Tuesday, 2 February 2010

“The very fact it was twice oversubscribed demonstrates the strength of the offer.” D. Gill

[Edit: I write all this and then notice the Financial Times have written the same story....  Snap!]

So said David Gill about the now completed bond issue in his 5Live interview on Sunday.  Now “twice oversubscribed” (i.e. they had demand for an issue twice the size of the £500m they were trying to raise) sounds very reassuring.  Sadly such pronouncements are totally unverifiable.  The “chat” in the market for what it’s worth is that such is the deluge of “junk" or more politely "high yield" bond issues at the moment that most mainstream institutional investors gave United’s a miss and put their money into more “mainstream” issues.  Most comments I’ve heard (including, if you want corroboration, in the FT) suggested that the bonds had largely been sold to what are called “retail” investors, rich individuals who liked the idea of buying a Manchester United bond because of its association with our club.

But in any case that’s not the key issue here, the key issue is Gill assertion that the market demand meant the offer was “strong”.

The market thinks nothing of the kind.

The market thinks the offer was weak and that the price it was sold at does not adequately reflect the risks the Glazers have loaded on the club.  This can be seen in the “yield” the bonds have moved to since they started trading.  The yield on a bond is a reflection of what the bond market views the risk of the company issuing it to be (the higher the yield the higher the perceived risk).  [For more explanation of what a yield is, please see the section at the end of this post].

The United bonds (we’ll just look at the £ bonds but the numbers are virtually the same for the $ bonds) were sold at a yield of 9.125%.  This compared to UK gilts redeeming in the same year as the bonds (2017) that yielded 3.435%, a difference (or “spread”) of 5.69%.

The spread is a reflection of the financial risk of United as a business.  It’s the job of the bank syndicate that runs the bond offering to balance trying to get the lowest yield possible for issuer (i.e. the cheapest debt) with the need for the yield to not be out of kilter with where it will trade in the market, or else investors will make an instant loss (if the yield is too high) or profit at the expense of the company’s interest bill (if the yield is too low).

Since the bond issue was completed on Friday 22nd January, the price of the bonds has fallen in the open market from an issue price of £98.089 to a closing price today of around £93.50.  This has pushed up the yield to about 10.3%.  All the information on the bond is in the table below (from Reuters).

So what’s going on here?  Why has the price fallen (and hence the yield risen) so sharply? Well it could be that general interest rates have gone up.  But actually gilt yields have barely moved since the bonds were issued and the spread has risen from 5.69% to 6.805%.  That is a very substantial move for a corporate bond in only seven days trading.  The FT wondered whether it was the “worse debut by a high yield bond this year?”  I don’t have a full database, but from what I can see it is.

So on the back of ill-informed buying from private investors, United got their bond away at far too low a yield.  When the market got hold of it, it moved it very fast to a price that reflects the true risks.  A spread of over 10% is very high in today’s market (the typical “high yield” or “junk” bond yields just over 6% (using the Merrill Lynch Global High Yield Index as a benchmark).

Does any of this really matter?  Well in once sense no, the bond has been issued and the Glazers have their £504m to help repay the old bank debt and start phase 2 of their plan, to extract cash to pay their PIKs.

But in one sense it’s important.  Markets are not always right, so feel free to disregard what they say, but right now the bond market is telling us it doesn’t care what David Gill says, United is a very financially risky company.


Some boring technical stuff on bond yields

Bond prices relate to their yield (effectively the interest rate they pay).  Bonds like United’s pay a fixed “coupon” (twice a year in United’s case).   A bond yield at a given bond price is a combination of the return from receiving the coupon and the return from the price you buy the bond at compared to the price it at which it gets repaid.  There’s a bit of maths involved but basically a bond priced at £98, paying a £5 coupon that is redeemable at a £100 in one year will give you a return of £7 (£5 coupon + £2 as you make a profit when the bond is redeemed) or a yield of 7.14%.  An identical bond with two years before it was redeemed would have a yield of 6.09%.

As a bond’s yield rises, the bond’s prices fall and vice versa.  In effect the price is driven by the yield the market sets.  You can split the yield on a bond issued by a company into two elements; the underlying level of interest rates, often called the "risk free rate", and the additional yield that relates to the company itself (and the rights the bond has to the company’s cash and assets).  The risk free rate is usually considered to be the yield on government bonds (so for United’s sterling bonds the rate on UK government gilts and on the dollar bonds the rate on US Treasury bonds).