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Investors Just Threw A Ton Of Money At Unusually High-Risk Bonds For A Project That Doesn’t Make Money

Investors Just Threw A Ton Of Money At Unusually High-Risk Bonds For A Project That Doesn’t Make Money

MYLES UDLAND MARKETS  JUN. 22, 2014, 12:19 AM

“Where can you get 12% yield?”

Investors just took on a ton of risk to finance a new Florida passenger railway project being undertaken by Fortress Investment Group, reports Reuters’ Natalie Harrison and Shankar Ramakrishnan.

The project, called All Aboard Florida, plans to use existing freight railway on the east coast of Florida to carry passengers.

Reuters said the project does not yet have any cash flow and is already facing some political push back.

Fortress sold $405 million worth of debt, some of it in the form of “payment-in-kind” notes, or bonds that don’t pay a bondholder anything until they mature.

These notes are deeply subordinated in the capital structure. This means that there’s a long line of senior debtholders who have to get paid before these subordinated investors are considered. This is a particularly disadvantaged position in the capital structure during bankruptcies.

The report quoted one banker close to the deal that asked, “Where can you get 12% yield?” The banker said, “You can move down the credit spectrum, buy longer maturities, or move into something a bit more off-the-run in a company that you like, which this deal is a good example of.”

Reuters noted that the bonds are selling for more than 100 cents on the dollar in the secondary market, indicating strong demand for this type of debt.

In short, investors are looking everywhere and anywhere to get a decent return on their capital in this.

Some market watchers, however, will see this hunger for high risk as a sign of complacency and recklessness in the financial markets.

 

Fortress wows market with Florida railway bond

Fri, Jun 20 2014

By Natalie Harrison and Shankar Ramakrishnan

NEW YORK, June 20 (IFR) – Investment management firm Fortress stunned the market this week by selling a deeply subordinated payment-in-kind (PIK) toggle note to finance a new Florida passenger railway service.

Investors took on considerable risk – on top of the already risky PIK structure – as there is no cashflow until the project, already facing some political push-back, is up and running.

The All Aboard Florida project plans to expand an existing freight railway on Florida’s east coast to begin carrying passengers for the first time since 1968.

“We didn’t spend a lot of time looking at it just because we saw it as an equity play,” said Michael Sohr, a high-yield portfolio manager at AllianceBernstein.

“But we were watching to see whether it would get done.”

And get done it did, as lead bookrunners JP Morgan and Morgan Stanley priced the deal Tuesday in line with price talk at par with a 12% PIK coupon and 12.75% if PIK.

“Where can you get 12% yield?” one banker close to the deal told IFR.

“You can move down the credit spectrum, buy longer maturities, or move into something a bit more off-the-run in a company that you like, which this deal is a good example of.”

STRONG PERFORMANCE

The trade has performed well in secondary – it was seen bid at 101.75 late on Thursday – which underscores the willingness of investors to keep chasing after yield.

It was a boon for Fortress, which now will have to stump up less cash to finance what would be the only privately owned and operated passenger rail system in the US.

The line would connect Miami to Orlando via intermediate stations in Fort Lauderdale and West Palm Beach.

While some county commissions along the route are already making noises of opposition, Fortress is determined to win them over – and the success of the PIK trade is seen as a vote of confidence in the investment giant.

“This may be a project finance deal, but this passenger line is attached to a marquee name, the Florida East Coast (FEC) railroad, which is a one-of-kind unique asset,” said the banker.

“If you are moving freight in and out of Florida, it’s the only place you can go. If anything were to go wrong with the project, people believe Fortress will do whatever it takes to make it work, because it is so invested in the railroad.”

The fewer than 50 accounts that took part also had their eye on some 21 acres of expensive real estate owned by Fortress in downtown Miami, said another banker with knowledge of the deal.

To reassure investors, the deal was upsized to US$405m from US$390m, with the extra proceeds put in an interest reserve account to pay half of the cash coupon until the project is done.

The deal was also larded with investor-friendly covenants – including a lien on the land, the rights to the passenger track, the ability to run the business if the project goes wrong and an offer to purchase at par if the project is abandoned before an opening deadline.

“It is a bit of an equity story,” said another high-yield investor who did buy the deal.

“On the other hand, unlike large infrastructure related projects, most of the rail link is already there which reduces the build risk.”

The project will utilize existing infrastructure on the FEC freight route, adding in switches and platforms, with the eventual aim of extending to Disney World in Orlando.

“There is a belief that once it is up and running the passengers will come, partly because the roads are so congested around that area,” said the investor.

Another senior banker with knowledge of the deal said investors were also attracted by the possibility of government financing later on if the Orlando extension goes ahead.

“From a government perspective, Fortress is using private capital to get this passenger line started,” said the banker.

“If the government does offer a loan, Fortress absolutely will pay off the PIK. The government will want to have the first lien on the equity, not sit behind the PIK bondholders.”

The terms allow Fortress to buy back some or all of the bond at 112 prior to January 1 2017 with the proceeds of a government loan.

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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