a borrower nor a lender be

The genius of James Packer continues.

Crown Resorts is a BBB rated company and they have raised $600 million in debt through the public markets at 4% above the bank bill rate, which means currently the total coupon will be 6.27% range.

The paper matures in 2075 but Crown can redeem them in 2021. Lenders own debt which is subordinated. They will rank below preference share holders and other capital market debt but above ordinary shareholders. The money is going to be used to finance projects within Crown Sydney & Crown Towers Perth.

So what they have achieved is to reap a stack of long dated capital at a cheap price without the onerous banking liens and it was raised easily because investors are simply chasing any yield.

Investors should consider not whether they are being “paid” enough to take this risk as a lender but whether they have considered the risk/return (even the risk of underperformance) of owning the shares of Crown Resorts rather than its debt would a better proposition. I’m not writing about Crown’s risk or ability to pay its coupon or return your capital but whether the herd has simply filed into another hybrid income product without thinking about it.

Think of it in terms of the return shareholders may receive as a rate of return over the cost of the capital once they complete the expansion of the various casino projects?

I forgot to say that James Packer’s family company, Consolidated Press Holdings (CPH), also bought $50 million of this debt. I’m sure this gave the new debt investors added confidence that he has backing it personally.

That’s fine, but CPH also owns at least $4 billion of Crown Resort shares.

Sometimes analysis is difficult and sometimes it can be simple.

Abnormal Dividend Payments Aren’t Good

The dominant conversation that prospective clients are having with me is about their desire to earn a higher yield on their money.

I’m talking yield in terms of income.

A couple years ago they were earning 6% on their Australian Dollar cash held in the bank but now they are earning 2.7% and so the chase for yield begins, mainly via sub-standard, riskier assets in order to satisfy their single, blinding and qualifying criteria of income yield.

Surely, I must have written about that particular angle previously.

But the current trend amongst listed companies who are holding excess cash or re-generating pre-crisis levels of free cash flow – is to return cash to their shareholders.

We know that over the past couple years companies have “returned cash” by re-purchasing company shares. Appropriately, they have also re-financed debt at cheaper rates. This has also improved their “earnings per share” data which the stock market and analysts have loved.

Today’s trend is to return cash by increasing the company’s dividends at larger increments than in the past. Some companies are even making interim (or extraordinary) dividends in addition to their normal payment schedule.

Is this corporate board room’s new “increasing the share price” strategy? Raise your dividends abnormally, so those who are chasing yield will buy your shares and thus send your share price higher.

This also serves management handsomely, especially if they have share price performance linked remuneration (options, bonuses etc.), but I think this is also exhibits management’s laziness for their lack of ability to find ideas on how to use their company’s money to grow the business.

Company management would be quick to suggest that “this is in the best interest of shareholders”.

I don’t like this strategy, whether it’s from a corporate or an investing perspective.Historically, I have seen this occur before.

Today, the company appeases the market by handing out the cash and Tomorrow, it needs cash again; which is when they either issue new shares (which dilutes existing holders) or borrow money (often at interest rates higher than a couple years ago) which usually equates to a higher gearing ratio in their balance sheet.

One of our investing themes is to look for companies that are retaining their earnings. Our preference is to keep the money in the balance sheet and then deploy that capital to grow the business.

All this talk of corporate activists demanding cash being returned and balance sheets being lazy – blah, blah, blah.

I’d rather see the excess money left in the company’s bank accounts instead of leaving. If the board and management can’t develop a strategy on how to use that money appropriately, then they should be leaving, not the company’s money.

I think this is better for shareholders.

The Coming Slaughter of the Yield Pigs

Dollar in Piggy Bank

Major Australian banks have again raised billions of dollars by issuing debt.

In some instances, the issuer of the debt isn’t the parent company and in cases where it is, investors should wonder why do the most creditworthy banks in the world need to offer 300 basis points (or greater) above their benchmark rate, in order to attract investors?

Perhaps it’s because the debt is perpetual, its pays non-cumulative distributions, its unsecured and subordinated

Other questions to ask include; what is the credit rating of the debt, is if the credit rating of the debt is different to the issuer, when does the debt mature, can it be “called” or “converted”, are distributions franked, am I being paid fairly or enough for the risk I am taking or perhaps simply, does this investment benefit you or are the odds stacked towards the “house”.

I also question whether I should buy it at “par” rather than a discount.

Sadly, many Australian retail investors don’t possess the required skill and knowledge to analyse debt investments.

In turn, they often aren’t receiving objective advice,. Instead, they are often being “sold” the investment rather than being advised whether it’s appropriate for their portfolio.

There has been plenty of debt on offer, so I ask myself, why should I buy something that has ample supply?

The genius behind the banks decision is to raise capital when they don’t particularly need it and they do so when their costs (or the rates they offer) are cheap.

Australian interest rates are now at record lows with the current Reserve Bank rate sitting at 2.5%.

With the pendulum at an extreme, there is greater probability that interest rates triple in the next 10 years before they move to 1%.

Are these investors buying something at the wrong end of the cycle?

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