Since last year, the Singapore-dollar corporate credit market has seen several large and complex corporate reorganisations happening including at Olam Group, Keppel Corporation, CapitaLand Group, Singapore Press Holdings and ARA Asset Management.
Such reorganisations are not new and they follow numerous corporate credit issuers who have been acquirers or targets in mergers and acquisitions (M&A) and privatisation in prior years. Given that such reorganisations invariably impact an issuer’s credit fundamentals and are likely unexpected before their announcement, they offer valuable case studies for bond and perpetual holders who face such event risk.
Corporate reorganisations typically impact the credit profile
Summarising some definitions we have gleaned from corporate lawyers, corporate reorganisations generally refer to internal transactions involving the transfer of assets, whole businesses or shares between entities within the same group.
To note, corporate reorganisations are not the same as debt restructurings. In the former where corporate issuers undertake corporate restructurings, issuers are typically solvent and able to meet their long-term debt and other obligations. Many such issuers that underwent corporate reorganisations are considered higher grade issuers who are also leaders in their respective business segments. In the latter where corporate issuers undertake debt restructurings, participants of the Singapore dollar corporate credit market may recall credit defaults from several offshore companies stemming from the oil crash of 2014–2016 and a high-profile water treatment company in credit default that is currently being investigated.
While internal corporate reorganisations do not typically lead to credit default, such reorganisations change the credit profile of the issuer and consequently shift the risk-reward for investors. This is especially so because corporate bonds and perpetuals tend to be unsecured, unlike bank loans that are usually secured with collateral. When the legal entities get reshuffled around during a corporate reorganisation, the business profile changes for the entity that issues and/ or guarantees the corporate bonds and perpetuals. There may be no recourse for investors if the credit profile of the issuing entity or guarantor weakens post reshuffling (which can happen if assets are transferred away).
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Even if the corporate reorganisation does not immediately impact the credit profile, such as in the case where the holding company still ends up holding 100% of all its businesses and assets, such corporate reorganisations and changes to the corporate structure can be carried out as a precursor to and to facilitate other future corporate transactions.
As a non-exhaustive list, these could include (1) M&A which may involve a change of control and/or a change in capital structure and/ or a change in business nature, (2) carve-outs where business divisions are partially sold, (3) spin-offs where a subsidiary becomes a new separate company and the shares are distributed to current shareholders, (4) demergers or (5) privatisations.
Corporate reorganisations are not necessarily for the worse even though these are typically unexpected and entail event risks. The outcome depends on the rationale and exact nature of the transaction and the terms and conditions (for example, protections/covenants) that apply to the specific bond and/or perpetual instrument. For instance, in M&A, the credit profile of the acquirer may be very different from that of the target company, which in turn results in credit implications for investors depending on the eventual credit profile of the issuer/guarantor. Separately, near-term price dislocations caused by events may be opportune timing to invest at a lower entry price.
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Bondholders have limited say
Corporate reorganisations typically have improvement of shareholders returns in mind, especially in a matured market where organic growth rates are lower. This means we should expect transactions to tilt more shareholder-friendly than creditor-friendly. This is especially so because, unlike shareholders, bond and perpetual investors typically do not have the right to directly vote on whether or not corporate reorganisations can proceed.
That said, clauses in the form of covenants may exist that protect bondholders or partly mitigate against adverse impacts from corporate reorganisations. These include a “change of control” covenant which may compensate bondholders (for example by increasing coupon rate) when the beneficiary owners of the issuer change as well as “delisting puts” which allow investors to compel the issuer to redeem the bond when an issuer is taken private. Outside of event-related covenants, there are other covenants which protect the bondholder. The existence of “financial” covenants may disallow excessive debt to be taken (as debt is often used in acquisitions) and/or require the issuer to maintain a minimum level of assets in the company (assets may be sold or transferred away in corporate reorganisations). The “non-disposal” covenant is also crucial which disallows significant or material assets to be disposed of or transferred away, which is relevant for companies that own performing or hard assets (versus asset-light companies).
If the covenant (say financial or non-disposal) is breached and if this constitutes an event of default, bondholders would be able to demand an acceleration of or upfront repayment. However, not all issues are structured with sufficient protections, especially among higher grade bonds and perpetuals which are typically covenant-lite.
No free lunches in consent solicitation exercises linked to corporate reorganisations
The presence of covenants may compel issuers to either (1) request bondholders to waive a potential breach of key covenants through a consent solicitation exercise (CSE), usually in return for some compensation, or (2) repay in full before taking actions that are detrimental to the credit profile of the company. Although certain CSEs are not expected to have a credit impact (for example, a change in trustees), the same cannot be said for corporate reorganisations. Bond and perpetual holders should carefully consider the details of such CSEs when a company’s credit profile is expected to undergo significant changes, and weigh the cost and benefits of agreeing to such a CSE as short-term gain may lead to long-term pain.
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Investors may come together to negotiate for a better investment outcome. We have seen a recent CSE that saw a resolution dropped due to lack of quorum, and in our view, eventually result in a more advantageous outcome for that group of investors. However, more often we have observed investors agreeing to CSEs for a small one-off cash payment when rejection of the CSE would have resulted in a higher investment return.
Why would investors leave money on the table?
Corporate reorganisations often involve multiple steps, with details varying from transaction to transaction. This means that even if investors are familiar with the broad concepts of corporate reorganisations, specific terms and conditions governing the instrument need to be taken into context. Given the complexity, we believe investors tend to opt for the easiest rather than the most optimal decision.
Unlike the public equity market where timelines and documentation required on takeovers and other significant corporate transactions are spelt out, there are no guidelines governing the timeframes required for decision-making in CSEs, as far as we are aware. This means that a company can launch a CSE with a compressed timeline that may not adequately consider investors’ need to digest the information. Another aspect that increases the relative complexity of the corporate credit market is that companies often issue different instruments (for example varying maturity, subordination, perpetual), while there is generally only one equity instrument for each listed company.
An astute colleague of ours pointed out that choosing the easiest rather than the most optimal decision could also happen due to “prisoner’s dilemma” where individual decision-makers are incentivised to make a decision that may seem to be in their best interest but sub-optimal for the investor group as a whole. For example, issuers usually dangle small incentives for individuals to agree to CSEs quickly such as an “early consent fee”. Assuming a single individual’s vote is unable to change the outcome of the CSE, the rational decision for the individual should be to agree to the CSE. This will allow the individual to capture the small incentive should the CSE pass with no downside should the CSE fail. This is despite the likelihood of a sub-optimal outcome for the group in the passing of the CSE if every individual agrees to the CSE.
However, we acknowledge that circumstances surrounding the CSE may not necessarily be so black and white for everyone. Different investors have different investment risk tolerance levels, and different investment timeframes and may perceive the future credit profile trajectory of companies differently. Compared to times when the underlying credit profile is stable, this dispersion is greater at times when the fundamentals of the company are changing as in a corporate reorganisation and other corporate transactions.
At first glance, the SGD corporate credit market should not succumb so easily to the above-described scenario of prisoner’s dilemma as several institutional investors have a significant presence in the market. An institutionalised market implies potentially more coordination in seeking a better investment outcome, in addition to being better equipped to analyse the credit implications of a corporate reorganisation. However, as the SGD corporate credit market evolves, holdings have become more dispersed across many individual investors. Perhaps, it is time for minority investors to seek better.
Ezien Hoo, Wong Hong Wei, Andrew Wong and Toh Su-N are credit research analysts with OCBC Bank’s global treasury research & strategy
