New Issue: BIP FixedReset, 5.10%+292M510

Brookfield Infrastructure has announced:

that it has agreed to issue 8,000,000 Cumulative Class A Preferred Limited Partnership Units, Series 11 (“Series 11 Preferred Units”) on a bought deal basis to a syndicate of underwriters led by Scotiabank, BMO Capital Markets, CIBC Capital Markets, RBC Capital Markets, and TD Securities Inc. The Series 11 Preferred Units will be issued at a price of $25.00 per unit, for gross proceeds of $200,000,000. Holders of the Series 11 Preferred Units will be entitled to receive a cumulative quarterly fixed distribution at a rate of 5.10% annually for the initial period ending December 31, 2023. Thereafter, the distribution rate will be reset every five years at a rate equal to the greater of: (i) the 5-year Government of Canada bond yield plus 2.92%, and (ii) 5.10%. The Series 11 Preferred Units are redeemable on or after December 31, 2023.

Holders of the Series 11 Preferred Units will have the right, at their option, to reclassify their Series 11 Preferred Units into Cumulative Class A Preferred Limited Partnership Units, Series 12 (“Series 12 Preferred Units”), subject to certain conditions, on December 31, 2023 and on December 31 every five years thereafter. Holders of Series 12 Preferred Units will be entitled to receive a cumulative quarterly floating distribution at a rate equal to the 90-day Canadian Treasury Bill yield plus 2.92%.

Brookfield Infrastructure has granted the underwriters an option, exercisable until 48 hours prior to closing, to purchase up to an additional 2,000,000 Series 11 Preferred Units which, if exercised, would increase the gross offering size to $250,000,000.

The Series 11 Preferred Units will be offered in all provinces and territories of Canada by way of a supplement to Brookfield Infrastructure’s existing short form base shelf prospectus.

Brookfield Infrastructure intends to use the net proceeds of the issue of the Series 11 Preferred Units to fund an active pipeline of new investment opportunities and a growing backlog of committed organic growth capital expenditure projects, and for general working capital purposes. The offering of Series 11 Preferred Units is expected to close on or about September 12, 2018.

They later announced:

that as a result of strong investor demand for its previously announced offering, the underwriters have exercised their option to increase the size of the offering to 10,000,000 Cumulative Class A Preferred Limited Partnership Units, Series 11 (“Series 11 Preferred Units”). The Series 11 Preferred Units will be issued at a price of $25.00 per unit, for gross proceeds of $250,000,000. The Series 11 Preferred Units are being offered for distribution to the public on a bought deal basis by a syndicate of underwriters led by Scotiabank, BMO Capital Markets, CIBC Capital Markets, RBC Capital Markets, and TD Securities Inc.

The Series 11 Preferred Units will be offered in all provinces and territories of Canada by way of a supplement to Brookfield Infrastructure’s existing short form base shelf prospectus.

Brookfield Infrastructure intends to use the net proceeds of the issue of the Series 11 Preferred Units to fund an active pipeline of new investment opportunities and a growing backlog of committed organic growth capital expenditure projects, and for general working capital purposes. The offering of Series 11 Preferred Units is expected to close on or about September 12, 2018.

There are two non-standard elements to this issue. First, distributions are not dividends: they are Return of Capital and (potentially fully taxable) other things (commentary from my commentary regarding the announcement of BIP.PR.D:

I understand that the Return of Capital percentage of distributions is forecast – but by no means guaranteed! – to be about 50% over the next five years. See the discussion of BIP.PR.A for some sample calculations regarding the implications of this.

Second, it is likely, although not certain, that conversion of this issue into a FloatingReset when the time comes may be a Deemed Disposition and therefore trigger a capital gain or loss (commentary taken from my discussion of BIP.PR.D’s closing):

Update, 2017-10-11: Note that according to the prospectus, available on SEDAR under “Brookfield Infrastructure Partners L.P. Jan 19 2017 19:48:49 ET Prospectus (non pricing) supplement – English PDF 525 K”:
The reclassification of a Series 7 Preferred Unit into a Series 8 Preferred Unit or a Series 8 Preferred Unit into a Series 7 Preferred Unit, whether pursuant to an election made by the Resident Holder or pursuant to an automatic reclassification, may be considered to be a disposition of the Series 7 Preferred Unit or Series 8 Preferred Unit by the Resident Holder. The CRA’s position is that the conversion of an interest in a partnership into another interest in the partnership may result in a disposition of the partnership interest by the holder if the conversion results in a significant change in the rights and obligations of the holder in respect of the converted interest, including a significant change in the percentage interest in the profits of the partnership. Whether or not the reclassification of Series 7 Preferred Units into Series 8 Preferred Units or Series 8 Preferred Units into Series 7 Preferred Units would result in a significant change in the percentage interest of a Resident Holder in the profits of the Partnership is a question of fact that depends upon the facts and circumstances that exist at the time of the reclassification.

The new issue is extremely expensive according to Implied Volatility Analysis:

impvol_bip_180905
Click for Big

According to this analysis, the fair value of the new issue on September 5 is 23.41.

The ludicrously high figure of Implied Volatility is something I take to mean that the underlying assumption of the Black-Scholes model, that of no directionality of prices, is not accepted by the market; the market seems to be taking the view that since things seem rosy now, they will always be rosy and everything will trade near par in the future.

I balk at ascribing a 100% probability to the ‘all issues will be called, or at least exhibit price stability’ hypothesis. There may still be a few old geezers amongst the Assiduous Readers of this blog who can still (faintly) remember the Great Bear Market of 2014-16, in which quite a few similar assumptions made earlier turned out to be slightly inaccurate. The extra cushion implied by an Issue Reset Spread that is well over the market spread is worth something, even if nothing gets called.

Or, to put it another way, one can buy a whole lot of downside protection for very little extra money, relative to this issue. For instance, BIP.PR.D, FixedReset, 5.00%+378M500, ROC + Interest, is bid at 25.08 (theoretical fair value of 25.33, according to the above analysis, which ignores the interim dividend shortfall). You’re giving up about $0.025 p.a. in dividends until it resets 2022-03-31, sure, but that’s hardly a big deal and you’re getting a significant amount of protection in the event of a market downturn, and a bit more dividend afterwards. Is it worth it? Well, that will depend a lot on your aversion to loss … I’m just saying that buying the same amount of protection costs more in most other series of FixedResets.

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