ASIC warns on hybrids

Twitter: @PaperlinXsuX
ASIC Chairman Greg Medcraft said: "Retail investors may be attracted by the interest rates offered by household name companies and trusted brands, but hybrid securities should not be confused with government bonds or 'vanilla' corporate debt. In some cases investors are taking on equity-like risks but only receiving bond-like returns".

Read Greg Medcraft’s official bio here  If you wonder if this is worth reading, click here first

Mr Medcraft, what do you say about equity-like risks and nil returns from the unscrupulous issuers of PXUPA?

Hybrid issuers like to hide behind ‘black letter’ law but fortunately ASIC reads the mood of the markets. As previously mentioned, hybrids and other forms of corporate debt have recently received a boost in popularity as companies look to direct fundraising instead of being over reliant on the banking system. More details at In The Press, particularly by Jonathan Shapiro at the AFR.

We suspect ASIC’s cautionary notice published on November 24, refer table below for eight references, has resulted from a number of factors, not limited to:

1.      Christopher Joye’s critical article re-published here under Attack of the Hybrids on 23 November. Thankfully, Joye is highly regarded in government circles;

2.      The well publicised shenanigans of CMI Ltd (CMI) in its dealings with shareholders, Class A preference holders (CMIPC) and conflicts with ASIC;

3.      Increased negative press about hybrids at credible subscriber sites such as Eureka Report. When people like Robert Gottliebsen write about PaperlinX and PXUPA, people in authority take notice;

4.      ASIC’s recent seven day extension of the Origin Energy exposure period for its hybrid Prospectus. The extension was for ASIC to consider further the terms in the Prospectus, including aspects relating to the mandatory deferral of interest payments. The Origin issue has been very heavily subscribed because of the effective yield of about 9 per cent a year;

5.      Adverse press about PaperlinX in the AFR, Sydney Morning Herald and The Age. This started on 10 November with PaperlinX transparency absent as a letter to the editor of the AFR, submitted by your editor; and

6.      Publicity given to www.paperlinX-suX.com by the AFR and The Age. The financial press must think this case has merit.

Where to from here?

I’m encouraged by the support, and tactical intelligence, given by seriously committed PXUPA investors.

As previously reported, PaperlinX served a Concerns Notice pursuant to the Defamation Act 2005 (VIC) on late Friday, 25 November. I’m prohibited from publishing its contents.

My responses to date have been conciliatory; however PaperlinX apparently isn’t interested in identifying its specific concerns about this site. I submit that its demands are so broad as to be unenforceable. Time will tell.

I’ve served deadlines on PaperlinX all of which have now expired. The parties I’m dealing with at PaperlinX understand my sole objective is restitution of distributions for PXUPA. In the absence of ready cash, which I genuinely don’t believe and neither does anyone else including experts in this field of corporate debt, I’ve proposed a Compromise Offer here.

It appears that ASIC, the financial press and industry experts all disagree with PaperlinX to varying degrees. All that needs to happen is for PaperlinX to reverse its decision.

Here is the sad joke

At MoneySmart, a consumer advisory arm of ASIC, there is a list of Questions to Ask before investing in hybrids.

Question 1 is “What are the risks of investing in this hybrid security, now and in the future?” Helpful but unanswerable.

Perhaps a more relevant question for investors in hybrids would be:

“Have you taken steps to determine the financial morality of the directors of the issuer, in perpetuity?” 

This question is equally unanswerable, but it’s what now confronts investors in PXUPA and CMIPC.

Everyone knows that

·         The hybrid structure of interchangeable debt/equity only works for investors when the issuer acts ethically; otherwise hybrids would be subject to abuse by unscrupulous issuers; and

·         PaperlinX can afford to pay the Dec 2011 distribution, but it refuses to do so.

Conclusion: PaperlinX is unscrupulous.

Here is a list of publications that have commented upon the ASIC hybrid notice in the past few days.

