In our first Bonds Spotlight article, we take a look at the $200 million in convertible notes to be issued by Australian Foundation Investment Company (AFIC, ASX code AFI), announced on 14 November 2011. Given The Prince’s excellent (but sobering) assessment of Australian superannuation share performances, AFICs fixed-income offering should genetrate a lot of interest.
The Key Details
| Security type | Redeemable, unsecured convertible note |
| Coupon rate | 6.25% |
| Face value | $100.00 |
| Payment schedule | Half yearly, in arrears28 February and 31 August |
| First payment | 28 February 2012 |
| Maturity | 28 February 2017 (5 years) |
| Convertibility | Convertible to ordinary shares on any interest pay date, at the discretion of the holder (see below) |
| Funds raised | Between $100m and $300m |
| Offer opens | 23 Nov 2011 |
| Offer closes | 12 Dec 2011 |
| Listing date on ASX | 22 Dec 2011 |
| ASX code | AFIG |
| Minimum application | $5,000 (50 notes), IPO open to existing shareholders and participating brokers only |
| Brokers | RBG MorgansMacquarie Equities LtdE.L. & C Bailieu Stockbroking Ltd |
The AFIC notes are convertible to ordinary shares on any of the interest payment dates (so twice a year) at the discretion of the note holder. The number of shares will be determined by dividing the face value ($100) by the “conversion price”. The conversion price is calculated by taking the average of the daily volume weighted average prices of AFIC ordinary shares, traded during the five business days prior to the issue, plus a 25% premium.
For example, if the weighted average daily price 5 days prior to the issue was $4.00, then the number of shares each note would convert to is $100/($4 x 1.25) = 20 ordinary shares.
This gives the note holder the opportunity to take advatnage of any share price gains during the five year maturity period. This can happen either through converting the note at a discount to the trading price of AFIC shares (and hence providing a capital gain) or selling the note if it appreciates in value due to the conversion/share price arbitrage.
The Business
I covered AFIC in an equities spotlight article earlier this week. In summary, AFIC is a listed investment company that invests in ASX shares. Return on equity has averaged 7.5% over the last 10 years, whilst dividend growth has averaged a very respectable 14%. Net profit for FY11 was $233 million.
Their current asset base is approximately $4.5 billion, with 80% invested in mostly blue chip, ASX-listed shares and the rest in cash instruments. They only have $50 million in current, interest-bearing debt. This will increase by $100 to $300 million after the note issue, depending on the size of the take-up.
Are they good for it?
AFIC is an 80 year old investment company with a long-term investment philosophy and a strong dividend stream. An extra $300 million in debt (resulting in about $19 million in interest expenses) should be easily covered by existing earnings. The interest cover ratio (EBIT divided by interest expense) after the note issue will be a very healthy 15 times. In the event things do get hairy, AFIC could easily sell down some of their large asset base to fund interest payments.
The Return
Not counting any share conversion arbitrage profits, AFIC notes will provide the holder a 6.25% return on their investment. The calculated market price of the note at the IPO, based on the present value method, for a range of discount rates is shown below.
If the notes trade below $100 at any stage, then obviously the running yield (calculated as the coupon of $6.25 per annum divided by the note market price) will increase. The investment return will also increase if the AFIC share price moves above the conversion price plus 25%. I’d love to pick these notes up for less than their face value, but I won’t be holding my breath as the strength of AFIC (plus the prospect of capital gains from converison) could result in the notes trading at a premium to their face value.
Below are some comparative returns on other interest and non-interest securities (as of 22/11/11):
| Australian government bond (5 year) | 3.31% |
| Macquarie bank term deposit (5 year) | 6.25% |
| Woolworths dividend yield (inc franking credits) | 7.0% |
Summary
In summary, the AFIC convertible notes look like a nice, low-risk way to pick up a handy 6.25% on your savings. The issuing company is a listed investment company with a long history and a commitment to long-term, prudent investing. AFICs asset base and strong dividend income stream should ensure interest payments are easily met over the 5 year note timeframe.
The coupon is comparable to some 5 year term deposit rates, but it has the upside of increased liquidity from being listed on the ASX . This also provides an opportunity for capital gains if the market price increases after listing. It’s certainly more attractive than the current 5-year Australian bond yield.
In these volatile times, I think it will prove popular.
Disclosure: The author is a Director of a private investment company (Empire Investing Pty Ltd), which has currently has an interest in one of the businesses mentioned in this article. The article is not to be taken as investment advice and the views expressed are opinions only. Readers should seek advice from someone who claims to be qualified before considering allocating capital in any investment.