Standard covenants or double standards

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

Millicom and Atlas – the takeover

Many investors were busy with the events of last week, navigating the equity market volatility, which in the end really didn’t provide too much opportunity in credit markets. On one level this was disappointing – as stock pickers, volatility can be our friend. On another level, it was further evidence of the resilience of the high yield market. The Liontrust GF High Yield Bond Fund is well positioned and waiting for a larger sell-off (widening of credit spreads) before adding to exposure and executing on valuation opportunities. 

With a more focused high yield lens, our attention last week was brought to a company in our portfolio that was in the headlines for a potential takeover, and which presented a situation where bondholders were left scratching their heads.  

Millicom International Cellular SA (“Millicom”) is a leading provider of telecommunications services in Latin America. Atlas Investissement SASU (“Atlas”) is the largest shareholder of Millicom, with a 29% stake in the company. In recent months, Atlas has made a bid to buy out other shareholders of Millicom; its initial bid was rejected and, based on the Millicom Board’s recommendation, the subsequent bid is likely to follow suit. The Board’s position is that the bids by Atlas undervalue the company. 

If Atlas is successful with its takeover attempt, resulting in its stake exceeding 50%, then this would trigger the bonds Change of Control (“CoC”) covenant. The CoC covenant is standard for most high yield bonds, and is a key protection for bondholders from a change in ownership. If triggered, Millicom would have to make an offer to purchase all outstanding bonds at a predetermined price which is a small premium to par value. The covenant is particularly valuable if your bond’s current price is much lower than par value.  Millicom has a further covenant to be satisfied alongside the change in ownership – in order to trigger the CoC covenant, a bond rating downgrade must occur within 90 days of the change in ownership.

Amid last week’s volatility, Millicom announced that it wants bondholders’ consent to remove the CoC covenants.  If consent is given, then should a change in ownership occur coupled with a subsequent ratings downgrade, Millicom would not be forced to buy back its bonds at the covenant price. The announcement surprised bondholders, as the removal of a standard safety net for high yield investors is a big ask. 

Typically, material bond documentation amendments come with a reasonable consent fee. In this case, bondholders were offered a 2.5% premium. Some bondholders would consider this unreasonable, as it would only be paid once the company takeover has concluded, and most importantly would not compensate the bondholder for the risk that the new owner has a more aggressive financial policy. Furthermore, it also removes the upside of the bonds being potentially bought back at a premium to par value. For context, if the CoC covenant was triggered now, we would realise an upside of approximately 15%. 

On the one hand, Millicom’s Board is not willing to accept a takeover bid on the grounds that it undervalues the company, however, on the other hand, Millicom want bondholders to accept a small fee in order to remove a standard high yield covenant, which offers a great deal of protection and potentially provides a large upside. 

Putting this double standard to one side for a moment, investors are left in a tricky spot. There are various permutations, but what is on the table here represents a classic prisoner’s dilemma, an economic scenario made famous in the Hollywood movie, ‘A Beautiful Mind’. There is some likelihood that bondholders vote in a manner that is worse for both the collective and the individual.

On an academic level, it will be interesting to see if this consent solicitation will set a precedent for the importance of covenant protection in high yield bonds, and whether that importance has a price.

Sharmin Rahman, Global Fixed Income team

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KEY RISKS

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

The Funds managed by the Global Fixed Income Team: 

Consider environmental, social and governance (""ESG"") characteristics of issuers when selecting investments for the Funds. May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund. Hold Bonds. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay. May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings. May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative contracts may help us to control Fund volatility in both up and down markets by hedging against the general market. The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash.  May invest in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of the funds over the short term. May be exposed to Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails. May target an absolute return. There is no guarantee that an absolute return will be generated over the time period stated in the fund objective or any other time period. The risks detailed above are reflective of the full range of Funds managed by the Global Fixed Income Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.

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This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

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