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Should you bet on Crown’s new security?

Casino operator Crown Limited has joined the rush to issue ‘hybrid’ securities with its announcement of a new $400 million issue with a ‘headline grabbing’ interest rate. But how will this security – a mesh of fixed-interest and shares – stack up to other hybrids in this expanding space, and should your super fund buy it?

Background

Crown is an ASX top 50 company with a market capitalisation of $6.2 billion. Its principle interests are the Crown Entertainment Complex in Melbourne and the Burswood Casino in Perth. It also owns a casino in London and has an approximate one-third share of Melco Crown, the owner and operator of casino resorts in Macau. Crown recently acquired 10% of its listed rival, Echo Entertainment Group.

Crown says it intends to use the proceeds from the sale for ‘general corporate purposes’ and ‘ongoing capital management’.

The details

Hybrid securities differ depending on the issuer, but they generally offer investors the opportunity to buy a security that pays interest for a set period of time, after which investors may have the option to either convert the security to an ordinary share or sell the security back to the issuer.

The Crown Notes will pay interest quarterly on a floating rate basis at a ‘headline grabbing’ rate of five percentage points above the 90-day bank bill rate. With the 90-day bank bill at around 3.6%, this implies an interest rate of 8.6% per annum for the first quarter.

Crown is currently rated BBB by Standard and Poor’s, and Baa2 by Moody’s. These ratings are one notch above the minimum investment grade rating. The new Notes are yet to be rated, but Crown expects that up until the first call date in six years’ time (which is the earliest date the company may choose to redeem, or buy back, the securities) they will be classified as ‘intermediate equity’ by the ratings agencies. This means they will qualify as 50% equity when used by the rating agencies to assess the strength of Crown’s balance sheet, and for investors, it means features such as a very long term (like 60 years!) and the right for Crown to defer the payment of interest.

The notes are subordinated and unsecured and rank behind all senior obligations and unsecured creditors, but ahead of Crown’s ordinary shareholders. Put simply, they carry a higher risk than straight fixed-interest investments, but are lower risk than ordinary shares.

Interest payments can be deferred at the director’s option, however interest deferrals are cumulative and compounding and a dividend ‘stopper’ applies to the payment of dividends on Crown ordinary shares.

Interest payments must also be mandatorily deferred if Crown’s leverage ratio (defined as gross debt divided by earnings before interest, tax, depreciation and amortisation (EBITDA)) exceeds 5.0 on two different testing dates, or Crown’s interest cover ratio falls below 2.5. Neither look like being breached at this point. At the end of June, Crown’s leverage ratio was 2.1 and the interest times cover ratio was 7.2.

What are the chances of these ratios breaching their levels? Crown estimates that gross debt could increase by around 40% from around $1.5 billion to $2.1 billion and normalised earnings could fall by around 60% before the leverage ratio cap is exceeded. The interest cover ratio can withstand more material changes.

Details of the issue are as follows:

[1]The institutional book build on Friday will set the final margin, which is expected to be 5.0%.

Our View

On a pricing basis, a margin of 5% looks pretty attractive. Caltex, which is rated one notch higher at BBB+, priced its recent issue at a margin of 4.5% and this was comfortably swallowed by the market.

But take note of the finer details. The call date on the Crown Notes is six years – one year later than most other issues. They ‘nominally’ mature in 60 years, and the step up date (when the margin would increase by a further 1%) is 26 years away!

The product disclosure statement (PDS) notes that Moody’s and/or Fitch might continue to give these Notes some form of ‘intermediate equity’ weighting past the first call date, although Standard & Poor’s has indicated that it won’t.

Couple this with a company that has some fairly ambitious growth plans, and the bottom line is that an assumption that the Notes will be redeemed after six years is no foregone conclusion – there is an extra longevity risk with these Notes.

The positive news for yield hungry investors is that James Packer’s private company, Consolidated Press Holdings, has stated that it intends to subscribe for $100 million of the Notes. So, if that is taken as a comfort factor, this investment probably makes sense within a diversified portfolio of hybrid securities.

At the indicated $400 million issue size, secondary market liquidity on the ASX is not going to be as strong as some other issues – so this Note is ‘nibble’ territory rather than one to load up on.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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