Keybridge Capital Ltd Convertible Notes (KBCPA)

Regular readers will know of my interest in different types of securities like bonds, preference, hybrids, convertibles and so forth. As noted in previous posts, I wish there were more of them. Well structured and well priced alternate securities can offer investors a cracking deal especially in circumstances where downside is structurally limited (think WESN (now longer listed) and AFIG for example) and fundamentally limited with upside potential. Unfortunately there aren't many on offer (in Australia) and none really at a decent discount in this market. 

But please don't take my word for it - just look at the doyen himself, Warren Buffett. A great example of an alternate investment he made is Goldman Sachs (GS). Back in 2008 Buffett bought US$5bn of GS 10% p.a. preferred stock which included warrants to purchase a further $5bn ordinary GS shares at at a strike price of $115 anytime up to five years from date of issue. So that gave him the right to buy 43.5m shares for $115 which based on the current price of US$212 would have been a profit of $4.2bn. Interestingly, the deal was amended in 2013 so Buffett ended up with 13m shares but didn't have to pay for them (now worth $2.8bn plus his preferred's). That's a great deal.   

Apologies, I digress - back to the story. 

One new stock that doesn't fit the bill of upside optionality, but is interesting nonetheless is KBCPA. KBC is issued by the mother-of-all magnets to the value community - Keybridge (KBC). KBC itself is a collection of all sorts of investments all over the world. Please note it is not the purpose of this post to explore KBC - that is a long story in itself. KBC has a market cap of $27.8m (17.5c). The new KBCPA were issued at $1 in June and there are 5m on issue. 

KBCPA were actually issued to existing KBCPA shareholders as an in-specie (non-cash) distribution on a 1 for 36 basis. Why? There are a number of reasons. It provides additional funding in the future - i.e. issue more KCPA to help fund a project. This is smart - the notes are unsecured and provide debt without the banks placing restrictive debt covenants. More directly, the notes appear to have been a way to return some excess capital to shareholders without actually handing over any cash! Instead of KBC's cash going down, debt goes up. The effect to net equity is the same however they retain the cash to invest. And also quite smart is the new channel it creates to pay out franking credits. The notes are 7% fully franked meaning lots of franking credits for holders. 

So on a grossed up basis, the yield is 10% p.a. which is really attractive in today's market. A 10% p.a. yield is roughly the same as the long term combination of growth and dividends from the stock market - so you can understand if investors interested is piqued (especially if you think KBC is pretty safe). Even as I write, a few have trade above the issue price. 

For me, I want upside potential. Either through favourable conversion terms such as a fixed exercise price (see the Buffett deal) or a discount to the face value (in cases where the maturity term is fixed as is the case with KBCPA). Who knows, maybe the market will get really scared for some general reason or Nick Bolton stuffs something up and they get sold off well below face value. But for the time being these conditions are not present so it's a pass for me. 

Kristian 

Disclosure: no position in the above names

Redhill Education Ltd (RDH)

RDH was recommended to me by a friend about 5 years ago. I didn't buy and haven't really followed the stock for years now, however I  was recently reminded of it when researching another education company. Anyway, I've just finished reading through the annual reports back to 2010 (when it commenced life as a listed company), along with the 2010 prospectus and the cataclysmic earnings downgrade in 2011.  

The stock has presented tremendous opportunities to both lose and make money, and I think its history is both incredibly interesting and informative. You can see what I mean from the graph below: 

Source: Yahoo Finance

RDH listed back in September 2010 for an issue price of $1. 

RDH was already an existing company of two education businesses. The $16m capital raising was to buy two more education purposes and so creating a horizontally integrated business of what looked like quite different educational units. The CEO and CFO were new to the business. Original shareholders do not sell their shares into the float and put their stock in escrow. The prospectus (August 2010) forecast pro-forma 2011 Revenue $21.4m, EBITDA $4.9m, NPAT $3.4m, 12.6c EPS and a 3c DPS. No debt. Compared to an initial market cap (non-diluted) of $27m, this all looks pretty cheap and the stock rallies to $1.24.

So far, so good. 

7 February 2011 was a shocker. RDH downgraded in a massive way. FY11 forecast EBITDA was cut down from $4.9m to $1.1m. That's massive. All sorts of reasons were given for the downgrade: 

The stock tanks from 77c to 23.5c (note it had been drifting down from $1.24 to 77c from September to February). The CEO resigns later that month. The price keeps drifting lower to 10c in June 2011 tallying a 90% loss for investors in the float. FY11 does indeed turns out to be a shocker posting a pre-tax $3m loss although operating cash-flows are only just negative. The market cap is $3.5m v book value of $15.1m. 

Fast forward to FY12. New CEO (one every year so far). Lots of restructuring. Lots of write downs to assets. Book value drops from $15m to $6.7m. The stock wallows at 9c. Operating cash-flow is actually slightly positive - most of the P&L is hit by write-downs to the balance sheet in different areas. 

So what it looks like so far is a revolving door of management, macro issues and all at the same time trying to bed down two simultaneous acquisitions. You wouldn't touch it with a barge poll, right? 

FY13. The stock has more than doubled to 21c when the preliminary full year figures are released (July 2013). The numbers are looking much better. Revenues up, EBITDA is positive and operating cash flows are an impressive $1.6m. Lots of cost-cutting, new products, re-structure and possibly a better macro environment. At a market cap of ~$6m, the stock is starting to look cheap. 

FY14. The company reports a blinder and the share price has moved up to the $1.40 range. Revenues up 19%, NPAT is finally positive, EBITDA $2.7m and $3.2m in operating cash-flows and $6m in the bank. Just think the whole company was worth $3.5m in FY12. 

And forecast FY15 has more of the same big improvements. 

Note the original prospectus numbers have still not yet been met. 

So there was potentially a 14x return there. More conservatively 5-7x if you were buying as the positive news started rolling in 2013. 

Kristian 

Disclosure - no position in the above name(s)

United Overseas Australia Ltd (UOS)

This is probably the best Australian growth stock you've never heard of. Full credit to Nigel and Max (who also works at Harness) for pointing this stock out to me. The long-term performance of this stock is truly outstanding and its future continues to look bright. I recently took a position on a long-term view, and if you are looking for a good write up on the stock, please check-out the article on the Harnesss website. 

Kristian 

Disclosure: own UOS