The Brookfield/MidOcean consortium’s takeover offer of A$9 per share or A$18.4bn represents a 55% premium vs Nov 10 closing price. Management indicated it would likely accept the offer if there’s no higher bid. However, it would still need to pass the necessary ACCC and FIRB checks & balances.
Origin doesn’t have immediate financing needs, with its 1H22 net debt-to-equity ratio sitting at just 19.1%. The deal would see Brookfield run the energy business, with EIG’s MidOcean Energy take on its LNG business. Moody’s and S&P have both affirmed their BBB/Baa2 ratings post the takeover news.
The way the deal is structured would imply that going forward Origin will not remain a consolidated energy/LNG business. That is, the business may be split into parts post acquisition. EIG MidOcean Energy is an LNG competitor while Brookfield (post Ausnet acquisition) has access to the domestic energy market. What is unclear is how each business is run their financial profile?
There was little information regarding the final structure and financing requirements. We note, Origin is currently lowly geared, and so there is capacity to gear up/weaken the balance sheet further from here. For investors, there is Change of Control (CoC) protection in the AUD and EUR bonds. As per usual, a CoC would require both rating agencies downgrading the company to sub-IG within a 90 day period.
We would note the share price is implying regulatory risk as it is trading around $1.5 per share lower than the takeover offer.
Based on the three scenarios listed below, we see strong merit/relative value in opportunistically adding the Origin AUD 2027s.
1. CoC is triggered (40%) – if the debt remains at the energy business and the LNG business is split off, then there is potential for a sub-IG rating – especially as there is capacity to gear up/weaken the balance sheet. Investors would be taken out.
2. CoC is not-triggered (40%) – if the debt remains at the energy business and the LNG business is split off, then there is potential for an IG rating to remain. Investors would then be left with exposure to an energy business, with structural challenges around energy prices and renewable investment.
3. ACCC and FIRB do not grant approval (20%) – company remains as is with a presence in energy markets and focus on energy transition. Bonds continue to pay interest.
In terms of price/yield implications for the AUD 2027s:
1. Bonds are paid out at 100. Depending on the timing of CoC triggering, this would translate into a holding period return (HPR) of high double-digits.
2. Bonds would likely reprice to reflect the slightly weaker credit – our expectation would be that the ratings get downgraded to BBB-/Baa3 respectively. The current ASW margin is +200. A downgrade could see a new ASW margin of +300. If we assume a new ASW margin of +300, then the bond price would fall from A$85 to A$80 – yield would increase from 6.2% to 7.4%.
3. Bonds do not reprice. Price and yield remain at A$85 / 6.2%
In normal conditions, option 2 would be credit negative as bondholders would lose out $5 in price terms. However, the notable difference in this current interest rate cycle is that the Origin bonds are trading at such a heavy discount to par @A$85. Thus, the upside or capital appreciation from option 1 far outweighs the downside from option 2. Thus, we see strong merit/relative value in opportunistically adding the Origin AUD 2027s.