Review: Seek releases a new fixed-rate hybrid

Co-founder of the Switzer Report
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Important note: Seek cancelled this capital raising on Wednesday 13 June 2012. Click here for more information.

Seek, Australia’s leading online employment classifieds business, is the latest company to join the list of hybrid issuers.

While most of the issues in the past 12 months have been floating rate issues, this issue differs because it promises the ‘yield seeker’ a fixed rate of return – a minimum of 8.6% (grossed up) for the first five years.

A top 100 company, Seek dominates the online employment market in Australia with a market share of more than 70%, and its increase in net profit since listing has seen its market capitalisation rise to $2.2 billion. More recently, it has diversified into education and training services, and international online employment businesses in identified growth markets.

The Australian and New Zealand employment businesses generated $75 million of Seek’s $90 million EBITDA (earnings before interest, tax, depreciation and amortisation) for the first half year of 2011/12, with education providing $6 million and the international division $9 million.

The issue

Seek is raising $125 million via the issue of the notes, which are subordinated and unsecured. The proceeds will be used to reduce in part Seek’s existing syndicated debt facility, and to provide flexibility to fund further investment in international businesses.

The notes will be treated as ‘equity’ in the company’s balance sheet, and will pay a distribution that is expected to be fully franked. While the margin and rate are described on a gross basis, the actual distribution will be adjusted for the tax effect. This means that for the first five years, investors should expect a minimum fixed fully franked distribution of 6.02% per annum (8.6% x 0.70), paid half yearly.

While the notes are perpetual, Seek (at its option) may call the notes after five years by electing to redeem them in full or convert them into ordinary shares (at an effective 2.5% discount to the then market price).

If Seek doesn’t call the notes, the margin is increased by a further 2% (effectively from a gross rate of 5% to a gross rate of 7%), and the notes then pay a distribution that floats over the 180-day bank bill rate. A dividend stopper is also applied, which prevents Seek from paying dividends to its ordinary shareholders.

The institutional book build will set the final margin. Based on the current five-year swap rate and a guaranteed minimum rate of 8.6%, the final interest rate for the first five years is likely to be in the range of 8.6% to 8.9%.

Details of the issue are as follows:

What I like about it

Seek’s strong track record and dominant market position in Australia are key positives. While exposed to a slowdown in employment and new competitor risk, Seek is relatively lightly geared. The product disclosure statement (PDS) points out that post the issue, Seek’s pro-forma interest cover ratio is 7.7-times, and its leverage ratio (borrowings/EBITDA) is 1.1. While these numbers are a little disingenuous (as equity is replacing debt – and still needs to be ‘serviced’), the bottom line is that they are reasonably strong metrics.

We also like the margin, particularly at the higher end. No doubt, Seek would have to pay more to its Bank’s than the rate it is offering to investors with this issue. The problem though is we are not seeing too many other fixed-interest investment opportunities at this sort of margin.

What I don’t like

At $125 million, this issue is small by market standards, so expect limited secondary market liquidity. Also, the jury is out about Seek’s move offshore and its diversification into training and education services.

Any perpetual structure is also a negative, however you have to expect that the dividend stopper and step up margin are pretty big incentives for Seek’s Board to protect the interest of note holders and ensure that the notes are called at the first opportunity.

Bottom Line

In a diversified portfolio of fixed income securities, a small investment in Seek makes sense. This is up the risk spectrum from some of the other hybrids out there, so any investment should be commensurate with the risk.

Hurry for Heritage Bank Retail Bonds

This issue is due to close tomorrow (Wednesday) at 5.00pm. At 7.25% fixed for five years, this rate is now well above the market, so be quick (you might not get much more than a minimum application). See www.heritage.com.au.

Also in the Switzer Super Report:

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.

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