As commonly known, BHP Billiton Limited (BHP) is the worlds largest diversified resources group with a global portfolio of quality assets, whose core activities comprise of production and distribution of minerals, mineral, material products and petroleum. BHP was formed by the merger between BHP, a leading global natural resources company, and Billiton, a premier mining company in the world. It is listed in four different securities exchanges around the world, including Australian Securities Exchange (ASX), New York Stock Exchange (NYSE), London Stock Exchange (LSE) and Johannesburg Stock Exchange (JSE).
As one of the four biggest banks in Australia, ANZ Banking Group Ltd (ANZ) is a major Australian-based bank with retail and business banking in Australia, New Zealand and the Asia Pacific. It has been expanding into presence in 14 Asian countries. Australian operations comprise most of ANZ's business, offering a broad range of banking and financial products and services to retail, small business, corporate and institutional clients, including commercial and retail banking, insurance services as well as funds management.
With a fully integration of the design, development, assembly testing, installation, production, sale and support servicing of gaming machines and other related equipment and services, Ainsworth-Game Technology Ltd (AGI) design and manufacture the A560, Ambassador and Celebrity range of gaming products along with a range of entertaining stand alone progressives and linked games to the worldwide markets.
As an ASX listed A-REIT, Growthpoint Properties Australia (GOZ) is one of Australia's leading fund management companies, which specialises in the investment of industrial property, with a variety of quality tenants such as Woolworths, Coles Group, etc. It currently owns a diversified portfolio of 25 industrial properties throughout Australia. It has a stapled entity structure, with internalised management, consisting of Growthpoint Properties Australia Limited (the Responsible Entity) and Growthpoint Properties Australia Trust. The Stapled Group aims to provide investors with a tradeable security producing consistently growing returns and long-term capital appreciation.
Characteristics of Each Type of Security
Ordinary Share
Ordinary shares, also known as common shares, are the most commonly traded securities. Holders are expected to gain income in the form of dividends, capital gains and voting rights. They are granted the ownership of a company, who accordingly are able to influence the corporation through votes on establishing corporate objectives and policy, share splits, and electing the company's board of directors. In case of a rights issue, holders of ordinary shares receive preemptive rights, which normally enable them to purchase new shares at a discounted price. Ordinary shares have no maturity date. Holders of ordinary shares may receive regular dividend payments in cash, shares or other forms, if the company trades profitably. However, the dividends vary over time with the level of profits and ordinary shares have the lowest priority to claim the assets when the company is liquidated, the ordinary share holders generally face higher risk and their returns are relatively more volatile, contingent on company earnings, reinvestments as well as the efficiency of the market. Even so, the long-term return of ordinary shares, on average, is higher than any other securities (Lonergan, Wayne 2003).
Preference Share
The preference share, also called preferred share, is a special type of equity security that has properties of both equity and debt instrument and thus it is generally considered as a hybrid security. Preference shares are ranking ahead of ordinary shares, but are subordinate to bonds in case of liquidation. They generally pay a fixed dividend either semi-annually or quarterly that is paid out prior to any dividends being paid to ordinary share holders. The dividends may be cumulative or noncumulative, but in most cases they are cumulative. In case of bad situation, unpaid dividend would typically be credited to the preference shareholder's account and accumulated to the future payment. On the other hand, preference share dividends could be participating or nonparticipating, while the latter is the common case. Participating preference shares share in earnings with the ordinary shares beyond its stated dividend payment. Typically speaking, preference shareholder's return is locked at the fixed dividend payment streams (because of the feature of nonparticipating) and therefore it does not tend to appreciate as quickly as the ordinary share if the company runs well. Preference shares usually carry no voting rights. However, they do have contingent voting rights. That is, in times of financial trouble, for instance, if the company failed to pay the dividends for a certain period, preference shareholders would be given the rights to elect some of the directors, vote approvals on the issuance of new preference shares, mergers and acquisitions, etc. Preference shares have no maturity date, but may be callable by the issuing company. This provides flexibility for company management, but on the other hand, it may be detrimental to the investor. Preference shares are usually nonconvertible, but some of them may carry the conversion feature to attract the investors, which is identical with convertible notes. Similar to bonds, preference shares are rated by the major credit rating agencies. However, the rating for preference shares is typically lower since preferred dividends do not carry the same guarantees as interest payments from bonds and they have lower ranking to bond holders when the company is wound up.
For companies, preference shares have two main advantages. The money raised by preferred shares does not have to be paid back, whereas a bond issue must be redeemed on the maturity date. Companies can also write part of the dividends paid as an expense - a considerable tax benefit over ordinary share dividends that are paid out of company's after-tax profit. When investors are evaluating a preference share they should compare the rate of return to that provided by bond issues of the same company. Then, the merit of buying preference shares, which may grow in value as well as provide income, must be taken into account against the greater risk of equity loss compared to bond investments.
Convertible Note
A convertible note is a type of unsecured note with the conversion feature which enables the holders to convert the notes into ordinary shares in the issuing company or cash in equivalent value at specified times during its life, at an agreed-upon price. As a kind of bond, a convertible note pays a predetermined income stream through its life (coupon payment) and also repays face value at maturity if not converted.
Basically, from the issuer's perspective, convertible notes offer the company a lower cost to raise fund compared to other debt securities. It also provides the issuer with tax benefits. In exchange for this benefit, the value of the shareholder's equity will be reduced due to the expected share dilution when the holders of convertible notes convert their notes into ordinary shares.
