Friday, 19 March 2010

Bond price update - investors making a profit!

The chart below shows the bond price from its first day of trading on 25th January to its closing price yesterday. I have added a line showing the issue price of the sterling bonds (98.089) and a line showing the closing price on 1st March 2010 (the day before the "Red Knights" announced that they were looking at putting together an offer for United).  The announcement came on the same day as United announced results for the three months to 31 December 2009.

The first thing to say is that having been the worse performing "high yield" bond issue of 2010, the MU Finance plc bonds are now trading above their issue price.  Investors are now showing a profit on their original investment (the same is true for the US$ bonds but I will stick to the sterling issue for ease).  Furthermore, this turnaround is emphatically not related to a rise in bonds generally, the "spread" on United's bonds has fallen to a post issue low of 578 basis points (i.e. a yield 5.78% above gilts).  The price move is United specific. 

You can see from the chart that the bonds started trading well below the issue price.  I argued at the time (as did other less biased commentators) that the bonds had been mis-priced and that the issue price did not reflect the inherent risks of the Glazers' business model, something I stand by.  As the chart shows, by late February, the price had stabilised and as I wrote at the time, the huge fall in mid-February looked excessive.

The interesting movement in the bond price has happened in March of course.  Sky News fisrt reported the existence of the Red Knights on the evening of 1st March, after the markets had closed.  The next morning the price rose from 93.75 to 95.00 with all this move occurring prior to United publishing its quarterly results that day.

If United is sold (or if other events mean the Glazer family lose control of the club), the bonds have to be redeemed at 101% of their face value.  This makes a probability of there being an offer for United a key influence on the bond price.

There is of course no way of knowing why the price has risen so sharply in March. It is possible that all of the appreciation is due to the bond market reappraising the club as a business.  For me, there was nothing of note in the Q4 2009 results statement.  Since then the club has announced three new sponsorship deals with Telekom Malaysia, Turkish Airlines (despite one senior manager from the airline being photographed wearing a green and gold scarf at a recent home game, if you don't believe me I know someone who has a photo) and most recently South Africa's MTN.

These sponsorship deals are all "nice to haves" for the club, but I doubt they generate more than £1m each per annum in profit.  Half of this extra profit has been wiped out in higher interest costs from the $ bonds.  The club has partially hedged the February 2011 coupon payment (at a cost of course), but the August 2010 and all other future payments are currently unhedged.  The annual $ coupon payment is fixed at $35.6m.  At the time of the bond issue, sterling was trading at $1.61.  As I write it is $1.515.  This has the effect of increasing the sterling cost of the $35.6m from £22.1m (at the time of the bond issue) to £23.5m today.  All that hard work from United's commercial department and most of it is needed just to stand still as the currency falls......  On the pitch of course things have been going very well, but this has little impact on United's long-term ability to pay its debts.

So I don't see what could have radically changed the bond market's view of United's bonds since the start of the month, except of course an increasing belief that the club will be sold and that the bondholders will get their payout at 101%.  As I said above, such a supposition cannot be proved, but the bond price move should make those who see a successful bid for United as pie in the sky at least pause for thought.



Jeremy said...

Can you briefly explain what "partially hedged the August 2011 coupon payment" means?

andersred said...

Actually there's a typo in that! It should say February 2011 and I've amended the blog. Not that it changes much.

United have to pay the two coupons on the two types of bonds twice a year (in August and February).

The $ bond is $35.6m (so $17.8m in Aug and in Feb).

The £ bond is £21.9m (so £10.9m in Aug an in Feb).

These amounts are fixed in their respective currencies until 2017 when the bond has to be repaid (unless the bonds are redeemed earlier).

In the recent Q4 2009 results presentation, United said:

"$15mm of Feburary 2011 coupon hedged".

This means they have taken out a derivative to fix the $:£ rate on $15m of the $17.8m due in February 2011. This has a cost but it means that any fluctuation up or down in the $:£ rate will not change the £ value of $15m of the $17.8m due in February 2011. We do not know what rate they hedged at but it will be somewhere between $1.61 and $1.50 (the recent range).

Obviously if the pound is above whatever the rate hedged at is, they'll lose money. If it's below they'll make money!

Like I said, the next coupon (August 2010) is unhedged.

Hope that helps!


Jeremy said...

Helps a lot, thanks. It's the term "hedged" I didn't know. Now I do, cheers.