Gunns (GNS) $1.41 FOREST hybrids (GNSPA) $88Font Size: Decrease...

Gunns (GNS) $1.41 FOREST hybrids (GNSPA) $88Font Size: Decrease Increase Print Page: Print Tim Boreham | September 09, 2008
WITH Gunns' proposed pulp mill looking increasingly shaky, the forestry group's stock has become as popular as a greenie at a lumberjack convention.

While only game retail investors now would touch the stock, FORESTS hybrid securities may offer an attractive alternative.

In the equity raising it had to have, Gunns last week squeezed $336 million from the instos at $1.50 per share, and is seeking $91 million from retail holders.

But to the surprise of some, it decided not to recall the $100 million of FORESTS on issue, as it was due to do this month.

Instead, Gunns took the option of rolling over the securities at a “stepped up” coupon rate. This equates to the 90-day bank bill swap rate, as applicable on October 14, plus 500 basis points (compared with a margin of 250 basis points).

The margin is then reduced by 30 per cent to render the coupon payments fully franked (if anyone cares, FORESTS stands for “rankable optionally redeemable equity settleable transferable securities”.

In effect, Gunns is buying further time and funding-flexibiliy to sort out the mill issue. But by October next year, Gunns will either have to trigger redemption of the FORESTS at $100 face value, or ordinary Gunns shares at a 2.5 per cent discount to the prevailing price.

According to Hybrid Man, Criterion's adviser on exotic securities, holders stand to make a 25 per cent-plus gain if Gunns redeems the FORESTS next October. This takes into account the coupon payment over that time (9.75 per cent unfranked at current values), as well as the difference between the $100 face value and the current $88 market value of the securities.

Gunns can opt to redeem earlier. If it did so in, say, January 2009, the annualised return would rise to a whopping 70 per cent.

Of course, the exercise is not risk-free, but the hazards are minimal, relative to other investments yielding such returns.

The main danger is that Gunns goes broke, but given that last week's raising reduces the company's debt-to-equity ratio from 105 per cent to 55 per cent, this is unlikely. FORESTS holders also have priority in a wind-up.

Gunns shares might well come under further pressure up to the redemption date. But it's worth remembering that, should Gunns opt to compensate with shares rather than cash, the holder simply receives more shares than otherwise would be the case.

FORESTS are not the only hybrids lost in the financial woods at the moment. While perceived as risky debt instruments, they're often safer than the ordinary shares.

Criterion rates FORESTS a BUY, but as usual investors should seek their own expert counsel.