Friday 15 March 2013

Healthscope Notes (ASX: HLNG, HLNGA)

Details of new Healthscope Notes (HLNGA) announced 

The new Healthscope Notes (HLNGA) have been priced at 10.25% p.a. The offer has been very popular with investors allowing Healthscope to not only price the yield at the bottom of expectations but also increase the offer size substantially to $300m. Raising the offer size is annoying: more high yield debt = higher interest costs = higher risk. I find this very strange. I can (kind-of) understand switching some senior debt for lower grade debt to alleviate some banking covenants pressure, but expanding the offer from $150m to $300m doesn't pass the smell test. The extra $150m in debt will cost $15.4m p.a. in interest and the interest on the existing debt that is being switched out of is almost certainly much less than that. Healthscope already has a massive interest bill wiping out most of the EBIT so the increased offer will all but wipe out short term profitability altogether. So why do it? Healthscope must improve earnings to justify debt levels and while that is likely, it is not a certainty. Yes, the yield on offer is seductive however I fail to see a margin of safety. 
    
For my money (literally!) I am not convinced by HLNGA. 

Disclosure: sold HLNG, not applying for HLNGA

A General View on Preference/Income/Hybrid securities

Depending on the time frame, the long term return of the Australian share market is anywhere from 9-11%. This includes both capital growth and dividends, however it does not include franking credits. The taxation system favours capital gains over income, so depending on your marginal tax rate or which accounting entity you use will greatly influence long term after tax returns. For retirees with an allocated pension or what is now called an account based pension paying 0% tax there is essentially no difference between receiving income or capital gains, excluding transaction costs and reinvestment opportunities. So, for people paying minimal or no tax, does it make sense to earn a consistent 8-10% from income type securities however make no decent capital gains? My personal opinion is potentially yes*. Growth based investors may want spicier trades, such as RCU (click here for the recent post). Some investors want a combination of growth and income such as WESN (click here for the recent post).  The quality of the income security is obviously paramount. But as a generalisation and depending on your personal goals etc I think there can be a case for these types of securities, even just as a parking spot while waiting for higher performing investments. These income type investments have greatly under-performed the stock market over the last 9 months yet as a group have sailed through very stormy seas in recent years. In short they have provided equity like returns for debt type risk. 

I cover most of the listed income/hybrid type securities in Australia and there are enough quality issues to form a decent portfolio, which form one component of my families superannuation. Over the last four months of my sabbatical I have spent considerable time researching similar overseas issues and have come home empty handed. Hong Kong and Singapore have very few listed income securities. The UK and EU region do actually have quite a few on offer but none really tempting enough to take on the currency or fundamental risk. The USA has lots! They tend not to be as clean as Australian income securities such as having 'maturity dates' that aren't really maturity dates but allow the issuing company to redeem the stock. The conversion price is often linked to the ordinary share price, introducing a degree of equity price risk. As a crude generalisation, USA plain-vanilla preference shares deliver 4-5% returns while issues yielding 8% or more tend to have skeletons in the closet. Therefore, relative to historical long term stock market returns, overseas investors don't appear to have the same opportunity to earn equity like returns from income investments that Australian investors do. It is no wonder these investments are popular in Australia and there is every reason to believe this sector will see more issues. 

Kristian  

*Please note this site is not authorised to provide financial advice (the site disclaimer can be found here).

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