Thursday, November 6, 2014

BILT Paper perpetuals with 12.3% yield offers good investment opportunity

INTRODUCTION
Disclosure: We own this instrument in our portfolio.

BILT Paper, the subsidiary of Ballarpur Industries, India's largest manufacturer of paper, has a US$ denominated perpetual bond that offers 12.3% yield based on Bloomberg offers (coupon: 9.75%, Price: 92.5 cents. Bloomberg ticker: BILTIN 9 3/4 08/28/49 Corp, ISIN: USN08328AA95).

The discussion below summarizes the events that led to a distress in the bonds and argues that the situation is now on a mend, resulting in a potential investment opportunity for buy-and-hold investors looking for yield. 

BACKGROUND
Largest Paper Company in India and Malaysia...
Member of the Gautam Thapar led Avantha Group, Ballarpur Industries is the manufacturer of writing & printing paper in India and Malaysia, with a market share of 25% and 30% respectively. BILT Paper BV is the subsidiary of Ballarpur Industries that owns the pulp and paper manufacturing and forestry assets (where as rest of the more 'consumer' businesses such as specialty paper, branded stationery and hygiene business are owned directly by Ballarpur Industries). The group is the only vertically integrated manufacturer in India, controlling the entire chain from plantations to pulp to paper. It also has captive power plants at all its locations.

Ballarpur Industries is listed in India (TIcker: BILT IN) and BILT Paper also intends to get listed in an overseas stock exchange (likely Singapore).

...with ambitious expansion plans...
Malaysian operations were acquired in 2007. Following the financial crisis, BILT Paper went on a massive expansion spree. It increased the paper capacity from 780,000 tons to 1million tons and expanded the pulp capacity from 462,00 tons to 752,000 tons. The expansion aimed to increase vertical integration and reduce costs.

...but poor execution...
However, the execution was bad. The expansions were delayed, there were cost overruns, Indian rupee tanked and the cost (and value) of its US$ debt sky-rocketed. Its balance sheet took further toll when it bought two captive power plant units from Avantha Power for US$103mm. With economic slowdown India in 2013, paper prices also suffered, affecting the profitability. Plans to list BILT Paper were indefinitely postponed.

...resulting in stretched balance sheet...
Though BILT Paper is not listed, it has published its annual report for 2013 (presumably because it is preparing for an IPO). The following analysis is based on its June 2013 Annual Report. (FY14 annual report is not available yet. My guess is that FY14 balance sheet is slightly worse)

BILT Paper had FY13 revenues of US$722mm and EBITDA of US$98mm. Interest payment, including the distribution on perpetuals, was US$68mm. That results in interest coverage of 1.44.

Unlike the company's auditors, I do not see perpetuals as an equity (it requires servicing and though coupon deferrals are possible, it is construed almost like an event of default). Assuming that perpetuals is a debt, the company has total equity (Book Value) of US$509mm and net debt of US$870mm. That translates to a gearing (net debt to equity) of 1.7x and Debt to EBITDA of 8.7x. These are highly stretched debt levels - Debt to EBITDA of 3-4x are considered more 'normal.'

...and rumors of a likely default
In 2H 2013, when the rumors were rife that BILT Paper is going to default on the coupon payments, the bonds hit a low of 60cents to a dollar. Later, the rating agency Fitch downgraded the perpetuals to B+.   

INVESTMENT RATIONALE
Though the bonds have since recovered and now at 92.5 cents, are well above their distressed levels, but we believe they still offer an attractive risk-reward. 

1. Capex has peaked: Between 2010 to 2013, BILT Paper embarked upon a massive capex of over US$400mm. With the pulp mill in Sabah commissioned in FY13 and in India earlier this year, the last leg of capex is finally over, and the the Chairman Mr. Thapar declared so in his address to shareholders in FY13 annual report. Going forward, I expect only the maintenance capex of about US$20-30mm per year. BILT Paper should generate positive cashflow, which should go towards reducing the debt and improving the balance sheet.

2. Profitability to improve going forward: With the new pulp mills stabilized and operating optimally, BILT Paper would be totally self-reliant on pulp. Vertical integration should reduce pulp costs and improve the profitability going forward, which will be further enhanced as its plantation in Sabah is also expanded.