From the investor's position, a major advantage of convertible notes is their defensive-aggressive feature, which provides security of principal and interest income, and also offers the possibility of an increase in capital value. Although the convertible note typically has a lower coupon rate compared to the corporate bond, it carries additional value through the option to convert the notes into ordinary shares, thereby participating in the growth of the company's equity value in the future. In addition, convertible notes of some small companies offer higher interest to attract investors compared with their ordinary shares. By the contrast with the equity securities, the convertible note, as a kind of bond, carries lower risk since it offers the holders seniority in both interest payments and asset claims when the company goes default. This will definitely protect the speculators on some cases of ordinary share trading.
On the other hand, there could be some drawbacks of convertible notes. They are generally rated lower than otherwise identical nonconvertible notes and thus company has to pay higher rate of interest. Convertible notes are subordinated to other debt securities in case of claim to assets when the company is liquidated. Furthermore, most convertible notes are callable. If this happened, the holders have to convert or sell the notes.
Rights
Rights issue is an issue of new shares made to existing shareholders in order to raise additional funds in the secondary market. Generally, the holders who accept the rights offer will be charged a fee or application money and receive new shares in proportion to their current shareholding at a discounted price by a predetermined date. There is no obligation to take up a rights issue. Shareholders may choose to let the offer lapse. The rights issue may be renounceable or non-renounceable, where renounceable means that the rights can be traded in the secondary market. The rights issue will lead to a drop in the share price because of the increase of outstanding shares. By taking up all the rights, the shareholder will maintain their proportionate ownership in the company. Otherwise, the value of their holding will be diluted due to the price drop.
For the investor, a rights issue by a highly geared company to strengthen its balance sheet is often a bad sign. Profits are already low (or even negative) and future profits are diluted. Unless the underlying business is improved, changing its capital structure achieves little. Alternatively, a rights issue to fund expansion can usually be regarded somewhat more optimistically.
Risks and Ranking
Ordinary shareholders may lose part of their investments when the share price drops or all their investments in case of bankruptcy since they have relatively low ranking order. If the stakeholders with higher priority claim all the assets, the ordinary shareholders have to take loss and thus may lose all their money. So do the preference shareholders.
Convertible notes are safer than preference or ordinary shares for the investor. They provide protection, because the value of the convertible note will only fall to the value of the floor. Therefore, the note holder may only lose part of the investment.
Rights generally have much lower price relative to the ordinary shares. The investor just need pay a small amount of money for the rights to be eligible to purchase the new issued shares at a future date. Thus, the rights holders may lose all the money they invested in the rights, typically a small proportion of their wealth.
Should the company operate bad and then go bankruptcy, these four types of securities would be able to claim the assets according to the following order: convertible notes, preference shares, ordinary shares and then rights. As a kind of debt security, convertible notes are granted the highest priority among these four. After that, preference shares would claim the remaining assets and then ordinary shares if there is still any left. The rights holders are ranked at the lowest level when claiming the company's assets.
Main Factors and Investment Decision
To make the right investment decision, investors have to take into account many factors, the major ones of which are outlined as follows.
Investor's investment objective and financial budget
Macroeconomics factors, i.e. inflation, unemployment rate, interest rate, etc.
Characteristics of the security
Company background and quality of corporate management
Return requirement and risk tolerance. Typically, risk aversion investors aim to minimize the risk for the same return or alternatively maximize the return for certain risk.
Capital structure and dividend policy
Market efficiency
Liquidity, which implies how easy and fast the security are traded. The higher liquidity, the narrower bid-ask spread and thus the more easily investors can trade the security at an expected price level.
Investment horizon (time frame)
Tax considerations
Unique needs, such as specific hedging needs, age, wealth, etc.
Specifically for individual investors, the basic factors affecting their return requirement and risk tolerance usually arise from their stage in the life cycle (Bodie, Zvi, Kane, Alex, Marcus, Alan J 2004). Young people may invest in growth securities for high return while the retired usually put their money in securities with stable income and low risk.
The investor's objective is to resell the security and gain income return in one month while the main risks are liquidity and volatility.
Since there is no dividend paid out during this month for BHP, the only form of income the investor can get is capital gain from the share price appreciation. As discussed above, although ordinary shares have lower liquidity risk and narrower bid-ask spread, they are generally too volatile (risky) for short-term investment. The share price may fluctuate widely and there is no protection on ordinary shares. The investor may suffer a loss because of unexpected events. That is why most investors would like to hold a diversified portfolio to reduce the risk of ordinary shares.
Identical to ordinary shares, preference shares are broadly traded in the market and thus they have high liquidity but high price volatility. This is too risky for the investor if he/she wishes to resell in one month.
In contrast, Rights normally carry wider bid-ask spread and higher liquidity risk and are generally open for trade in market for a limited period only. For instance, GOZRA is tradable in market from 25 August to 10 September, 2010. The investor can simply purchase the rights during this period and exercise the rights on 24 September to buy its ordinary shares at $1.90, which is lower than the current share price. However, it had a bid price of $0.001 while the ask price was $0.015 as at the close of market on 3 September. What is worse, there was no trades during the whole day.
The convertible note shares the benefits of both debt and equity securities. As mentioned above, it offers the investor fixed interest payment like any other types of debt securities and also provides the option to enjoy the capital growth of the company. The investor will get certain amount of interest payment during the one month time and potentially earn more from the share price appreciation.
According to the analysis above, the investor would be best off if he/she invests in the convertible notes. One month later, the notes can be either converted to the ordinary shares or resold directly.
