Delivering alpha through innovative financing structures
Necessity is the mother of invention, and this is indeed also true when it comes to capital structure engineering, which has been well illustrated by two recent examples in the US that offer compelling investment opportunities.
Sprint is a Caa1/B rated wireless operator that faced challenges earlier in the year and was subsequently unloved by investors. The company needed to undertake an operational turnaround, which it ultimately did, whilst finding a cost-effective way to access the debt capital markets to refinance near-term maturities. With yields at the unsecured level prohibitively expensive there was a need for something different. One option was to issue secured corporate debt, but that would alienate unsecured investors and is limited in scope. So, Sprint introduced a novel transaction, whereby a bankruptcy remote vehicle was created to issue new notes backed by a portion of Sprint’s wireless spectrum. The collateral represents approximately 14% of Sprint’s spectrum; valued by an independent firm at $16.4bn. This collateral backs the $7bn note programme, of which $3.5bn was issued last week. The notes were rated Baa2/BBB and priced to yield 3.4%, which is a price concession to IG-rated TMT peers. As a result, there were nearly $30bn in orders for the $3.5bn deal, primarily from IG-oriented investors.
Transocean is another HY issuer with expensive unsecured funding costs that brought an interesting transaction to the market. Transocean is single-B rated offshore energy driller, which produces deep and ultra-deep water drilling ships that are capable of sustaining crews in remote locations for extended periods of time. Their ships are considered ‘best in class’ but in a lower oil price environment, where multi-national energy companies are rationalising their capital spending budgets, Transocean has faced challenging revenue declines. Transocean was IG rated as recently as Oct 2015, but with lower oil prices, its rating has been cut to B+. This makes funding new ships and near-term debt maturities more costly. So, Transocean introduced an interesting transaction that reduced its funding cost and at the same time offered incredible value to discerning investors. Similar to Sprint, Transocean set up a bankruptcy remote vehicle to hold collateral and issued notes from this entity. In this case, the collateral is a new drilling ship that is under a 10-year operational contract with Royal Dutch Shell (double-A rated). The contract is non-cancellable in the first five years, after which Shell can cancel the contract but must pay punitive break fees. To counter-balance this break-clause, the bond amortises at 10% per year for the first seven years and pays the remaining 30% at maturity in year eight, so the outstanding debt balance is always covered by contractual cash flows. The result is that Transocean have managed to issue a BB+ rated secured bond (c.f. B+ unsecured rating), reducing their net cost of funding while giving investors the comfort of secured cash flows.
This novel way of utilising contracted cash flows represents a compelling investment opportunity, in our opinion. We have been adding the Transocean bond to our portfolios in the 7.2-7.4% context, compared to the typical 4.5% currently being offered by BB-rated US corporate bonds. The opportunity exists because many investors relate to the challenges in the US energy sector and not the specifics of this particular bond, and we suspect many investors incorrectly view this as outright Transocean risk. As we have mentioned in the past, this market has opportunities for those investors willing to search and carry out the extra due diligence. These collateralised structures are yet another example of this.
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