Money: A capital scheme

By MARK FRYER

With the banks paying just over 6 per cent, any investment offering 9 per cent is guaranteed to attract interest.

So it is with Guinness Peat Group's bid to raise $250 million from New Zealand investors, with the promise of at least 9 per cent for the next five years.

But while 9 per cent has obvious attractions, Guinness Peat's deal is a little more complicated than your standard bank term deposit.

What's on offer here are something called capital notes, a type of fixed-interest investment with its own peculiarities.

Guinness Peat isn't the only company to issue capital notes, but its offer is particularly large, high-profile, and comes at a time when there is strong demand for fixed-interest investments.

But before filling in the application form and mailing off your cheque, it's worth asking a few questions.

Who is Guinness Peat and what does it want?


Guinness Peat Group (GPG) is a London-based investment company - meaning it buys stakes in other companies - whose shares trade on the UK, Australian and New Zealand sharemarkets.

Its investments are a diverse lot: everything from a chunk of car distributor Inchcape, to Australian aluminium company Capral, to New Zealand fruit and vegetable company Turners & Growers.

The chairman is one Sir Ron Brierley, who you may have heard of.

What it wants is $250 million. The capital notes offer amounts to Brierley and friends asking you to lend them a cool $250 million.

Guinness Peat is keeping mum about what it plans to do with all that cash, beyond saying it wants to be ready to "act quickly and decisively when required".

The secrecy is not unnatural, given that the element of surprise can come in handy when you're in the business of buying up big chunks of other companies.

What are capital notes?


Just another way in which a company can borrow money from the public.

Boil it down and a capital note is simply a promise by the issuer - in this case it's a company called GPG Finance, wholly owned by GPG itself - to make interest payments at certain dates in the future.

So far, they're much the same as other fixed-interest investments, such as Government stock or corporate bonds.

However capital notes come with a couple of twists.

Twist number one is that capital notes have an "election date" - November 15, 2006, for GPG's notes.

At that date investors can either convert their notes into ordinary GPG shares - paying slightly less than the market price - or keep holding them, on conditions to be advised at the time. GPG also has the right to compulsorily purchase notes at that date, regardless of what the noteholder might want.

Twist number two is that, like most such investments, GPG's notes are "unsecured" and "subordinated".

What that boils down to is that, if GPG gets into financial trouble, note-holders will be well back in the queue lining up for a payout - behind the other people GPG owes money to, but ahead of ordinary shareholders.

What's the big attraction?


In short, the attraction is 9 per cent. The first payment is due on November 15, then every three months until November 15, 2006.

It could be more than 9 per cent; GPG is promising to pay either 9 per cent or the rate on November 2006 Government stock, plus another 2.75 per cent, whichever is higher (the final rate will be set on September 13, but at the current Government stock rate it would be a shade over 9 per cent).

Guinness Peat says note-holders will receive the full interest payments, without any tax being withheld. But, like any other interest payments, they will be taxable.

Besides the return, capital notes have the advantage of being tradeable, in the same way as some other fixed-interest investments such as Government stock.

That means that, if you want to get your money out before November 2006, you can sell some or all of your notes to other investors.

The notes are expected to be traded on the Stock Exchange, and some banks also buy and sell fixed-interest investments.

Because these are capital notes, not shares, you don't benefit from any rise in GPG's share price (or suffer from a fall), and you won't get any dividends.

What are the risks?


The big worry is that GPG could get into financial strife and be unable to make good on its promises.

Ultimately, if the company went into liquidation, note-holders' chances of getting back all their money could be slim.

Short of that danger, if GPG does strike problems then note-holders who want to exit before November 2006 might find there are few buyers for the notes, and that the only way to get out is by selling at a low price.

The trouble is, measuring the size of that risk is next to impossible for most investors.

Some fixed-interest investments come with a credit rating - "AAA" for the most secure, "AA" for those on the next rung down and so on. The better the rating, the lower the return the borrower has to offer to attract investors.

But, like most capital notes, GPG's are not rated.

One firm which specialises in credit ratings, Standard & Poor's, recently warned that investments such as capital notes carry "materially higher risks to investors" compared with more highly ranked fixed-interest investments - though they are less risky than shares.

"The real question I think you've got to ask yourself is, are you being paid enough for the risk?" says Craig Stobo, chief investment officer at BT Funds Management.

"Some might argue, relative to what you can get at the bank, yes. Others might argue that because they're not secured and the cash flows are lumpy with this sort of organisation you might want a higher return than what has been offered."

While Guinness Peat has a good track record of deal-making, he says, "They're unsecured so you're relying on the management and the company to repay you."

Aaron Hing, head of financial advice at Spicers, says: "It's going to come down to the ability of the individuals who run GPG to make sound decisions going forward. Yes, they've got a good track record but who's to know what's going to happen?

"Sometimes we're a little cynical on these because we say you're getting a fixed-interest return but taking an equity risk."

Even if GPG prospers and makes all the interest payments on time, anyone who sells before the election date runs the risk of making a loss - or the chance of earning a capital gain - because they will have to take whatever price the market sets for the notes.

That prospect of a capital gain or loss doesn't apply if you hold the notes through to the election date, but it's worth keeping in mind if you think there's any chance of having to sell early.

What are the alternatives?


If it's fixed-interest you're after, there's no shortage of choice.

Beyond the familiar term deposits, there are a variety of fixed-interest investments which trade in the same way as capital notes.

Depending on the term you want, and the risk you're willing to take, you can choose from Government Stock (now offering 5.71 to 6.48 per cent, depending on the term, which can be more than 10 years), corporate bonds (5.46 to 7.18 per cent, depending on the issuer and the term), and capital notes offering anything up to 11.85 per cent.

The minimum investment is typically $5000 or $10,000, though it can be as low as $1000.

Such investments are available through sharebrokers and some banks.

At least one more major issue of capital notes is likely, with the giant dairy company GlobalCo expected to offer $100 million or more, though that is not expected until October at the earliest.

The practicalities


Guinness Peat capital notes are available only through NZ Stock Exchange members.

The minimum investment is $5000, and thereafter in multiples of $1000.

The offer runs until September 11, although it could close earlier if GPG raises the $250 million it wants before then.

There is no application fee (GPG pays brokers handling the notes a 1.25 per cent commission).

* Contact Personal Finance Editor Mark Fryer at Business Herald, PO Box 32, Auckland. Phone (09) 373-6400 ext 8833. Fax (09) 373-6423. e-mail mark_fryer@herald.co.nz