Astrea V 3.85% Bonds – Understanding What You Are Buying Into
A week later, after the IPO had closed, I had more time to look at the structure of the Astrea IV bond and acknowledged that it could be a safe one, but only because of all the credit enhancement safeguards put in place. See Understanding the Safeguards of Astrea IV 4.35% Bonds for more info.
Thus, when the IPO for Astrea V 3.85% bonds was launched this week, the first thing I checked was whether it has similar safeguards as Astrea IV 4.35% bonds. It has. Still, it is necessary to re-iterate that being PE bonds, Astrea bonds are not traditional bonds and it is important to understand the risks of the underlying assets. Below is a summary of the risks that I am aware of.
Understated Loan-to-Value Ratio in Fund of Funds
High Leverage Used by Buyout Funds
80% of the Astrea V investments are in buyout funds. As discussed in Would I Invest in Astrea IV 4.35% Bonds?, buyout funds use a lot of debts when acquiring companies. Typical debts is in the region of 6-7 times Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). High debts at the underlying PE funds, couple with a Fund of Fund structure, underestimates the true, look-through LTV ratio of the Astrea bonds.
Assurance of Net Asset Value
Astrea V has a portfolio value of USD1,342M. This is an important figure that is used to compute the LTV ratio. After the debacle of the Hyflux preference shares and perpetual securities, it became clear that asset values should not be taken at face value. Hyflux's main asset, Tuaspring Integrated Water and Power Project, which has a stated Net Asset Value (NAV) of $902M as at end of Financial Year 2017, could not be sold at close to book value. Given that PE investments are illiquid assets, what is the assurance that the portfolio value of Astrea V is really as stated?
This question was posted during the Astrea Investor Day in Jan 2019 and during the public roadshow on Astrea V bonds conducted with SGX Academy on Saturday. Azalea's management replied that the NAV of PE funds is checked by reputable auditors. In addition, there are secondary markets where PE funds are traded. The value at which they are traded is close to the NAV reported by the PE fund managers. Furthermore, when the PE investments are disposed of, Azalea cross-checks the sale value against the reported NAV. In most cases, the sale value exceeds the reported NAV.
PE in a Potential Bubble
PE investments have generated better returns than public equities in the last 20 years. This has resulted in a lot of funds flowing into PE investments, and increased competition between PE fund managers to find good deals. This has led to assets being purchased at higher prices. At the same time, the debts used by buyout funds to acquire companies has been on the rise. At some point in time, the PE boom will probably end, potentially leading to falls in NAV. See Bain & Company's report on Private Equity: Still Booming, but Is the Cycle Near Its End? for more info.
At Saturday's roadshow, Azalea replied that this is also a good time for selling assets in the PE funds that Astrea V has already invested in, which will result in cashflows coming back to the Astrea bonds. Furthermore, as most of the PE fund managers have a lot of experience running PE funds, they believe that the PE fund managers will be able to navigate the environment.
While I agree that this is a good time for selling assets in PE funds, this also means that the high asset prices are reflected in the portfolio value of Astrea's investments. In the event that asset prices correct, Astrea's portfolio value will also decline. This will lead to a rise in the LTV ratio, but there is a safeguard in place if the LTV ratio exceeds 50%.
Although I believe Astrea IV and V bonds to be fairly safe for retail investors, I cannot emphasize enough that the reason this is so is because of the credit enhancement safeguards that Azalea painstakingly put in place. Also, for investors interested to buy Astrea bonds, please understand what you are buying into.
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