3. Investment by IFC improves the balance sheet and credit profile: Last month, IFC announced plans to invest US$100million in equity and provide up to US$150mm in loans to BILT Paper. The equity investment has already come through giving IFC a 14.3% stake, according to the announcement on 4th November (IFC's investment puts the equity value of BILT Paper  at US$600mm). BILT's press release earlier mentioned that IFC loan would be used to refinance some of the highest cost debt. The effect is to increase the equity, reduce the debt and gearing and the finance costs. Having IFC as an equity and debt investor in the company provides comfort for other investors. This could improve chances of BILT Paper's successful IPO and also open up other sources of funds.

4. Yield pick-up if the bonds are called: There is a likelihood that the perpetuals will be called at the next call date. Perpetuals come with a step-up clause in the coupons. At the next call date in 2016, the coupon steps up to 5yr US Treasury note + 8.57%. For instance, the current yield on 5yr US Treasury note of 1.63% would put the new coupon at 10.3% (and will fluctuate according to yield on Treasury note at each coupon date). Between now and 2016, the Treasury yield is likely to only increase, resulting in even higher coupons and creating even more incentive for the company to call the bonds. If the bonds are called, the yield to next call works out to 14.75%

If they are not called in 2016, the next call date after 2016 is in 2021, when the coupon steps up by another 1%.

RISKS
1. Interest rates: Almost all of BILT Paper's debt is floating. Inability to quickly deleverage before the rates start rising could stress the cashflow .

2. Macro slowdown: Paper prices are highly susceptible to economic slowdown, as witnessed in India last year. Declining paper prices could put pressure on profitability.

3. Corporate Governance: Decision to acquire captive power plant from Avantha Group when BILT Paper's balance sheet was already stretched, was untimely and creates corporate governance red flags in my opinion. Similar transactions in future may create unexpected capex outlay and jeopardize the balance sheet.

CONCLUSION
We own BILT Paper perpetuals in our portfolio. With improving macro conditions in India, increased access to funding by the company and a lack of capex, I believe that with 12.3% yield, the bonds offer excellent investment opportunity for buy-and-hold investors seeking yield (Minimum ticket for the bonds is US$200,000 in face value).

Sunday, November 2, 2014

"It is my company:" Corporate Governance From the Perspective of an Asian Entrepreneur

Asian companies are different from their developed market counterparts: majority of them, even the very large ones (when not government owned), are controlled by a single owner-entrepreneur, or at best a family. They may have sold the shares to investors, but few of these entrepreneurs like to cede control. 

Over my 11+ year career as an equity research analyst and fund manager, I have met over thousand listed Asian companies, many of them multiple times. Armed with MBA, CFA and with hubris gathered from years of investing experience, I have nodded my head in disgust at lazy balance sheets, wasteful capital allocation, general disregard for corporate finance principles and poor corporate governance. On numerous occasions I have given unsolicited advice to CFOs, CEOs, and the big bosses, on how to run their companies, at least the financial side of it.

Today, I'm going to turn the tables, and think from their perspective, the perspective of an Asian Entrepreneur. The typical profile I have in mind is not the savvy founder high-tech internet enterprises listed in the US; that forms just a very small universe. Typical profile is a first generation entrepreneur, often without a college degree, zero knowledge of high finance, but a gut for business, risen typically from a trader to a manufacturer, a self-made man.

So here it goes, in his own words.

It was my company
I used the entire savings that I had, borrowed money from relatives to start my business. Initial years were tough. Banks denied me loans. I used my house as a security for the loan, and when that was not enough, my wife's jewelery. As the business grew, profits came in, but I didn't see much of that. I ploughed nearly everything I earned back into the business. Banks were less reluctant to lend money now, but I still had to beg and they still charged very high rates.

Then, two sleek guys in smart black suit, cuff-linked shirts and glimmering ties paid me a visit. With their shining faces, intent look in their eyes and gelled hair, they looked like clones. They were investment bankers, they said, not bankers. Apparently there is a difference, I was about to find out.

We will raise money for you, they said.

You will give me money? I asked.

No, they said. Mr. Market will give you.

How much will it cost? I asked.

Nothing, they said.

No interest? I asked.

No interest. And no repayment, imagine. This is called equity. 

I took them to dinner. They paid for it, and I knew they were different from bankers. Over drinks they told me, they will help me sell a part of my business.

But it is my company, I said.

It will still remain your company. The other guys -- so called investors -- will just get a piece of paper. They'll get tired of it in one, three, or at most six months. Then they'll trade that piece of paper among themselves. Some of them may request to meet you periodically, but you can always hire someone to do it for you.

