As part of my families superannuation (retirement) fund, we own some notes called HLNG. They are issued by private hospital and pathology operator Healthscope. The notes were issued when Healthscope was taken over by private equity, and I bought in shortly after. The investment has been profitable. The idea of buying this type of stock and others such as AFIG (click here for the article) is to provide our portfolio with some low risk, high income generating ideas as a balance to more volatile trade ideas. I won't go into Healthscope in detail, and as a summary these are the key points:
- Private hospital and overseas (ex Australia) pathology divisions = good
- Australian pathology division = bad
- Private equity owns Healthscope = lots of leverage
Lots of leverage isn't so bad when a business has very stable cashflows, which Healthscope mostly has. However Australian pathology has been deregulated with a resulting downward pressure on profitability. I've been monitoring this situation for years now, however the most recent results and issuance of more of these notes has me concerned.
First, let's look at the half year results to December 31: Revenue $1.114bn, EBIT $109.3m, Interest Costs $92.3m and NPAT ($109.1m). Pretty much all of the pre interest and tax (EBIT) profit is swallowed up by interest payments. Profitability is being dragged down by Australian pathology, however it only accounts for a small portion of profits and the dominant business - private hospitals - are growing very nicely thank you very much (and probably will continue to do so). Large impairment costs have been responsible for the large after tax loss for the half.
Okay, so let's look at the notes themselves and the new offer. HLNG are hybrids: they rank below senior debt but rank ahead of equity holders. They pay a fixed rate of 11.25%, mature for $100 (or maybe a little bit better if Healthscope is re-floated) on 17 June 2016. The current price is $105.50. The overall yield to maturity is 9.2% p.a. That's the most we will make and if business turns sour, we could lose money. I don't think that is likely; but it could happen. What has me worried though is Healthscope is 'voluntarily' offering new notes that will rank equally with HLNG as a way of paying down senior debt. Does it really make sense that you would swap debt with a lower interest cost for a higher interest cost? I'm not convinced. The new notes will mature 25 March 2018 and will pay between 10.25% to 10.75% depending on a bookbuild. At the very least, it makes sense to sell out of HLNG at current prices and buy into the new notes at the face value of $100, or even a bit above if you don't/can't buy them through the IPO: the choice is hold HLNG and earn a yield of 9.2% or buy the new notes and potentially hold for a few more years and earn at least 10.25%.
I'm not decided on buying the new notes, however in the meantime I am selling HLNG.
Kristian
Disclosure: currently own HLNG (in the process of selling).
you are a moron - it does not make sense to sell off HLNG as long as you bought them at face value ($100) or close
ReplyDeletealso selling will realize capital gains and the new notes have a longer run til maturity
one point in favour of the new notes is the size of the issue seems relatively small
disclosure: own HLNG; considering the new notes
Thanks for the feedback. Perhaps I am a moron! Apart from tax issues (as you point out), it shouldn't matter what price you paid for the stock; it matters what the current price is and what the future prospects are. I've found this out the hard way: selling winners too soon and let losers run far too long. I'm getting better at that.
DeleteHowever, the new notes simply have a better IRR and if you believe in Healthscope as an investment, wouldn't you actually prefer a slightly longer term to maturity as you get to keep the investment longer and enjoy the income etc?
I am probably being too conservative in my view of the debt levels of Healthscope given the quality of the underlying business. Again another lesson I have learned is that is better to be safe than sorry even if it means missing out on some good trades. But that's just my simple opinion.
I hope this clarifies my thoughts.
hi there. i think the % figure Yield to maturity you have given is wrong. Based on $104.15 last sale, it is 9.92%
ReplyDelete11.25- (4%capital loss/3yrs to maturity)
additionally im not sure, re article date, but there was a dividend, so the yield to maturity would be higher if someone bought it prior to dividend.
i wouldn't call people moron though, theres no need to make this personal.
i agree with your view it is risky, but the underlying business private hospital looks good. we hold a fair chunk of these.
Hi,
DeleteNot to sure about the difference in YTM's. Thank you for pointing out the recent ex-date. As you would have seen, the price tends to shed roughly the amount of the distribution, hence the lower price over the last few days. There will probably be some selling as investors opt to switch into the new notes. This potentially presents an opportunity to pick-up the existing notes cheaply.
I am about to post an update on the details of the new notes pricing and some further thoughts for consideration.
Kristian