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Lessons learnt from Hyflux's troubled waters, web of creditors; restructuring faces hurdles

Goola Warden
Goola Warden • 8 min read
Lessons learnt from Hyflux's troubled waters, web of creditors; restructuring faces hurdles
SINGAPORE (Feb 25): For much of the time since it was listed in 2001, water treatment company Hyflux was the poster child of entrepreneurship. In May 2018, however, the company announced it was seeking a court-supervised process to reorganise its debt and
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SINGAPORE (Feb 25): For much of the time since it was listed in 2001, water treatment company Hyflux was the poster child of entrepreneurship. In May 2018, however, the company announced it was seeking a court-supervised process to reorganise its debt and businesses. On Feb 16, it held a hastily arranged media briefing to explain the processes for restructuring, such as the scheme of arrangement for unsecured creditors, preference share and perpetual security holders, and a subsequent extraordinary general meeting (EGM) for equity holders.

To sum up, the holders of Hyflux’s $400 million worth of preference shares and $500 million worth of perpetual securities (PnP) will receive the second worst deal in the restructuring (the worst is for its shareholders). For every $1,000, PnP investors will receive just $30.15 in cash and $76.39 in Hyflux shares, or 10.7 cents for every $1 invested, if the scheme of arrangement meets all its conditions. On the other hand, the complexity of the voting process with different classes of creditors does not ensure a successful restructuring. The alternative is liquidation, where secured creditors such as Malayan Banking and the Public Utilities Board (PUB) can exercise their rights.

Hyflux’s troubles stem from its Tuaspring project, which it clinched in 2011. At the time, the company said the planned $890 million desalination plant could produce 318,500 cu m per day. Included in the desalination plant called Tuaspring — eventually Tuaspring Integrated Water and Power Plant — is an onsite 411MW combined cycle gas turbine power plant. Tuaspring has a water purchase agreement with PUB to supply water for a concession period of 25 years, starting from 2013. The first-year price for the desalinated water is 45 cents per cu m.

Tuaspring bears brunt of blame

When Hyflux bid for Tuaspring, it was already in a weak financial position. It had just $514 million in shareholders’ funds and net debt of $377 million, whereas the project size was $890 million. In 2011, Hyflux issued $400 million worth of preference shares with a coupon of 6% to help fund Tuaspring. In January 2014, it issued $300 million in perpetual securities, which have since been replaced by new tranches. The latest was a retail offering of $500 million of perpetual securities; the other tranches were for accredited investors.

“Funding for the Tuaspring project was through project finance debt as well as preference shares and perpetual capital securities raised by Hyflux,” the company replied when queried by the Securities Investors Association (Singapore). In its affidavit filed in relation to its court-supervised reorganisation, Hyflux explains that the shareholder loans and equity from Hyflux to Tuaspring were funded from the proceeds of the issuance of the $400 million preference shares, two earlier issuances of perpetual capital securities totalling $475 million and other corporate debt of Hyflux. “For the purpose of redeeming these earlierissuances of perpetual capital securities, the company raised the $500 million perpetuals,” Hyflux explains. According to the company, it embarked on a divestment of Tuaspring in early 2017 to free up capital for redemption of preference shares in April 2018, but was unable to find a buyer.

“Several challenges arose, including (i) losses from electricity generation, (ii) lack of potential buyers’ understanding of the market risks in the Singapore power market compared with other jurisdictions, as well as (iii) unexpected delays with respect to regulatory approval before bidders could get access to project information,” Hyflux says.

Although the Tuaspring power plant was projected to turn in profits as soon as it was operational in 2013, the oversupply of gas in the market caused wholesale electricity prices to drop from $220 per MWh in 2011 when the Tuaspring project was awarded, to an average of $81 per MWh in 2017, resulting in significant losses from electricity generation, Hyflux says. This led Hyflux to report a full-year loss in 2017. “When losses were also reported in its first quarter 2018 results released on May 9, 2018, certain financiers expressed concern over their ability to continue with existing credit exposures to the group,” Hyflux says.

Following the court-supervised process implemented last year, Hyflux is experiencing hiccups in its TuasOne waste-to-energy project. “The TuasOne WTE Project has been [affected] by slippages in the completion timelines. As a result of the delays in the estimated completion deadline, the projected cost-to-complete for the TuasOne WTE Project was $177 million,” Hyflux says.

Financing of Tuaspring starts to raise questions

Lessons could be learnt from the Hyflux experience. The credit standing of successful bidders of strategic infrastructure projects are likely to be more carefully scrutinised in the future.

