The recent announcement by Olam that they will be raising debt with warrants of US$1.25 bil is nothing short of shocking. This comes right after the CEO Sunny Verghese saying that they did not need to go back to bond markets for another 6 months or so. The fact that they suddenly turned around makes their credibility questionable.
High Cost of Debt
For each 1000 shares, rights will be issued to buy 313 bonds priced at 95cents on the dollar. These bonds come with a 6.75% coupon making them effectively 8% in yield. This is far higher than any of the bond issues Olam had done in the past few years. It shows a dramatic rise in risk levels.
Warrants Attached Makes the Rights Even Pricier
What’s worse is that the bonds are stapled with 162 free warrants to subscribe to Olam at $1.575 within the next 3-5 years. With the warrants, Carson Block estimates the effective cost to be in excess of 10%. Existing bond prices have dropped significantly, resulting in higher yields of up to 12%. So the cost of borrowing is extremely high now, reflecting the risks of Olam and may be unsustainable as Olam is significantly overleveraged and has huge cash burn. The cost of new debt is much higher now and Olam may be in trouble as the older debt tranches mature.
Temasek to Underwrite The Issue, A Bailout?
Why does Temasek need to underwrite the issue if banks were still lending money freely to Olam? Muddy Waters thinks that this is more of a bailout and confirms their theory that Olam was within days from collapsing. While days from collapsing may be somewhat exaggerated, the fact that Temasek has to underwrite the deal does say a lot about the bank’s support for Olam at this point. Remember that some of the REITs were forced to issue highly dilutive rights issue as they were unable to refinance their debts when the banks turned off the taps.
Olam’s Counter Reports Do Not Effectively Address Muddy Water’s Claims
After reading Olam’s counter reports, they have little to offer in terms of the huge accounting discrepancies highlighted by Muddy Waters. They also countered with a lawsuit which is useless and simply a waste of resources. It was a mistake to simply dismiss the 133 page report as there were a lot of issues raised which needed to be answered.
Olam’s Refusal To Take Muddy Waters Offer For a Rating Was a Big Mistake
Another mistake is for Olam to refuse to take up Muddy Waters offer a debt rating. Even Noble Group debt are rated, so why the fear of a proper debt rating for Olam? Unless they are afraid that a poor rating would push yields to even more unsustainable levels. Even then, the right move would be to bite the bullet and then try to address concerns raised by the debt rating agency to bring confidence back to investors.
It will be interesting to see how all this plays out. Bond holders who have debts maturing next year should hopefully be safe as the company is unlikely to fall that soon. The future debt maturities though are questionable. This can be seen by the drop in prices due to the higher duration for longer maturity bonds. Perpetual bond holders are the worst hit as they bought at par and now the perpetuals are trading less than 80cents on the dollar.
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