It is still my company 
So I did what the investment bankers said. We were just making cheap batteries, but a bunch of their nerds wrote up some crap about how we were the next e-vehicle play (whatever that means), and these investors couldn't have enough of my paper. I got more money than I needed.

And I enjoy meeting my investors, mostly young kids in suit and tie full of themselves. I humor them, pretend that I listen to them, take them to a tour of my plant. When they ask all sorts of bookish financial questions, I turn to the guy I hired and gave him the fancy title of CFO.

They're worried about corporate governance, my CFO said once.

What corporate governance? I asked.

They want to see minority interest protection -- audit committee, compensation committee, more independent directors, things like that.

That only opened up more job opportunities for my relatives, friends and people I wanted to oblige. One independent director is a government official I needed on my side, another is my brother-in-law. The audit committee head is my brother; he just uses a different surname.

When I want to take some money out, my accountant shows me the way. One year I used M&A, another year I over-invoiced capex. Every year I give myself and my cronies stock options.

For now, I'm enjoying this game. If I get tired, I'll just have to show some bad numbers, poor corporate governance, and privatize the whole thing at throwaway prices.

They think they own a part of my company; of course they're dreaming. I let them, and go back and do what I want. It is, after all, still my company.    

 

Monday, June 23, 2014

Should you still be invested in bonds?

Now that the interest rates are going up globally, should you continue to invest in bonds? The answer depends not only on what bond yields you are getting and where you live, but also on whether you own your property or not. How? Read on...

 

Beating inflation

The point of investing is to make your money to work for you. At a bare minimum, you want to ensure that the value of your capital does not erode over time. I hope to achieve that for my savings by investing primarily in stocks. However, I also have a smallish bond portfolio.

By above logic, I should be buying bonds only if I believe that the returns on my bond portfolio will beat inflation. Since I live in Hong Kong, I will elaborate using Hong Kong as an example.

Since 1981 (earliest the data is publicly available), inflation in Hong Kong has averaged 4.6% (year-on-year basis, monthly data). So I should be happy if the current yield on my bond portfolio is well above this average. (in US$. There's an underlying assumption that HK$ will maintain its peg to US$, at least for the near future).

Okay. Simple enough? Hardly. There are obvious holes in the thesis.

Illusion of averages

4.6% average does not guarantee that the inflation in the near future will not exceed the returns I am getting from my bonds. Hong Kong has a history of very volatile inflation rates, reaching a high of +16% in October'81 and a low of -6.1% in  August'99. It stayed above 4.6% for prolonged periods from 1981 to 1984, and then again in the pre-handover euphoric years of 1988 to 1996, falling below 4.6% only after the Asian crisis, as the chart below shows.

 

Monday, June 9, 2014

A Little bit of 'Samatva'




“Samatva”
-Balance, sameness, an evenness of mind, equipoise

I first came across this word at the weekly Gita classes at the Chinmaya Mission in Hong Kong. In verse 48, Chapter 2 of Gita, Krishna urges Arjun to perform actions while remaining ‘balanced.’ Actually, Sri Krishna was asking for a lot more – he wanted Arjun to ‘perform actions abandoning attachment, remaining the same to success and failure alike.’ But then Arjun was a much more ‘evolved’ disciple. For me, ‘balance’ is a good start. 

Control over time
Today marks the first anniversary of my being officially unemployed. When pressed for a reason in my exit interview, I mumbled something about wanting to leave at a high point, but mostly, I wanted to take control of my time, as this post explains.

So, what have I been up to since then? Mostly, I traveled a lot. Of the last 365 days, I was on vacation for 94 days. Besides traveling I read a lot (no, not about finance or investments or self-improvement, but mostly fiction), and attempted to write a book (and still attempting to sell it). I also set up my own fund, “Samatva Opportunities Fund.”

Blog
And finally, this blog. 

I have been thinking about blogging for at least last six months, and I would still not have put my words on paper, were it not for this excellent blog article that I came across a few days ago, A guide to young people: What to do with your life. A must read for parents of teenage children, but sensible advice for just about anybody. For one, spurred me to stop procrastinating  -- my wife wouldn't agree to such a sweeping statement -- but at least, I've made a start.

What do I intend to write about? Just about anything I wish to chew on. Everyday finance. Things that I’m figuring out. Notable posts I find on the blogosphere, and some other things I don’t know yet. How often? I don’t know. Whenever inspiration strikes.

See you soon. Until then…...stay ‘Samatva!’