Tuesday 9 October 2012

CO-OP 5.5555 ... it's not what you do, it's the way that you do it

The rationale for my purchase of some of the Co-op’s BB+ rated perpetual bonds was incomplete in so much as there were two attractions to the trade. The first appeal was the price and potential return on the bond, which I have detailed prior (and repeated below). The second appeal was the method through which I bought them, which was through my spreadbet provider, ETX Capital.

While it is widely known that indices and equities can be traded with margin and tax efficiently through a spreadbet, surprisingly few investors are aware that it is also possible to trade bonds (sovereign and corporate) the same way. In the case of bonds, this has the great advantage of mitigating the tax liability on any income streams from the coupons, i.e. the coupon is received in its entirety, gross, rather than receiving net of tax. Further, ceteris paribas, the income returns can be enhanced through purchasing the bond on margin. 

The above is probably easiest made clear through a description of my purchase of the Co-op perpetual. The bonds were/are priced at 77p/shr and pay a coupon of 5.5555p/shr (7.2% yield) until December 2015. So I bought 100,000 of them through ETX Capital at a cost of £77,000. Therefore, I expect to receive £5,555.50p per annum through to December 2015. However, ETX Capital offer 25% margin on this line of stock, so the capital which I had to provide totalled 25% x £77,000 = £19,250. I still receive the £5,555.50p pa, so my return on equity (ROE) = £5,555.50 / £19,250 = 28.9% pa. 

In December 2015, the Co-op can decide whether it wishes to call them at par (100p/shr) or not. If the Co-op calls the bonds then I’ll get 23p/shr (100p less purchase price of 77p), or a capital gain of £23,000 and will have accumulated three lots of 5.5555p/shr in between, an income stream totalling £16,666.50p. That comes to 39.7p/shr, or a £39,666.50p gain, or a 51.5% (gross) return over three years. But, because I have bought through ETX Capital, the tax free return on equity is actually £39,666.50p / £19,250 = 206% (gross) over three years. 

Of course the Co-op may decide not to call in 2015 and in that event the coupon drops from 5.5555p/shr to 3-month LIBOR +205bp. Not calling is generally discouraged, but it would mean a post 2015 coupon of c. 2.69p/shr (at current LIBOR). If the bonds aren’t called and the coupon drops to 2.69p/shr, then I reckon the price of the bond drops to c. 68p. This price would equate to capital loss of £9,000, but having still received the 5.5555p coupon each year, the total gain would equate to £16,666.50p - £9,000 = £7,666.50p over three years. Again, because I have bought through ETX Capital, this is tax free and the return on equity = £7,666.50p / £19,250 = 39.8% (gross) over three years. 

So I reckon that having bought through ETX Capital, the ROE over three years will be somewhere between 39.8% to 206% . That appears pretty attractive to me, and I expect the Co-op will call the bonds, which is why I bought and did so through ETX Capital.

Co-op 5.5555 08/29/49 perpetual bond
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.


  1. Hi Matthew,

    Interesting way of playing this bond ! I'm interested in your calcs/use of ETX, since it appears from your figs that they're not charging you anything for the credit they're giving you (75%)...is this correct ?

    Also interested in your take on AVN's latest IMS btw.


  2. Hi,

    Yes, good spot. The return potential I have detailed is gross. ETX Capital charge me (and I presume others) 2-3% pa for the cost of funding. Accounting for this, I reckon the ROE will be between 5-172% over three years. Overall, I think the likelihood is that at some point the Co-op make a tender offer over the next 12-18 months at 88-90p. In which case, the ROE (post funding cost) will be somewhere between 75-94%. If that happens, I view that as an attractive return over that time frame for the risk involved.

    On AVN, I sold short after the release of its prelims announcement (10 Oct). I have already detailed my key concerns, which centred on the "conservative accounting" rhetoric and more so the Filiago financing/acquisition.

    While I have not spoken to Avanti (my prior attempts of communication have been ignored) I have heard that the company has recently advised that no cash has gone to Filiago. I don’t see how this can be the case. In Avanti’s 2011 accounts, it clearly states (within the Investing cash flow section) that there was a cash outflow for £8.857m relating to a payment for “other financial assets and investments.” This would appear to be the loan to a major strategic partner (which now appears to be Filiago). This then turns up on the balance sheet as an “other financial asset”, although it is for £9.135m, and is detailed further in note 13. To date, there appears to have never been a cash flow back from this strategic partner. The cash has been replaced by a business (Filiago) which contributed a £0.5m loss from date of acquisition to 30 June 2012, has net liabilities of £0.763m and has goodwill and intangibles of £9.211m. In short, Filiago had £2k of cash by the time it turned up on Avanti’s balance sheet. The rest of the cash is gone and replaced by a subjective estimate of intangible items.