Qantas leaves bondholders on the tarmac

To me this represented the height of the glory days of finance. Could the national carrier really be taken over by a gang of big swinging financiers, and a mountain of loose loans? Surely Private Equity had gone too far.

***Qantas leaves bondholders on the tarmac (15 December 2006) ***

While the A$11 billion Qantas takeover by the Airline Partners Australia onsortium has the share market buzzing, Qantas noteholders are not sharing in the excitement.

The deal brings the classical conflict of debt and equity to life. Christmas has come early for shareholders in the form of a healthy premium, but bondholders are facing a significant capital loss as the entity’s credit rating looks set to slip from BBB+ to BB territory or beyond.

“It has once again highlighted the importance of covenants and change of control clauses,” said an investor.
“Hopefully now given this, we can make a stronger case to ensure bond structures better protect investors in the future,” said another investor.

Qantas has a A$100 million outstanding issue due in October 2007. The airline also has a number of outstanding US dollar issues US$450 million, due 2013, US$513 million, due 2016, US$236 million due 2009, according to Westpac capital markets research.

According to S&P, the bond documentation does not include any covenant protection against an LBO, and as such cannot demand repayment in the event of a successful LBO. This leaves noteholders fully exposed to the adverse effects on the credit.

There have been rumours that Qantas intends to follow PBL's example of buying back notes or compensating bond investors for a credit downgrade. Some observers however doubt that Qantas would have the same incentive to do so, given the limited protection offered in its documents relative to PBL bonds.

To finance its new private form Qantas looks certain to revisit capital markets in the future, with a requirement for an estimated $7.5 billion to $8.5 billion in debt, of which about $2.5 billion would need to be subordinated debt, and a stated capital expenditure program of $10_billion

According to reports, about half of the bid debt amount will be raised through notes secured by the Qantas aircraft fleet.

Qantas would not be the first Australian airline to issue bonds backed by its aircraft. According to Westpac capital markets research, Ansett Australia issued fleet backed notes about a decade ago.

“Given aircraft leases are quoted in US dollars, the $US market would appear to be the deeper market for an issue,” said Michael Phillip, head of Westpac capital markets research. Debt investors will be large stakeholders in the

Qantas of the future but at present, a number may be forgiven for feeling less than enthusiastic.

“As an Australian I feel somewhat offended that Allco et al claim that they are all Australian and that the deal struck is good for all stakeholders. Sort of the same feeling when Hoges divorced his wife,” said a fund manager.

He added: “What one picks up on the swing one loses on the roundabout. Pity the poor conservative Aussie that shoves his money into Fixed Income - multiple downgrade and at least a 1.5 per cent hit, and I imagine most shareholders have some fixed income super”.