Associated with the deal, Hydro One also announced a $1.4 billion bought deal offering of convertible debentures, which will be initially represented by instalment receipts until the acquisition closes, which isn't expected until the middle of 2018. I haven't had a lot of time to research and analyze the issue, but here are some quick thoughts:
- $1.4 billion, in sheer dollar terms, is massive for a convertible debenture offering in the Canadian market.
- This is a bit of a complex structure and unconventional for a convertible debenture, so interested investors will want to read the press release carefully and speak with their investment advisors before subscribing.
- The convertible debentures are being sold on an instalment basis at a price of $1,000 per debenture, of which $333 is payable on the closing of the offering (which is expected August 9) and the remaining $667 is payable on a date (sometime in mid-2018) following the satisfaction of all conditions precedent to the closing of Hydro One's acquisition of Avista.
- The instalment receipts bear an annual interest rate (paid quarterly) of 4.00% per $1,000 principal amount until the closing date of the acquisition (again, which is expected in mid-2018). However, because only $333 of a $1,000 investment in the instalment receipts is payable upfront (on August 9), an investor is in effect getting $40 worth of interest on an initial $333 outlay, which translates to approximately a 12% effective annual yield.
- After the acquisition closes (in mid-2018), the interest rate on the convertible debentures drops to 0%, sweet nothing.
- The convertible debentures are convertible into common shares of Hydro One at any time after the acquisition closes in mid-2018 until the maturity date. The conversion price is $21.40 per common share. Note that Hydro One closed yesterday (July 19) at $22.53, so this issue is technically already in-the-money.
- The debentures mature on September 30, 2027, so nominally, this is a 10-year convertible debenture. A 10-year convertible debenture is rare in the Canadian convertible debenture market.
- However, I say the convertible debentures are nominally 10-years because as long as Hydro One shares don't completely tank and stay above (or near) the conversion price of $21.40, most (or substantially all) of the convertible debentures will be converted far before the issue is scheduled to mature. With a 0% interest rate after the acquisition closes, there would be little incentive to hold on to the convertible debentures long-term in the (probable) scenario of Hydro One share price not completely crashing.
- For an investor, I view this offering of convertible debentures essentially more like owning an in-the-money call option on Hydro One shares over the next 10 years. But instead of "paying" for the option, Hydro One effectively pays the investor 12% on the invested portion upfront (recall, 4% interest on a $1,000 debenture, but only $333 is payable upfront on August 9) for the option. I know it's not a perfect analogy, but this is just my simplified way of viewing things.
- For Hydro One, this is effectively a deferred equity issuance, disguised as a convertible debenture.
- Hydro One gets a foothold growth platform into the US.
- According to Hydro One, the deal looks to be accretive to earnings in the mid-single digits (percentage-wise) from year one.
- The terms of the offering, though complex, seem attractive as long as you are comfortable with the business and prospects of Hydro One.
- As a utility, Hydro One will be negatively affected by rising interest rates.
- The Ontario government will still own over 40% of Hydro One after the Avista deal closes; some investors consider the Ontario government's ownership block a negative, as political interference may be a perceived or real risk.
- Hydro One isn't cheap, and by my count, is trading at a trailing P/E ratio of about 19.7x.
As always, remember this blog is for information only. Please remember to consult a professional investment advisor before making any investment decisions.
Picture of the Day
Chasing waterfalls. Skógafoss, Iceland. Copyright © 2006 Felix Choo / dingobear photography.
This issue looks identical to ones that ema and fts have done in the past couple of years. Both of those were very profitable investments. I received a 75% fill of my order via RBC direct investing.
ReplyDeleteHi Peter, thanks for your comment. When I saw the press release for Hydro One's offering, I vaguely recalled a utility or two (but couldn't remember which ones) that had done similar offerings. Thanks for reminding me. I was less lucky ... I received zero fill on my order, too slow on the draw I guess. Opportunity missed. But I do hope you do very well on your allotment. Happy investing!
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