Tuesday, 19 August 2008

Gunns and the sale of assets

Discussion about the possible reasons for Gunns proposing to sell $170 million of their plantation assets has largely overlooked the fact that $120 million worth of hybrid securities called FORESTS (Frankable Optionally Redeemable Equity Settleable Transferable Securities) which trade on the ASX under the symbol GNSPA need to converted to shares or redeemed by 14 October 2008 or else Gunns may face an increased payment of 2.50% pa to the holders of the securities.

Existing shareholders aren’t always keen to see more ordinary shares issued when the share price is languishing. It dilutes their holding too much. This is particularly true of the old Auspine shareholders who accepted Gunns’ shares when the takeover occurred but who have since lost a third of their value.

Hence converting the hybrid securities to ordinary shares may not be the most attractive option.

Redeeming the securities may be the preferred path.

But having to sell assets to do so is a little bit of a surprise for a Company that is proposing (still?) to lead the State into our Glorious Economic Future.

According to the prospectus for the securities issued in October 2005, approximately 70% of the $120 million raised was to be used for land acquisition by Gunns’ MIS business.

As a point of interest, the hybrid securities pay a return of 2.5% above the 90 day bank bill rate. Because the distributions paid to security holders are fully franked, 70% of the returns are paid in cash while the remaining 30% is a franking credit. So in cash terms the interest bill to Gunns for MIS land acquisition has been less than the 90 day bill rate.

In order to be able to pay a franked distribution, a company must have available franking credits. These arise when a Company pays income tax.

In Gunns’ case, in recent years, Gunns has made profits, and paid income tax largely because of their MIS business which only survives because of tax subsidies to investors who purchase a leasehold interest in land owned by Gunns but which has been financed by hybrid securities which pay cash interest at less than the 90 day bill rate.

So not only have taxpayers subsidised the entry fees paid by MIS investors, they have also subsidised the returns paid by Gunns to hybrid security holders who provided the funds to Gunns to purchase the land in the first place.

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