Institutions wary of BHP’s ‘toecutter’ bond buyback

BHP is buying back bonds when other major corporates are raising capital. Picture: Bloomberg

In the last few weeks Australian institutions became very jittery about the sharemarket and poured almost $6bn into corporate bond issues launched by nine companies.

But the total subscriptions to these nine issues was a staggering $16bn – a $10bn over subscription – leaving a huge unsatisfied demand. Paradoxically, the worlds biggest miner, BHP, stunned bond hungry institutions by going the other way – it wants to buy back BHP bonds from the institutions. Normally BHP would be laughed out of town by the US and Australian institutions holding the bonds, because the buyback price yielded, in US dollars, around 2.4 per cent – they would lust after BHP bonds at that price.

But in the original issue BHP inserted a “toecutter” clause in the trust deed and BHP may use that clause to convince unwilling institutions to unload at a time when they are buyers, not sellers. It’s true that the BHP bonds are denominated in US dollars but a lot of Australian as well as US institutions grabbed the chance five years ago to lend to BHP at 6.75 per cent. The Big Australian’s US dollar yield offering of around 2.4 per cent contrasts with property group Goodman being able to raise $400 million at 2.2 per cent, albeit in Australian dollars with total subscriptions totalling staggering $2.1 billion. Application amounts were slashed.

I will explain how BHP’s “toecutter” clause works below. But first, the Australian rush for bonds has had few precedents. Most of the bond securities are long term and rank well down the security scale. But it didn’t matter to the institutions who, irrespective of security, were simply desperate to lock in interest rates, usually in the 2 to 3 per cent range, for between five and 10 years in the belief that interest rates are not going to rise and equities are high.

The highest yielding bond was from Qantas which offered 5.39 per cent. Qantas filled its $500m raising, with oversubscriptions of $400 million – the lowest of the oversubscription rates. For the record, the other eight corporate bond raisings were: ANZ ($1.25b), Aurizon ($500m), CBA ($1.4b), Coles Group ($450m), Goodman ($400m), IAG ($450m), QBE ($500m) and Suncorp ($250m).

BHP is tendering to buy 69 per cent of its $US2.5bn 6.75 per cent subordinated fixed-rate notes and is making a similar tender for its Euro denominated notes. While the notes are due to be repaid in 2075, BHP can redeem them at $US100 in 2025. In recognition that the company would almost certainly redeem them in 2025 all yield calculations are based on a 2025 maturity. BHP is offering $US123 for each $100 bond which means the Big Australian is investing money on a yield of around only 2.4 per cent. It simply wants to reduce debt when it is cash rich. Given the capital profit, naturally it will attract many institutions. But normally such a rate would not be attractive to today’s bond hungry institutions. But the “toecutter” clauses in the trust deed make not participating a dangerous strategy.

BHP has the right to extend its 69 per cent tender to 80 per cent. If 80 per cent of the bonds are acquired by BHP then the “toecutter” clause can be an triggered and BHP can buy the remaining 20 per cent at just $US100 – $US23 below the tender price. Bond holders who hold out might get only $US100 for their entire holding. It’s a vicious clause which is frightening institutions. But BHP is not breaking the law – it’s within its rights and probably calculates that if 80 per cent of bonds are bought at $123 and 20 per cent at $100 then it’s not a bad BHP deal. The unhappy bondholders need a Mad Max.