11. april 2022
The Power of a Value Bond
By Klaus Blaabjerg and Peter Dabros
We are a value manager across the global credit markets. Unlike larger managers, we can access bonds across the size spectrum in both large and smaller credits. In this note we provide an example of a small cap Energy issuer in the North Sea which has been acquired by a larger operator. The bond is a 1% position in our Global High Yield portfolio – the acquisition will further enhance our returns.
- Large highly diversified credit funds are unable to provide meaningful exposure to smaller, less well covered bonds.
- Smaller credits are often penalised by Rating agencies due to their size.
- With high energy prices set to remain, we are finding a wide variety of attractively priced bonds across Energy names particularly in the North Sea.
- Change of Control options provide significant upside for bond investors in a takeover.
At Absalon we invest in Global High Yield bonds that are undervalued. These are bonds where the spread is too high compared to the underlying default risk. When we start to look at undervalued bonds with change of control put options embedded, that are issued from small cap companies with undervalued assets (seen from an equity point of view); our potential sourcing of alpha becomes meaningful!
The best way to show this is a very recent example. Last week Ithaca Energy made an offer to acquire Siccar Point. Ithaca Energy and Siccar Point both have business operations in the UK’s North Sea oil fields. Ithaca Energy (North Sea) PLC operates as an oil and gas company. The company focuses on the production, appraisal, and development of oil and gas asset portfolios. Both companies have “standard” high yield bonds outstanding with a list of covenants attached. One such covenant being the Change of Control option. This option is a put option, allowing the bondholder of Siccar Point to sell the bond to Ithaca at a price of 101. In the Absalon Global High Yield fund we have a position in the Siccar Point 9% 2023 bond of more than 1%. This bond traded at an average price of 95 mid-March.
The Ithaca offer announced today means a significant uplift in the alpha for Absalon Global High Yield fund. Here is how it works:
Ithaca Energy signed sale and purchase agreement to acquire Siccar Point Energy. Transaction is subject to regulatory approvals and expected to close around the end of Q2’22.
Ithaca Energy is rated B3/B+ (Moody’s/Fitch). Its senior unsecured bonds are trading in the 103.25/103.5 for context that is a yield of 7.8% and a spread of +525bps.
Siccar Point Energy bonds should obviously trade up immediately to reflect the change of control event (with a put at 101 for 15 days once a Change of Control event is declared).
Return scenario to put:
- Put at 101 (bond moves to 101 very fast from below par)
Return scenarios if credit spread Ithaca/Siccar harmonizes and the change of control option is not put:
- Ithaca at +525bps, basically the same maturity, is equal to 104 in Siccar Point
In other words, we can either sell our position in Siccar Point now at 101. Or we can wait until the spread of the two bonds have harmonized equal to a price of 104. Looking at live prices in Bloomberg it appears that this harmonization has already taken place, as most investment banks are making a price at 103 mid-market in the bond. As a third option, we could decide to wait even further for additional upside down the line if as we expect Ithaca will look to refinance Siccar debt (105.4 on March 2023). So, to sum it up; From mid-March our bond in Siccar Point has gone from 95 to a current price of 103. We have a decent coupon of 9% on top of this. Waiting one more year we will get a return of an additional 2.4 bond points plus a coupon of 9%. That is alpha indeed!
In the Absalon Global High Yield fund we have an overweight to the Energy sector compared to the ICE BAML global high yield index. Much of our Energy exposure is based in the North Sea in large part because the bonds are cheaper here but also because of ESG considerations. We don’t want to invest in shale gas or oil sands, and regulation and oversight of environmental issues is relatively strict in the North Sea compared to the rest of the world. The year-to-date alpha for the Absalon Global High Yield fund is currently 2.6%. The fund offers plenty more of these undervalued bonds and is well positioned for the future we believe.
Siccar bond agreement:
Mandatory repurchase due to a Put Option Event
(a) Upon the occurrence of a Put Option Event, each Bondholder will have the right (the "Put Option") to require that the Issuer purchases all or some of the Bonds held by that Bondholder at a price equal to 101 per cent. of the Nominal Amount.
(b) The Put Option must be exercised within fifteen (15) Business Days after the Issuer has given notice to the Bond Trustee and the Bondholders that a Put Option Event has occurred pursuant to Clause 12.3 (Put Option Event). Once notified, the Bondholders’ right to exercise the Put Option is irrevocable and will not be affected by any subsequent events related to the Issuer.
"Change of Control Event" means a person or group of persons (other than the Sponsors or their Affiliates or affiliated funds) acting in concert gaining Decisive Influence over the Parent Holdco, the Parent or the Issuer