Brian Gaynor: Pay your money ... and take the risk

The GPG Finance capital notes issue indicates that the huge demand for high-risk fixed-interest securities is undiminished.

It also shows that New Zealand investors are not afraid to buy debt securities that have no credit rating and the issuer has no commitment to repay the loan.

GPG Finance is raising $200 million through a capital note issue with the right to accept oversubscriptions up to $25 million.

GPG Finance will then lend this money to Guinness Peat Group on an unsecured basis. This money will be subordinated to all other creditors of GPG Finance and Guinness Peat Group.

JBWere, the organising broker and lead manager, says GPG Finance put the issue out for tender and it had the best offer at $6.1 million.

To secure its bid, JBWere had to obtain firm distribution commitments from other brokers, who will be paid a fee of 1.5 per cent.

This fee is not disclosed in the investment statement or prospectus. JBWere says the 1.5 per cent fee will be paid out of the $6.1 million it is receiving from GPG Finance and the requirement is to disclose fees paid directly by the issuer.

As most brokers have taken a firm commitment there is almost no independent analysis of the GPG Finance issue.

This is unfortunate because in most sophisticated financial markets, particularly the United States, these debt securities are considered to be extremely complex and most individuals will invest in them only through specialised fixed interest mutual funds.

Other features of this issue are worth noting:

* In December 2008, noteholders can choose whether to roll over their notes or convert them into GPG shares. They do not have the option of redeeming their securities for cash - this is the sole discretion of GPG Finance.

* The note issue will nearly double Guinness Peat Group's long-term debt.

* Neither GPG Finance nor Guinness Peat Group has been credit-rated by a major rating agency.

Guinness Peat Group is on a sound financial footing but leveraged investment companies usually become riskier as they get bigger.

New Zealand investors should be well aware of this as there have been more than 40 listed investment companies in the past 20 years and most have gone under or have destroyed substantial shareholder wealth.

Only one, Brierley Investments, had a successful run for 10 years or more.

The interest rate GPG Finance is offering - the greater of 8.6 per cent or a margin of 2.9 per cent above the Government bond rate - is not commensurate with the risk.

It is highly unlikely that Standard & Poor's would rate GPG Finance any more than BB.

On the basis of a BB rating, and interest rate spreads in the United States, GPG Finance should be offering about 5.5 percentage points above five-year NZ Government Stock rates. This suggests that the notes should have an interest rate in the vicinity of 11 per cent rather than 8.6 per cent.

New Zealand investors are far too willing to accept relatively low interest rates on subordinated, unsecured and unrated fixed-interests securities where the issuer has no requirement to pay back the loan.

As Guinness Peat Group has no apparent need for the money, its issue gives the impression that the group is coming to the market before New Zealand investors wake up and start demanding interest rates commensurate with risk.

Tranz Rail

Who is buying Tranz Rail shares? Since July 4, more than 26 million shares have been traded through the market at or above Toll Holdings' offer price of 95c a share. This is more than 12.4 per cent of the group's share capital.

These figures indicate how difficult it will be for Toll to achieve its 90 per cent acceptance condition, as anyone who has bought shares for 95c or above in recent weeks will not be a willing seller at this level.

The current share price also indicates that the majority of shareholders don't believe Toll's 95c offer will be successful, because if they did they would be heavy sellers at 96c and above.

Capital Properties

Capital Properties' one for three rights issue at 75 cents has given another big boost to underwriter Forsyth Barr and its sub-underwriters.

They received an underwriting fee of 1 per cent and the issue had a shortfall of 5,574,321 shares, 9.5 per cent of the shares on offer.

Assuming 14 cents a share profit will be achieved on the shortfall, the underwriter and sub-underwriters will make about $1.2 million from the underwriting agreement.

Last year Capital Properties had a one-for-three rights issue at 72c, and Forsyth Barr was also the lead underwriter.

That issue had a shortfall of 5,503,127 - 12.7 per cent of the shares on offer - and based on a similar 14 cents a share profit on the shortfall, the underwriter and sub-underwriters should have made approximately $1.08 million.

In total these parties made about $2.3 million from the two deeply discounted rights issues.

Brook Asset Management, one of the sub-underwriters, has written two strongly worded letters to Capital Properties chairman Colin Beyer. They contain a number of criticisms, including:

* The capital raisings are dilutionary and will have a negative impact on earnings per share and dividends per share.

* The board has replaced cheap debt with very expensive equity as the gross dividend yield on the new shares is more than 12 per cent.

* The company has not indicated how it is going to use the money except to say it will replace debt.

* The underwriting fees, including the capital profit on the shortfall, are excessive for deeply discounted issues.

Brook Asset Management concludes with the comment that shareholders are interested in net asset backing per share, not the total gross value of the company, and it does not expect Capital Properties to announce any property acquisitions or developments unless these investments yield more than 13 per cent. This is the approximate cost of raising the new equity, including Forsyth Barr's underwriting fees.

All four Capital Properties directors took up their full entitlement in the latest issue, but shareholders still have little idea what they are going to do with the money.

Tower

Tower's four-for-three rights issue at 90c closed yesterday and looks as if it will be substantially undersubscribed. Rights trading closed on Friday after 23.96 million rights or 10.2 per cent of the issue entitlements were traded.

This is a relatively low figure considering that about 40 per cent of the shares are held by shareholders with 5000 or fewer shares and many of these will not take up their entitlement.

Capital Properties had shortfalls of 12.7 per cent last year and 9.5 per cent this year, yet only 10 per cent of its shareholders held 5000 or fewer shares.

On the basis of Tower's shareholding structure and rights trading, it is reasonable to assume that there will be a shortfall of at least 20 per cent, representing 11.4 per cent of the group's total capital. The shortfall could be as high as 30 per cent or 17.1 per cent of total capital.

A large shortfall will benefit Guinness Peat Group as it already owns 11.65 per cent of Tower, is the underwriter to the issue and will be able to able to pick up a large number of new shares, depending on its sub-underwriting arrangements, at 90 cents. These shares are now trading at $1.39.

Tony Gibbs must have a big smile on his face today.

* Disclosure of interest: Brian Gaynor is a Guinness Peat Group and Tranz Rail shareholder.

* Email Brian Gaynor