Tuesday 06 December 2016 by FIIG Research Company updates

Transurban Queensland Finance – Consent needed for a change in terms

Noteholders of the 2021, 2023 and 2024 Transurban Queensland Finance (Transurban; formerly Sun Group Finance) bonds have been notified of a consent event

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What are investors being asked to consent to?

  • The bond documentation benefits from a distribution lock up ratio which prohibits equity distributions if the interest coverage ratio (ICR) is below 1.4x
  • ICR is broadly defined as net group cashflow divided by finance costs
  • Net group cashflow is defined under the current documentation along the lines of “EBITDA less capex” with certain carve outs for specified project capex that are not being funded out of operating cashflow. Essentially, it looks like “EBITDA less maintenance capex”
  • The proposed amendment would increase the scope of the carve out and render it more general, such that any capex funded by finance debt, equity, or distributable cashflow which has been retained from prior periods would not be deducted from the new definition of net group cashflow

Why are these changes being proposed?

  • There are two main, large projects currently being negotiated, scheduled for completion over the next two years, totalling A$580m
  • The planned funding for this additional capex is through debt (Transurban Queensland Capex Facility)
  • As such, the company believes that it would be in the spirit of the original documentation to include this additional capex in the carve outs to net group cashflow
  • This would allow Transurban to continue with equity distributions whilst its lumpy debt financed projects are underway

What are the implications for noteholders?

  • The original definition of net group cashflow was intended to reflect operating cashflows before large project capex, with the ICR threshold requiring that financing costs be covered by 1.4x or more out of the operating cashflows before equity distributions are made. It is not unreasonable – given existing carve outs for project capex from the net group cashflow definition – that the company is seeking to allow them to carve out future debt financed capex
  • However, given there are no explicit incurrence covenants surrounding permitted debt leverage, by consenting to the proposed amendment, investors would be consenting to equity distributions continuing to be permissible whilst the company’s credit profile deteriorates – temporarily or otherwise – through increased financial leverage
  • To put the size of the two potential projects in context, FY16 EBITDA for Queensland Motorways Holding Pty Ltd was A$86.6m
  • We also note that S&P has previously downgraded Transurban Group (and Sun Group Finance, linked with Transurban Group) due to its decisions to undertake large development projects. (There are coupon step ups on S&P downgrades, of 15bps if to BBB-, and 40bps if sub investment grade)

Is there any benefit for noteholders?

  • The  explanatory memorandum does not indicate any consent fee being offered to investors

Other logistical details

Bonds affected are:

  • AU3CB0225910 (fixed rate 2021)
  • AU3CB0239929 (fixed rate 2023)
  • AU3FN0025987 (floating rate 2024)

Our recommendation

Whilst this consent solicitation is being presented as largely a “technicality”, the amendment renders a slight but not immaterial deterioration of the terms and conditions. Holders of the 2021, 2023 and 2024 Transurban bonds are essentially being asked to agree to equity dividends continuing to be paid, while the company incurs additional debt to finance large project capex. Given Transurban is not offering any consideration for the change, noteholders should consider voting against the proposed amendment to limit the possible deterioration of the credit and thus lower bond prices. We also note lower retained capital due to expenses associated with the projects and ongoing dividends.

It is worth noting that we think that the majority of holders are likely to read this corporate action as a technicality and therefore the amendment is likely to pass

For the vote to pass, 66.66% of noteholders by value need to approve the request.