Intro
This entry constitutes a novelty – so far, all entries have been about a
specific stock, while this post is about an attractively priced bond with an
excellent risk reward situation (and why not profit from it?). The Canadian
company that issued this bond is Alaris Royalty, a highly diversified royalty
firm with the majority of its assets in the US. Alaris’ business model is to
advance money to companies and in return receives a percentage of the investees
revenues – in other words, Alaris sits in the capital structure between the
equity holders and banks, a form of hybrid capital. Hence, companies requiring
money usually have one of the following needs: growth capital, partial
liquidity, recapitalisation or for a management buyout (MBO). Alaris has been
public since 2008 and currently holds royalty interests in 16 partners.
Valuation
Alaris is only as strong as the weakest link in the chain, its royalty
partners – if they are able to make their royalty payments to Alaris then
Alaris will do fine and generates a significant amount of cash flow. However,
by having a meaningful portfolio, sooner or later some of the investees will
face difficulties; the crucial thing is to make sure the losses and gains will
balance out within the broad portfolio. Looking at the balance sheet as of end
of March, Alaris has total investments (its royalty investments) of approx.
C$740 million and cash as well as promissory notes of around C$50 million. On
the other side of the balance sheet, the liabilities, loans amount to roughly
C$150 million and the aforementioned bond is with C$92 million in the books. As
a result, assets are close to C$800 million while interest-bearing liabilities
amount to C$242 million – at least as of March a wide margin of safety.
By now, you may ask yourself: what is this bond exactly? The Alaris bond
is actually a subordinated convertible debenture that pays annual interest at
5.50%, can currently be bought at 85% and will be repaid at 100% in June 2024. This
translates into a yield of approx. 10.1% p.a. – not too shabby in the current
interest rate environment. As always though, the devil is in the detail: The
bond is subordinated, meaning if Alaris goes belly up, proceeds will be
received ahead of the shareholders but after other loans and borrowings are fully
paid back. Furthermore, according to its prospectus, Alaris can choose to repay
the bond with its own shares, at the then prevailing price and a discount of
5%. In short, if worst comes to worst, bondholders might end up as shareholders
– a scenario the company and the bondholders want to avoid under any
circumstances and as of now only has a low probability.
What’s next?
Luckily, Alaris sold its biggest investment ‘Sales Benchmark Index SBI’
in February 2020 for roughly US$91 million and its proceeds were used to repay
its credit line. It is evident that the timing was superb, and a potential
later sale would have resulted in lower proceeds. From a total portfolio point
of view, Q1 2020 was still alright and most partners showed sufficient coverage
ratios. It won’t come as a surprise though, that Q2 will look much worse and
that Alaris might have to either postpone or even waive some of the royalty
payments from its partners, followed by potential write offs of some of its
investments. However, this shouldn’t worry bondholders yet and Alaris still has
a lot of wiggle room in case it needs to preserve liquidity, be this either
through the complete suspension of the dividend or making use of further
drawings of its credit line.
Current Price
C$85.00
(i.e. 85%), listed on the Toronto Stock Exchange under symbol ‘AD.DB’
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