Myer Notes

Sydney Morning Herald

Wednesday August 16, 2006

BARBARA DRURY

A MINIMUM INTEREST RATE OF TEN PER CENT SOUNDS GREAT, PARTICULARLY WHEN IT'S BACKED BY ONE OF OUR BIGGEST DEPARTMENT STORES. BUT IS IT A GOOD INVESTMENT? BARBARA DRURY LOOKS AT THE PROS AND CONS OF A NEW FIXED INTEREST SECURED NOTE.

What it is Myer Notes have a headline-grabbing minimum interest rate of 10 per cent fixed. The notes are simply named yet they are a little more complex than first meets the eye - the interest is set at a guaranteed minimum level, but payment is not guaranteed.

Myer's new owners hope to raise $224 million with this issue of notes to refinance the debt they took on to buy the business earlier this year.

Technically speaking, Myer Notes are subordinated secured notes. Taking that one word at time, notes are a form of debt where investors lend the company money in the form of the issue price and receive interest over the term of the loan, in this case, six-and-a-half years. On maturity, if investors have not traded them on market for cash or exchanged them for shares beforehand, Myer pays back the purchase price and any interest owing.

Secured, in this case, means the loan is secured against the assets of Myer. "Subordinated" means that investors in the notes rank behind senior debt providers if the company collapses, but before shareholders.

How it works Investors have until September 8 to apply for Myer Notes with a term of six-and-a-half years and a maturity date of March 2013.

The interest rate will be fixed at 10 per cent or the swap rate on the issue date plus a margin determined by the bookbuild which was completed on Monday, whichever is the higher.

If initial demand from institutions was high then the rate is likely to be set at 10 per cent. However, if demand was lower than anticipated then the rate could be set a little higher to attract investors.

Interest is payable twice a year, beginning next January. On maturity the notes will be redeemed at the principal amount plus any interest owing.

The guaranteed minimum yield is 10 per cent, but there is a sting in the tail. Payment of interest is not guaranteed. If the Myer stores do not generate enough cash to pay the interest or the issuer, Myer Group Finance, becomes insolvent, then it can be suspended.

Zac Fletcher, a director of the issue's underwriters, Goldman Sachs JB Were, says any interest suspended will accumulate and be increased by 2 per cent a year. The trigger point to suspend interest will be a fall in Myer's debt service coverage ratio (the amount of cash flow available to pay the interest) from the 1.7 times forecast to 1.05 times. In other words, things would have to go badly wrong.

The notes are tradeable and trading is expected to begin on the ASX on September 18.

Noteholders have the right to exchange their notes for listed shares in Myer at a 2.5 per cent discount to the retail share price if the group decides on a public float. If this happens within the first two years the issuer will pay 105 per cent of the issue price of the notes and 102.5 per cent thereafter.

The issuer also has the right to redeem the notes before maturity if it refinances the senior debt, the value of all notes on issue falls below $50 million or value of an investor's holding falls below $500.

What it costs Each note costs

$100 and there are no extra fees. The issue is aimed squarely at personal investors with a relatively low minimum subscription of 50 notes or $5000. There is no upper limit.

Pros The high yield is sure to grab the attention of anyone dependent on a fixed income from their investments while the potential for a discounted entry into any future Myer float is also appealing.

Myer is Australia's largest department store chain and a leading brand and it is in the hands of highly experienced retailers and financiers.

Earlier this year Coles sold its Myer stores and Melbourne CBD property to a consortium led by Newbridge Capital along with its parent Texas Pacific Group and the Myer Family Company. Texas is a buyout specialist and owner of department store retailer Debenhams in the UK and a stake in Neimen Marcus in the US.

Myer's management team is led by ex-Woolworths executive Bill Wavish and includes expertise from Debenhams and Rupert Myer, grandson of Myer's founder. They aim to cut costs at the same time as expanding Myer's private brands with strategies developed at Debenhams.

The notes rank ahead of existing shareholders, who would lose $300 million in equity before Noteholders lost their money.

Cons The 10 per cent yield is a warning that this is a high-risk investment. To put the rate in perspective, the best yield on 5-10 year AAA rated bonds and debentures is about 6.25 per cent. The outlook for discretionary retailers is clouded as rising interest rates are expected to force consumers to tighten their belts.

Tony Lewis of Lewis Securities says he is passing on the notes because of their high risk. He says that despite Myer's long history, the business under new ownership is basically a highly geared start-up.

Liquidity is also a risk because investors can only redeem their notes ahead of maturity on-market. Lewis says if the company misses an interest payment or trading conditions at Myer stores deteriorate badly then he wouldn't be surprised to see the Notes trading at a discount to their issue price.

And if the company goes belly up, $675 million worth of senior debt must be paid out first in the event of a wind-up. In the worst case scenario, noteholders could lose everything.

Where it fits in Myer Notes are difficult to pigeonhole because there are few comparable products on the market. Jim Stening, the managing director of fixed interest specialist FIIG Securities, says the notes are high risk as far as fixed interest goes but preferable to many current high yield, property-backed debentures.

Stening advises investors who want to take a punt on the ability of the high-quality management to turn the business around to allocate only a small portion of their fixed interest portfolio to Myer Notes.

© 2006 Sydney Morning Herald

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