How privatisation affects bondholders

THE recent streak of public companies going private continues this year with BreadTalk Group and Perennial Real Estate Holdings (PREH) the latest to announce plans to privatise the companies, with major shareholders buying out shares from minority shareholders.

The likelihood of privatisation is not remote for Singdollar bondholders, who have seen many bond issuers privatised in recent times such as Neptune Orient Lines (NOL), Global Logistics Properties (GLP) and CWT. Whenever a listed firm is privatised, shareholders usually rejoice, since they might be able to reap the rewards of higher offer or exit prices. However, can the same be said for bondholders?

Bondholders of privatised companies are often worse off

From our experience, the answer is usually no. One reason is that more often than not, bondholders will lose access to timely updates on performance (eg semi-annual financial reports) or significant changes to the company (eg major acquisitions/disposals), which are not required for private companies to disclose.

Comparatively, listed companies must disclose material information, especially in annual reports. Such disclosure is useful for current and potential investors in assessing the credit profile of the issuer. Without quality disclosure, liquidity in the bonds may also decline.

Privatised companies are also not subject to public shareholder scrutiny. The firm's ability to have a much freer hand to make changes can be detrimental to bondholders. For example, privatised companies can take on significantly more debt, dispose of core assets and even withdraw significant cash from the company.

One example is CWT, which after privatisation in December 2017 saw its warehouses and metals and logistics businesses put up for sale by its indebted shareholder HNA Group Co (HNA). Another example is GLP, which saw its gearing increase substantially following privatisation. These actions have not turned out well for bondholders as they weaken the credit metrics of the company.

Also, changes to controlling shareholders can be detrimental if the new shareholder is weaker than the previous one. For example, GLP's USD bonds maturing in 2025 dropped about 11 points from November 2016 to January 2017 (bond price of 103 to 92) when news broke about its potential sale. GLP was previously around 37 per cent owned by GIC Pte Ltd, which is viewed as a comparatively strong shareholder.

Another example is NOL, which saw its SGD bonds fall more than 30 per cent in value when Temasek Holdings was looking to sell its 67 per cent stake to CMA CGM SA. We note that bond investors tend to attach a premium to companies held by Temasek, and Temasek-linked companies are prolific issuers in the Singdollar bond market.

Making an educated guess on which issuers might go private

Given the potential downsides, we think it will be useful for bondholders to think about the risks when an issuer is privatised. We observe several common reasons that may lead to privatisation.

There is almost always an upside to the acquirer in a privatisation move. Upsides can be immediate, such as when the target is trading below book. For example, PREH's offer price puts the price-to-book (P/B) ratio at 0.6x while United Engineers Ltd (2019) and Keppel Land Ltd (2015) were taken private below 0.9x P/B. Similarly, the offer to privatise Wheelock & Co came when the stock price was trading well below 0.5x P/B. That said, a low book value is not the only measure of value.

While Croesus Retail Trust (2017) was taken private at 1.23x P/B, the offer price looked somewhat cheap in comparison to Reits listed in Japan, which were trading at higher P/B ratios and lower yields while cap rates had been on a compression trend in Japan.

Another example is CapitaMalls Asia Ltd, which was privatised as there was significant earnings accretion despite the offer price above 1.2x P/B. In general, we think it is tempting for privatisations to take place if the stock market assigns too low a valuation to the company (whether on an absolute level or relative to peers).

Value to the acquirer also comes about from synergies that may materialise. For example, China Vanke Co Ltd was one of the consortium members which bought out GLP as there were strategic fits in the logistics property sector. CMA CGM bought out NOL seeing significant operational synergies and the chance to increase its market share to 11.5 per cent from 8.8 per cent. Goodpack was privatised in 2014, with KKR's Asia Fund II seeing potential to grow the business through the private equity firm's relationships. In general, synergies exist when the acquirer can enhance the value of the acquisition, resulting in the willingness of the acquirer to offer a price higher than what the market can currently value it at.

Staying listed also entails costs including continuous disclosure and approval by shareholders, such as in the form of Annual and Extraordinary General Meetings. This can slow down the transformation of the company. One key reason for BreadTalk to go private was to give its management more flexibility to address upcoming challenges - especially useful given the impact of Covid-19 on its bakery and restaurant segments.

