What Could Cause A Bond Issue to flop? Home Afrika Case study

In a previous post, I explained in simple terms why Apple resorted to issuing a corporate bond even with so much cash reserves. First let us recap on the basics of a bond. When a company issues a bond, it is borrowing your money for a certain period of time defined in the bond terms, and it agrees to pay you interest at a fixed rate (coupon rate) at defined times until the bond matures. For example, a company may issue a 5 year bond at 15%, with semi annual payments; this means that it will be paying interest of 15% split into two payments a year for a period of 5 years after which it pays the principal.

Home Afrika (the only listed real estate company in Kenya) recently had to raise debt via a bank after its Kshs 900 million bond failed to raise the minimum amount required of Kshs 500 million. The company had sought to issue a 5 year bond at a rate of 13.5%.

What could have caused this bond to fail in a market where government bond issues and corporate bond issues (like the BRITAM issue in 2014) are routinely oversubscribed? It is definitely not because of insufficient cash/liquidity in the market, so three other factors come to mind:

1. Company perception / reputation: The success of a bond issue just like a share issue is largely pegged on how investors perceive the issuing company. Where the company is publicly traded, this perception is easy to gauge from the performance of the Company’s shares. Home Afrika made its stock market debut in June 2013 at Kshs 12 per share, and is currently trading at Kshs 3.90 per share, after announcing a 72% drop in its profits last year. It is therefore not surprising that the public bond issue was not successful. When a company’s performance is not very impressive, shareholders then consider a second factor:

2. Coupon rate of the bond: As mentioned in the Apple post, a bond pays the investor a fixed interest amount which is determined before the issue by the company. When a company is determining this rate, it considers the market (using the government bonds as a guide), and risk perception. The Home Afrika bond rate was 2.63% above the government rate for a similar bond. The critical consideration here is; in light of the dismal performance of the company’s shares and decline in profits, was this premium high enough for the risk it was exposing potential shareholders to? It is possible that the investors considered the risk too high and therefore would have desired a greater return, may be 15-16%.

3. Bond terms relative to the company’s other borrowings: Usually the company has the say on what terms to issue their bond. It for example may choose to issue a bond that is secured against the company’s assets, or one that is not secured. This to a large extent shapes investor perception depending on (1) above. If the company is strong financially, it can successfully issue a non secured bond at a reasonable rate of return. If its prospects are perceived to be shaky however, then a secured bond stands a better chance in the market.

So there you have my 3 key thoughts on why this particular bond did not succeed. What are your thoughts? Have you ever considered investing in a bond?