‘Debt’s back baby. People are buying this crap’. That’s a quote, attributed to a banker, your author recently heard. It wasn't related to this offer, but if you're buying into the high yield securities market, it's worth bearing in mind.
MYOB Subordinated Notes is a fair but risky offer. Bain Capital, owner of MYOB Group, is paying handsomely to claw back some of the capital it has invested, offering a margin of 6.7% over the 90-day bank bill rate on the $150m offer.
Compared to term deposits, bonds and blue chip shares, it’s a spin of the wheel.
MYOB is a great business, selling accounting software that customers can’t easily ditch. But it’s highly leveraged, with senior debt of around $0.5bn, which must be repaid before the Sub Notes, and a debt-to-equity ratio over 100%.
The leverage makes it vulnerable to the unexpected. Competitors (such as the recently listed Xero)will be chasing market share and a price war, litigation, law changes or data security issues are apossibility. Any of these could bring the Notes unstuck.
There are four reasons why this offer is so high-risk.
1. This is not a hybrid. To get your money back, you won’t be able to convert into listed shares.This is traditional subordinated debt that must be repaid from operating cash flow. And that’s a risk (see 4).
2. The payoff is ‘all or nothing’. Despite the Sub Notes five-year maturity, the senior debt must be repaid first. Any default, or breach of key financial ratios, will see payments on the Sub Notes suspended. If everything goes according to plan they’ll be very profitable. If the unexpected happens, you’ll lose a lot of money.
3. The offer size can be increased. During the book-build the offer size was increased from $125m to $150m. It may increase further. That means more risk for investors. MYOB and Bain can use the increase to pay back more of Bain’s capital, without paying a higher rate to reflect the increased risk. The more successful the float, the better the deal for Bain and the worse for investors.
4. MYOB must grow earnings to repay its debt. By 2015, MYOB needs to make scheduled principal repayments on its senior debt and ensure it complies with its ‘senior leverage ratio’—a cap on the amount of debt it can have. It can’t do either on current earnings. MYOB must keep growing earnings for the Sub Notes to pay interest, and be repaid in their entirety at maturity.
This is a simple proposition. If earnings continue to grow, MYOB Sub Notes will be highly profitable.If something bad happens, they’ll blow up. Payments will be skipped, maturity will be deferred and the $0.5b worth of senior lenders will hold all the cards.
That’s the deal, and that’s why the Sub Notes are paying a 6.7% margin.
Richard Livingston is the managing director of Intelligent Investor Super Advisor, an online service providing SMSF and investing advice. This article contains general investment advice only (under AFSL 282288).
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