Singapore Airlines to redeem its convertible bond: Good news for bond holders?

Singapore Airlines announced on 25 October its intention to redeem its $3.86 billion convertible bonds (including a 10.4% interest payment on the principal amount).

These $3.5 billion 2020 Mandatory convertible bonds (MCBs) that were issued during the pandemic when air traffic was severely impacted was just part of the airline’s overall $19 billion rescue package, but with this move, could this be a sign that the airline is out of the woods?

Also, with this redemption, are shareholders (including Temasek) on the winning or losing end?

Finally, what are the chances of Singapore Airlines redeeming its $6.2 billion 2021 MCBs?

Continue reading to find out.

Recap

Before that, here’s a refresher on SIA Mandatory Convertible Bonds (MCBs):

During the pandemic, two tranches of MCBs were issued: 2020 MCBs and 2021 MCBs. In general, they both have the same maturity date and are zero coupons, as explained below.

• $6.2 billion of 2021 MCBs – May 2021
• $8.8 billion of rights shares and 2020 MCBs – April 2020

Maturity Date

• 8 June 2030

10 years for 2020 MCBs and approximately 9 years from the date of issuance for 2021 MCBs

Interest

• Every six months, SIA has the option of redeeming these MCBs early. Depending on the year of redemption, your annualised yield will range from 4% to 6%. The closer to maturity, the higher the yield.

Zero-coupon

• The MCBs are zero-coupon bonds, which means you will not get interest payments on a yearly basis. Instead, you will receive a single lump sum in cash (if redeemed before maturity) or shares (if redeemed at maturity). The maturity amount at the end of each year is as shown below.

Mandatory Conversion

• If the bonds are not redeemed, they will be converted to SIA ordinary shares at a conversion price of $4.84 per share upon maturity.

Why is the company doing this now?

SIA passenger capacity has gradually increased to 61% in the first quarter of FY2022/23 since restrictions began to ease in September 2021. As a result, it reported a record first-quarter operating profit of $556 million, the second-highest quarterly profit in the company’s history. This was also a $623 million improvement over the prior quarter.

From an operational standpoint, the company generates about $0.5 billion in cash per quarter, which isn’t much compared to how much it redeems. Nonetheless, this was done because the firm now has $16.1 billion in cash and cash equivalents. An amount that was used to buffer against the pandemic but is now unnecessary and, in fact, a burden given the current inflationary environment. With rising management confidence in the sustainability of the current recovery in passenger volume, it is probably why they have chosen to redeem the 2020 MCBs now.

Who ultimately benefits?

Singapore Airlines

The first and most obvious is the company itself. This bond insurance, along with the right issue, enabled the company to survive two of the most difficult years when some airlines were on the verge of bankruptcy. While it came at a hefty cost in terms of borrowing and dilution, it was necessary and has paid off. The company can now tell their story for many years to come.

Bondholders

Then there are the bondholders, those who own MCBs. With SIA redeeming the 2020 MCB early, the total return for investors is 4% annualised, which is not bad.

However, another way to look at it is that bondholders can no longer obtain a higher yield. That is because If SIA does not redeem it after year 5, the return will grow to 5% annualised and eventually 6%.

To go to the extreme, if the bond was not redeemed, it would have been converted to SIA ordinary shares at a conversion price of $4.84 per share upon maturity. Given that the current share price is now $5.14 per share and that it stays that way for the next 8 years, you could actually make some capital gains.

All of this is lost with the early redemption, but ultimately it was still a decent deal for bondholders.

Shareholders

This announcement has certain benefits for shareholders as well. Singapore Airlines’ stock gained roughly 2% following the announcement of this redemption. This favourable reaction was most likely due to the reduced level of stock dilution that could have occurred if the bond had been held to maturity. As such, it was regarded as beneficial to the shareholder.

Aside from that, this announcement raised the possibility that SIA may begin dividend payments soon, which is a plus for investors.

That said, although shareholders did benefit from both factors, in the overall scheme of things, did they actually benefit? While the convertible bond is expensive, what actually harmed shareholders is the rights issuance done in conjunction with the 2020 MCBs. When a business like REITs issues rights, it is usually to increase its market size and revenue. However, in the instance of SIA, this was used for operational purposes; therefore, there was no revenue growth. As a result, with more shares and flat earnings, earnings per share would be diluted. So, in the grand scheme, shareholders who owned SIA before the pandemic may have been on the losing end.

Temasek

What about Temasek, who has provided SIA with a ton of money? When only considering the 2020 MCBs, Temasek profited alongside the bondholders. However, if we take into account that Temasek is both the bondholder and shareholder of SIA (similar to the majority of SIA retail investors), it is likely that the dilution from the rights purchase overshadowed the benefit from the bond investment.

Will the 2021 MCBs be redeemed?

Looking at SIA’s outlook, group capacity has been hovering around 67% of pre-pandemic levels in recent months, and the company is expecting this capacity to reach 76% in the third quarter of FY2022/23. Following this pattern, SIA seems to be in an excellent position to consider redeeming its 2021 MCBs as well.

After redeeming the $3.5 billion 2020 MCBs, SIA would still have roughly $12 billion in cash, allowing them to redeem the 2021 MCBs easily.

Having said that, I believe the company would like to be slightly conservative here. Redeeming it now will leave the corporation with about $5 billion. While that is certainly a lot, keep in mind that in 2020, when shit hits the fan, the company actually burned $4.6 billion for the year.

You absolutely don’t want a scenario in which you redeem the 2021 MCBs and then issue another new bond shortly after should the situation worsen unexpectedly.

That said, I believe if SIA can keep up its positive cash flow in the coming quarters, the management will likely redeem the 2021 MCBs soon. So probably in a year or two.

Conclusion

Overall, this is excellent news for 2020 MCB holders, and for 2021 MCB holders, your turn will come soon.

Nevertheless, while the battle was won, SIA investors may have lost the war in the grand scheme of things. This leads us back to the discussion that just because a company is government-backed does not indicate it is a good investment, and investors should not let this affect their judgments.