Analysis: Tatts short on details and spread

Philip Bayley
Following the requirements of short-form prospectuses, Tatts has disclosed a pro-forma profit and loss statement and balance sheet. The statements are pro-forma as allowance is made for the imminent loss of its poker machine business and adjustment is made for the impact of the bond issue.

Key financial ratios are also disclosed. These are required in the absence of disclosing a credit rating, so that investors have some opportunity to assess the credit risk associated with the borrower.

For Tatts, it is not a case that it cannot disclose its credit ratings since it simply doesn't have any, from any rating agency. It shares this shortcoming with Primary Health Care.

And making an assessment of credit risk on the basis of a few ratios and summary financial statements is nigh on impossible for anyone, especially without the disclosure of any information about cash flow.

The key elements of the pro-forma financials disclosed by Tatts are: it has a leverage ratio of 2.7 times; a gearing ratio of 82.9 per cent; a balance sheet ratio of 30.2 per cent; an interest cover ratio of 6.7 times; and a current ratio of 89.1 per cent.

It's scant information on which to assess credit risk.
 
More telling is that this is a company with a A$4.8 billion balance sheet, of which A$4.0 billion comprises intangible assets. No details are provided on these intangibles.

Any impairment of the intangible assets would quickly wipe out shareholders' funds.

Details of Tatts' existing debt and debt maturity profile are provided. Tatts has a heavy debt refinancing burden to deal with over the next two years, against which the bond issue is only a drop in the ocean.

This is reassuring because it signals that Tatts is not desperate to issue the bonds.

However, without the ability to make any comparative assessment of credit risk, how can the Tatts bonds be priced?

Tatts is offering a coupon calculated on the 90-day bank bill rate plus a credit spread of 290 to 310 basis points. The spread will be decided in a book build on Tuesday. The offer will then open on Wednesday.

No doubt the book build will bring the spread in at 290 bps, as is typically the case. But is this fair compensation for the credit risk associated with Tatts?

In the retail bond market there are only two comparable issuers and neither have bonds outstanding with a seven-year term to maturity, as Tatts is offering.

The obvious comparable issuer is Tabcorp, Tatts' competitor. The senior unsecured floating-rate bonds issued by Tabcorp in May 2009 are currently trading at a spread of 275 bps over the 90-day bank bill rate.

This is clearly the benchmark that has been used to determine the indicative spread for the Tatts bonds. But the Tabcorp bonds only have 1.9 years to go before they mature, not seven. Tabcorp also has an investment grade credit rating.

Primary Health Care, like Tatts, does not have any credit ratings, and its bond, issued in September 2010, still has 3.3 years to run. This makes it a more appropriate benchmark, although still not a great one.

Its bonds are currently trading at a spread of 497 bps over the 90-day bank bill rate. Is Primary Health Care an appropriate benchmark for the credit risk of Tatts then, and, therefore, the pricing of its bonds?

Who knows? But the difference in the pricing of the Tabcorp and Primary Health Care bonds is sufficient to suggest that the pricing of the Tatts bonds is way too tight.