Investors chasing yield may be attracted by the new hybrid securities issue from Crown Resorts. An indicative margin of 4.0% over the bank bill means that these subordinated notes will initially pay a headline-grabbing yield of over 6.0% pa.
However, before you rush off to place large sums in this offer, consider the following:
- when Crown issued its first series of these subordinated notes in September 2012, it paid a margin of 5.0%. At that time, its balance sheet was also stronger (lower leverage ratio); and
- government guaranteed term deposits are paying a margin of around 0.5% over the 90 day bank bill. Your effective margin (credit spread) for this Crown risk is 3.5%.
Crown Notes II
Crown is raising at least $600m through the issue of Crown Subordinated Notes II. The monies will be used for general corporate purposes, including financing Crown Sydney, Crown Towers Perth and other anticipated growth projects.
Crown is currently part way through a $2.8bn capital expenditure program for Crown Melbourne and Crown Perth. Crown also plans to develop Crown Sydney (an iconic six star hotel resort), a casino resort in Las Vegas and a five star hotel and apartment complex adjacent to Crown Melbourne. It has also lodged a proposal for a site at Queen’s Wharf in Brisbane.
Importantly, these Notes will be classified as ‘equity credit’ by the Ratings Agencies until July 2021, and possibly thereafter. This means that the Ratings Agencies will treat them as 50% equity and 50% debt when assessing Crown’s credit worthiness. The features that allow them to be counted as part capital include subordination, optional interest deferral, mandatory interest deferral (see below) and a very long maturity date (2075).
Notwithstanding the long maturity date, Crown can at its option redeem the Notes from July 21, and at every interest date thereafter. Given that this is the date that the classification as ‘equity credit’ may also be wound back, the market will initially price the Notes on the expectation that they will be redeemed in 2021.
The Notes will pay interest at a margin of 4.0% over the 90 day bank bill. Each quarter, the fixed margin will be applied to the then current 90 day bank bill rate to determine the interest rate for the next quarter.
For the first quarter, using the current 90 day bank bill rate of 2.27%, noteholders will be paid interest at a rate of 6.27% pa.
Details of the issue are as follows:
Mandatory Deferral of Interest
An important feature is that Crown must mandatorily defer the payment of interest if its interest cover ratio is less than 2.5 times, or its leverage ratio exceeds 5.0 times on two consecutive reporting dates.
Crown’s leverage ratio is effectively its gross debt divided by its normalised EBITDA (ie the number of years of earnings it would take to pay off its debt). To get a sense of these numbers, the following table shows Crown’s ratios on a pro-forma basis compared to the deferral levels.
While these ratios look pretty comfortable, a 51% decline in Crown’s EBITDA (over two consecutive half year periods) would trigger the leverage ratio, while the interest cover ratio would be triggered by a decline in EBITDA of 72%.
Bottom line
One of the positive features surrounding this issue is that Mr Packer’s private company and major Crown shareholder, Consolidated Press Holdings, has said that it will invest $50m in the Notes – certainly a sign of confidence.
Another positive is that Crown as an entity is considered to be investment grade by the Ratings Agencies. Under an ASIC regulation that I will never understand, Crown is prohibited from promoting its ratings to retail investors. For the record, Crown is rated Baa2 by Moodys, and BBB by each of S&P and Fitch.
Now, the ratings above refer to the overall credit worthiness of the issuer, and not this particular issue. These Notes are subordinated – the bottom of the pile when it comes to repayment upon liquidation. Further, it is not that inconceivable that Crown could see a drop in EBITDA of 51% which would trigger a mandatory deferral of interest.
Invest with your eyes “wide open”. An attractive margin and yield, however not a huge premium for the risk. Investing in these Notes makes more sense when it is within a diversified portfolio of securities.
Existing Crown ordinary shareholders and CWHNA holders can apply as security-holders. Broker firm offers may be available from CommSec, UBS, Deutsche Bank, NAB, Westpac and ANZ.
Important: 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. Consider the appropriateness of the information in regards to your circumstances.