Source	URL
ASIC	ASIC
MoneySmart - by ASIC	MoneySmart
Christopher Joye	Christopher Joye says
AFR	AFR says ...
The Australian	The Australian
Insto Australian Financial Markets	Insto says ...
Professional Planner	Professional Planner advises ...
Money Management	Money Management.com

Dec Distribution - Dead or Delayed?

Three questions for PaperlinX:                                  Twitter: @PaperlinXsux

1.      Why is it that you appeared to be so accommodating to PXUPA holders in June 2009 and are so truculent now? Which is the true PaperlinX?

2.      What is different between June 2009 and December 2011?

3.      Elsewhere I've raised the concept of accruing hybrid distributions along the lines recently implemented by Woolworths and Origin Energy. Will you give this consideration?

Below is an extract from an article written by Jim Stening, founder and MD of FIIG Securities, and published in Eureka Report on June 17, 2009. This was two days after PaperlinX announced that the June 2009 distribution on its hybrid PXUPA would not be paid, due to pressure from lenders. ASX release here. 

Stening’s observations are probably more relevant now because:

1.      PaperlinX has taken the unusual step of announcing in October that the Dec 2011 distribution will not be paid; and

2.      This time there is no pressure from PaperlinX’s lenders.

Foregone or just delayed?

"The PaperlinX hybrid is a non-cumulative security. That means that if a payment is missed, then technically it is gone forever. The non-cumulative clause for a hybrid is one of the preconditions for a security to be regarded as equity on a company’s balance sheet and why it is included in the terms of issue.

However, as I’ve pointed out before, hybrids are far more like debt these days than equity [Jim, how do you explain this chart?] and the clever bankers who concocted these securities came up with a solution to effectively make the hybrid cumulative. To appease hybrid investors, the securities can pay an “optional distribution” equal to the amount of the missed payment. The key word, however, is optional and although it is considered good form for the company to make this payment when possible, it is under no obligation to do so.

The wording of the announcement [to the ASX] and our subsequent discussions with management strongly suggest that PaperlinX would like to take advantage of this optional payment clause to appease the hybrid investors. However, due to the company previously breaching banking covenants, this decision is still at the whim of the lenders, not management.”

Read the full article here.

Addendum to earlier edition, voluntarily updated

To its credit, PaperlinX goes through a process of considering optional distributions. This was best described on December 7, 2009 in the ASX Release advising that the Dec 2009 distribution would not be paid. This advice was positively effusive compared with that of June 15, 2009. Maybe they heard Jim Stening?

In its ASX Release of June 11, 2010 regarding the June 2010 distribution, PaperlinX also advised:

·         “The Board has decided that the missed June 2009 distribution will lapse; and

·         A decision on the missed December 2009 distribution will be made in due course.”

In its ASX Release of November 24, 2010 regarding the Dec 2010 distribution, PaperlinX also advised that “The Board has determined that the missed December 2009 distribution will lapse.”

So there we have it, distributions lapse 12 months after their scheduled date.

December 2011 Distribution

Curiously, advice about this distribution not being paid was buried in the proceedings of PaperlinX’s AGM which PXUPA holders are not permitted to attend. One wonders if this is proper advice. Jim, we need you again.

Disclaimer: I’m not a client of FIIG and have never met Jim Stening although I’ve attend some FIIG presentations.

About FIIG: FIIG was established in 1998 to provide investors with direct access to fixed income markets. Today it is Australia’s largest non-aligned fixed income broker.  An Australian Guide to Fixed Income is FIIG's 160 page comprehensive guide to the Australian fixed income market – a must read for retail investors serious about fixed income.

3Rs - Regaining Real Relevance

5 year chart of PPX vs PXUPA direct from the ASX Twitter: @PaperlinXsux

When PaperlinX missed its first distribution in June 2009, Jim Stening, MD of FIIG Securities, offered some apparently unheeded advice. Read his advice here.

Hindsight is wonderful, but if we don’t learn from the mistakes of history we’re sure to repeat them.  I encourage every investor in hybrids generally, and PXUPA specifically, to read Jim’s comments published June 17, 2009 in Eureka Report and ponder what might have been for PXUPA investors today.