Keppel Corp privatised Keppel Telecommunications & Transportation Ltd, citing the flexibility to allocate resources and capital more efficiently without the corresponding compliance costs of listing.

For SMRT Corp, which faced significant operating costs (Singaporeans may remember the numerous breakdowns), the privatisation by Temasek could remove the short-term pressures by shareholders for the company to deliver profits (eg by cutting maintenance costs) and focus efforts on delivering higher rail reliability.

CITIC Envirotech was delisted, with one of the reasons being increased control and flexibility while saving on compliance costs. Eu Yan Sang International was privatised by its then-CEO (together with new investors) who wanted control over succession planning. CapitaLand privatised The Ascott to "exploit business opportunities" and to fully integrate the Reit platform. In most instances, keeping the company private has allowed changes to take place more easily.

While there have been numerous examples, it is challenging to predict with precision the next issuer to be privatised, since we are not privy to firms' management needs or future plans. That said, companies which are more vulnerable include those trading low on valuations (eg share price steeply below book).

What should I watch out for as a bondholder?

If privatisation is a possibility, bondholders should watch out for the covenants provided and also consider the strength of the existing controlling shareholder.

The direct covenants protecting bondholders include delisting put and change of control put, which allows bondholders to put back the bond to the company upon privatisation or change in controlling shareholder. Alternatively, bonds may be structured with step-ups - where bondholders are paid an initial coupon but may see increases happen - when privatisation or change of control occurs. In such cases, step-ups are typically applicable if bonds are not redeemed (ie: stays as a liability of the issuer). Effectively, the issuer is paying bondholders to compensate them for the change in control.

An example was GLPSP 5.5 per cent PERP, which was structured with a step-up of 5 per cent. This led to the issuer choosing to redeem the perpetual given the punitive increase in distribution rates.

However, if the step-up is insufficient, this may not be punitive enough for the issuer to redeem.

For example, when CMA CGM acquired NOL, it allowed NOLSP 4.4 per cent '19s to step-up by 150bps instead of exercising the change of control call. Despite investors being paid more, with the increase in distribution rates by 150bps, prices of NOLSP 4.4 per cent '19s plunged below 80 cents to the dollar in June-September 2016.

That said, some step-up is better than none; prices of NOLSP 4.65 per cent '20s, which does not feature such a step-up, plunged below 70 cents to the dollar.

If there is no direct protection in the form of delisting or change of control put or step-up, bondholders can look to indirect covenants. The list of indirect covenants is non-exhaustive but crucially, the degree of protection depends on how iron-clad they have been written. To illustrate using CWT, the privatisation by HNA resulted in the bond prices being corrected by 20 per cent. While HNA subsequently sold a substantial part of CWT's assets, it is likely that CWT's financial covenants prevented HNA from stripping away more assets from CWT; CWT had to maintain a certain net worth and restrict debt from exceeding net worth by a certain ratio. Eventually, CWT's bonds were repaid upon maturity.

Bondholders should also consider the premium attached to the controlling shareholder. In the Singapore bond market, a change in shareholder (as shown by GLP, NOL, CWT) could have significant impact. Given that a significant portion of SGD bonds are issued by Temasek-linked entities, and knowing that investors attach a significant premium to the government-linked investment firm, investors should question if such a premium is justified.

While certain sectors are currently strategic (eg Singapore Airlines was cited as such by the Singapore government), this may change over time. After all, there is no sacred cow in Temasek's portfolio, as demonstrated by the divestment of NOL.

At the end of the day, Temasek is an investment company and it is free to increase, hold or decrease its investment holdings. Temasek also announced that it does not issue financial guarantees for the debt of its portfolio companies. It is useful if bond investors pay attention to the standalone credit profiles of these companies and assess if the reward is still commensurate with the risks.

Watch out for more privatisations down the road

Recently, KKR & Co (KKR) raised US$10 billion for its third Asia buyout fund, which follows KKR's Asia Fund II. KKR is an investment firm which holds numerous private equity investments and has completed a number of leveraged buyouts. The list of privatised companies is non-exhaustive and we can expect the wave of privatisation to continue.

• Wong Hong Wei, CFA, is a credit research analyst at OCBC Global Treasury Research & Strategy.

This column has been adapted from content by OCBC Global Treasury Research & Strategy and is printed here with permission from Global Treasury Research & Strategy.