Despite Hyflux’s financial position, banks continued to propose that the company issue quasi-equity such as PnP. Prior to the retail offering of perpetual securities, it was already pretty clear that sustaining coupon payments would be challenging. Yet, the bookrunner — the debt capital markets unit of DBS Group Holdings — upsized the offering to $500 million, from $300 million, in 2016.

By 1QFY2018, Hyflux had just $128.8 million in ordinary equity, no retained earnings or reserves, with the rest of its capital structure comprising preference shares and perpetual securities. In the meantime, net debt, excluding the PnP, was around $1.3 billion.

The Singapore bond market has experienced issues in recent years, particularly that of issuers defaulting on coupons for high-yield bonds in the offshore and marine sector. The high-yield bonds were not retail bonds, however, and were offered to accredited investors who were traditionally wealthy. The regulators may be interested in scrutinising the nature of Hyflux’s retail perpetual security offering and examine the financial advice it received. There were obviously gaps in disclosure.

No certainty of restructuring

According to OCBC Credit Research, Hyflux’s balance sheet “contains many levels of external capital that are subject to the debt moratorium”, including unsecured bank borrowings, senior bondholders, preference shares and perpetual securities. “This dispersion of interests (and bargaining power) has [probably] reduced the effectiveness of Hyflux’s debt moratorium and is likely to impede the provision of an acceptable restructuring plan for all parties within the timetable proposed,” OCBC cautions.

At the Hyflux briefing, a spokeswoman said: “In a liquidation, only unsecured creditors would receive a return. We did an analysis and the range was 3.2% to 8.7% to the senior creditors, noteholders and trade creditors. Even at that level, they get less than 10 cents in the dollar.”

The voting process in the scheme of arrangement is also fraught with uncertainty. First, 50% of the number present must vote for the restructure, and the 50% need to carry 75% in value. “If it doesn’t pass either threshold, the scheme fails,” the spokeswoman said. Equity holders must also approve the restructure in a separate EGM.

OCBC reckons dissent could emanate from the PnP class. “This is [possible], given the number (more than 34,000) of perpetual and preference shareholders [holding] $900 million in subordinated unsecured obligations, representing around 30% in total value of affected claims,” OCBC says.

There could be competing claims. Tuaspring was last valued at $1.5 billion in 2018. Maybank’s exposure to it stands at $602.4 million and OCBC estimates Tuaspring could fetch $553 million in a liquidation sale. According to Hyflux’s affidavit, however, in the event of a liquidation, PUB may terminate the water purchase agreement with Tuaspring and exercise its step-in rights to take over Tuaspring. “In that event, Hyflux would have little to no value to extract from [Tuaspring]. The scheme parties that only hold claims against Hyflux, in particular, the holders of the preference share claims and preference capital securities, are unlikely to have any recovery,” Hyflux states in its affidavit.

Despite its financial position, banks continued to propose that Hyflux issue quasi-equity such as PnP. Prior to the retail offering of perpetual securities, it was already pretty clear that sustaining coupon payments would be challenging. Yet, the bookrunner upsized the offering to $500 million, from $300 million, in 2016.

Expensive debt or cheap equity? The problem with perpetuals

Perpetual securities — popular during the quantitative easing years because they provided higher yields than plain-vanilla bonds — are not safe investments, according to prospectuses for perpetual securities. While they are recognised as equity by regulators and can be used to beef up capital, perpetual securities are often viewed as expensive debt. Because perpetuals are subordinated to senior and junior bonds, and rank above equity, they possess the disadvantages of bonds and equity.

In the Singapore context, the call dates are usually at the first five-year mark. If perpetuals are not called, there is often a punitive “step-up” in the coupon. In Hyflux’s case, distributions for its preference shares would rise to 8%, from 6%.

Interestingly, issuers of perpetual securities are not obligated to pay the coupon, nor does the company issuing them have to “call” these securities even though specific call dates are announced at time of issuance. Indeed, there is no obligation to pay distributions to holders of ordinary shares, preference shares and perpetual securities. Preference shares and perpetual securities are subordinated to bonds.

In addition, a deferral of distribution payments for preference shares and perpetual securities does not constitute a default. This is unlike bonds, where failure to pay the coupon at the appointed date represents a default and bondholders have the right to take action against the issuer, as was seen in the incidents of bond defaults in the offshore and marine sector.

On the other hand, perpetual securities are useful for real estate investment trusts, which look for several sources of liquidity and capital. REITs are regulated and have to abide by a regulatory debt-to-asset ceiling of 45%, rendering the perpetual securities issued by them to be relatively safe.

Investors who wish to invest in perpetual securities for their higher yields would be well advised to read the small print and check the issuers’ balance sheets and interest cover regularly.

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