On June 15, 2009 PaperlinX announced it had been forced to not pay the June 2009 distribution.  ASX announcement here.

Compare the then and now scenarios.

	June 17, 2009	November 29, 2011
Price PPX	49.5¢	7.9¢
Market Cap PPX	$298M	$48M
Price PXUPA	$29.00	$18.20
ASX 200	3,904	4,102
The Problem	“Balance sheet is OK, earnings are not”	I say the problem remains.
The Simple Solution	“Capital raising”	The easier more expedient solution is to rob the hybrid investors.

What’s happened at PaperlinX since June 2009?

PaperlinX would say that a lot has happened and that we must exercise patience to see the results.

I say that the Board foolishly ignored Stening’s advice. During 2009-10, every major listed company took the opportunity to bolster its finances. Now PaperlinX is crying poor to PXUPA holders when corporate Australia is generally flush with cash.

Three changes since June 2009 + SUGGESTED CHANGE #4 below

CHANGE #1 Toby Marchant replaced Tom Park as MD on November 1, 2010.  Announcement here.

But what really changed with Marchant’s appointment; after all he was formerly Regional President of PaperlinX UK, Ireland and South Africa from 2005 and became CEO of PaperlinX Europe in 2008?

The role of CEO Europe wasn’t replaced so Marchant is now MD of PaperlinX and CEO of PaperlinX Europe where 70% of group sales occur, and now has to worry about another ‘strategic review’ due by mid 2012. The latter will look good on his CV.

Maybe Marchant was and remains a large part of the problem as he was in charge of PaperlinX’s key markets for a long time? 

I also query other aspects of Marchant’s appointment arising from his comments, and those of others, published in The Australian on September 7, 2011.

Query #1  Marchant’s theme is Regaining Relevance, “because we had lost it, big time”. “WE” when he was leading 70% of the group sales effort?

Query #2  Toby’s view of Tom Park: “Marchant describes the criticism of Park as extremely unfair. Tom is an extremely good leader who did what he could with what he had in front of him. A lot of this was a consequence of circumstances [the perennial excuse of the incompetent].

"Tom was an excellent leader. He taught me a huge amount. I can honestly say I learnt more from Tom Park than anybody else I have ever worked for.” Toby, we all admire loyalty, but that last comment is a worry.

Query #3  Was Marchant a lame duck appointment? As one fund manager succinctly put it: "Toby was a senior executive in this company before he got the top job. He was going to lose anyway if it died. So he might as well take the top job, get paid more, and if he can turn it around he is a hero."

In summary, the jury is still out on Toby Marchant; however one cannot image him having the luxury of time enjoyed by Tom Park. We expect he is on a tight rein, but maybe not tight enough as seen by Change #2.

CHANGE #2

Diversification before completion of the strategic review. That’s a worry.

To quote Marchant:

“The new strategy will include accelerating diversification away from simple paper merchandising …”

“We have this incredible logistics set-up in all our big markets. It is easy for us to add to that logistics platform in a way which is much more efficient than for competitors in things like packaging and sign and display," Marchant says.

"We are moving out of the traditional merchant model to being a broad-based materials supply company to printing, industrial and corporate. With that comes better margins, better selling prices."

Sounds like an admission that the world’s largest fine paper merchant cannot make a success of its core business so what ‘regaining relevance’ really means to you is trying something different. Someone please tell me this isn't true.

Did you ask Lyndsey Cattermole about this idea? She has first hand experience, at Fosters, using common logistics for seemingly similar products. Fosters burned billions persevering with trying to add wine to beer. The beer went flat.

CHANGE #3

A revitalised Board with three non-executive independent directors appointed in the past 12 months.

The yet unanswered question is whether the new PaperlinX board has a spine? As an example, would it tolerate the remuneration nonsense of Tom Park?

The current board is small enough to be nimble and brings together diverse business experience. Personally, I’d like to see an additional director with a strong distribution/sales pedigree, based in continental Europe. Just to keep an eye on the group’s major market.

The reason is that merchanting is a fancy name for old fashioned wholesaling. Let’s not over-complicate something which is basically simple. Simple also means there are few if any ‘blue sky’ opportunities for PaperlinX. It will be a long slow slog for PaperlinX to ever make an acceptable return on equity.

Harry Boon was the logical chair. My concern is that his principal business experience is in monopoly style companies, Ansell and Tatts. How hard is it to make a success of selling sex and gambling? Is he up to the challenge of a rough and tumble business like wholesaling which has relatively low barriers to entry, and therefore low margins?

Mrs Cattermole and Messrs Clarke and McConnell must have done their due diligence before accepting their respective appointments. They are the great hope for all PaperlinX investors as loss of reputation would surely have been a concern for each of them.

Or did they all make the same mistake? Time will tell.

SUGGESTED CHANGE #4

1.      Regain relevance for investors by doing something extraordinarily simple; start making profits by selling more paper more efficiently.

2.      If and when this is achieved, and only then, consider diversification into related markets.

3.      If you cannot make profits being the world’s largest paper merchant, first ask the shareholders if they want to be part of your diversifications.

Parable of Willie Sutton

Willie Sutton was a famous bank robber whose name lives on as Sutton’s Law – the diagnostic process of considering the obvious first.

Sutton reputedly explained why he robbed banks: "because that's where the money is."

Such was his infamy; in 1950 Willie Sutton was on the FBI's list of Ten Most Wanted Fugitives.

He was also an accomplished escapist with five breakouts to his credit. This means he was also caught five times. Eventually Sutton faced imprisonment of two life sentences plus 105 years.

Sutton was a man ahead of his time. Today’s white collar crime would have suited him well. He acquired two nicknames, The Actor" and "Slick Willie" for his ingenuity in executing robberies in various disguises.

Fond of expensive clothes, Sutton was described as being an immaculate dresser. Although he was a bank robber, Sutton had the reputation of a gentleman; in fact, people present at his robberies stated he was quite polite. That was said of Ned Kelly too!

Because of his love for expensive clothes, Sutton's photograph was given to tailors as well as police departments. This eventually led to his downfall after being sighted on the New York subway by a tailor’s son.

How many morals can you find in this parable?

Read more about Willie Sutton

Why PXUPA is $18

Screwing hybrid holders keeps PaperlinX in business. It is shown below that PXUPA hybrids are now really circa 50% of the equity of PaperlinX.

5 year chart of PPX vs PXUPA direct from the ASX

Here is a chronology of PaperlinX’s capital raisings, excluding DRPs, since 2007.

Date	Investor Source & Form	Raised
Mar 07	PXUPA Step-up Prefs Issued	$285
Jun 09	PXUPA distribution not paid (est)	$20
Dec 09	PXUPA distribution not paid (est)	$20	$325
Oct 08	PPX entitlement	$185	$185
			$510

As at 30 June 2011, the equity of PaperlinX was reported as:

                                                                 

	June 2011		June 2007
Equity attrib to ord shares (PPX)	459.9	62.5%	1,628.7	85.5%
PaperlinX SPS (PXUPA)	276.5	37.5%	276.4	14.5%
	736.4		1,905.1

Whereas, discarding accounting conventions and just looking at where the cash went, the equity of PaperlinX should be considered like this at June 30, 2011:

Equity attributable to ordinary shares (PPX)	411.4	55.9%
Equity attributable to PXUPA	325.0	44.1%
	736.4

Continuing the same theme and if PaperlinX:

·         Has of loss of $46.4M in FY12 (possible), and

·         Doesn't pay the Dec 2011 & Jun 2012 distributions (seems assured)

then the equity of PaperlinX will realistically look like this at June 30, 2012:

	06/11	Change	06/12
Equity attrib to ord shares (PPX)	411.4	-46.4	365.0	50%
Equity  attributable PXUPA	325.0	+40.0	365.0	50%
	736.4	-6.4	730.0

PaperlinX can keep under-performing while PXUPA investors pay for the party. Now we know why PXUPA is trading at $18. The term 'junk bond' is a misnomer. It should be 'junk issuer'.