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Bond of the Week: 16 July 2013

Bruntwood 6% 2020 (New Issue)

    

Another property company, Bruntwood, is coming to the market (with a twist) and the issue closes on Wednesday. My apologies for not having got out an opinion on the issue earlier. My excuse is I have been on holiday in the Isle of Wight; driven there not only by the glorious sunshine but also shaunm (a contributor to the forum on www.fixedincomeinvestor.co.uk) who has commented that I have been taking an inordinately long time to complete my-self appointed task of kayaking round the Island  - something that can be achieved in one go by the very vigorous or mad. To that end Mark Glowrey, formerly of Bond of the Week, and I set off on the most treacherous bit round the Needles, going from Totland Bay to Freshwater. However when we got to the Needles there was no wind, the tide neither ebbed nor flowed and the water was as smooth as glass. At the lighthouse divers were diving, launches were parked up and a child was zooming around on an inflatable ring dragged behind a Sunseeker. More to the point, we landed at Scratchells Bay, a small cove made inaccessible except from the sea by towering chalk cliffs on all side. And there at the other end of the beach a member of the opposite sex flung off all her clothes and threw herself into the icy sea. Mark thought she might be Danish. Under the tropical sun the place had everything a Mediterranean millionaires playground should have; perhaps all that was missing was an eyeglass. Now here are the terms of the bond.

Issuer:                 Bruntwood Investments Plc
Coupon:               6%
Maturity:              July 2020
ISIN:                    XS0947705215
Listing:                London (ORB)
Denomination:      £100, minimum subscription £2,000
Covenants:                        75% LTV (company LTV)
1.5% interest charge
Change of Control
Security:              Over a pool of assets to the value of 1.1. Valuer Knight Frank
Lead manager:      Investec

The first thing to note is that Bruntwood is not a listed company but privately owned. Whereas many of the other property companies that have come to the ORB have been anxious to advertise that they have a heavy presence in London or are indeed increasing their presence there (Workspace, Helical Bar and CLS for instance), Bruntwood remains committed to their area of expertise, the cities of the Midlands, and has no intention of changing course. They own and manage 110 properties in Manchester, Liverpool, Leeds and Birmingham with over 50% of the portfolio in Manchester where they have 20% of the office space in the city centre. The company was started 37 years ago by the current CEO’s father with a loan of £50,000 and it is still 100% owned by various parts of the same family. The property portfolio is now worth £891 million – not bad going.

What is the strategy of Bruntwood? They are keen to emphasise that they are not property traders but property managers. They concentrate on providing a good service to their tenants (nothing is outsourced and they employ over 450 people).  The retention rate of clients, whom they aim to move from office to office as their space requirements change, is high. At the lease break point they retain 80% of tenants as opposed to a market average of 45%. I suppose a cynic might say some of this is due to the less dynamic and more localised nature of the economy compared to London. However, the reasoning should not be the issue. It is the effect of tenant retentions on the soundness of the business that matters. Their outstanding example, which they admit to be an outlier, is that of Berrymans the solicitor who started with them in 1980 with 1,000 sq ft and after 20 moves now occupies 80,000 sq ft. The hands-on approach of Bruntwood is like that of another ORB issuer Workspaces, a company about whom the CEO spoke well.

If everyone else in the ORB property sector seems to be emphasising London what positive spin did Mssrs Oglesby (CEO) and Crotty (CFO) put on the Mancunian commercial office scene? Firstly, when I suggested property prices had been and were continuing to be weak outside London post the downturn, I was told that you cannot generalise. Interestingly it was explained that mirroring the experience of a London-ward drift from the regions, there had also been a move of economic activity to the major cities of Lancashire and other Northern and Midlands counties away from the towns and smaller cities. An owner of commercial property in say Bolton, Bradford or Halifax would be in a considerably weaker position than Bruntwood with its concentration on city centres.

Mr. Oglesby said he had also detected the signs of a general turn around in commercial property. Until recently when looking at a commercial property (Bruntwood buys second hand) they had often been the only bidder – now there were competitors. I was told there are sound economic reasons for this nacent recovery. Outside London the UK is becoming a more competitive place. The real wage costs for employers have been steadily declining. There is a steady stream of graduates from good quality universities (Manchester has the largest student population of any European university). Accustomed to studying and partying in the Midlands, the new graduates are happy to stay on and there is demand for them as some companies relocate back to the UK (I was given some examples by Bruntwood). I asked if the bars and restaurants of Manchester were full. I was told they are heaving. Since I first went there myself in the early 1980s when Manchester was going through its post-apocalyptic Mad Max phase it has become a happening and with-it place – apparently they even have a gay village: very modern. The managements view of course all ties in with negative productivity growth in the UK apparent in current economic statistics highlighted by both a surprisingly low unemployment rate, and also a surprisingly low, close to zero, nominal private sector wage growth rate versus inflation of around 3%. Also the major cities of the Midlands do not suffer from the dependency culture that can be seen in the North East. Mr. Oglesby told me entrepreneurialism is alive and well.
Of course I haven’t yet mentioned the competitive advantage of rental costs compared to London. Bruntwood’s offices are kept in good nick but they are short of the top prime spot. Typically they let for £10-£20 sq ft. Nothing can be had for that price in the centre of London. We have offices near St. Paul’s for the remarkable bargain of £28 sq ft,  I like to tell this to all the property moguls who pass through our offices and I sit in satisfaction as I get a slightly strained response; they doubtless  feel it a disgrace that offices so central can have been had for such a poor price. The rental floor in the City is realistically something like £35 sq ft and it is then onwards and upwards.

Here are some figures. To the year-end of Sept 2012 the company made a profit of £12 million ( I believe it will be higher this year). Bruntwood has an impressive profit record and has increased profits every year over the last 15 years with the exception of 2010. Of course property companies are also measured by their net worth and this has fluctuated rather more as their assets are revalued on a regular basis. For the last four years net assets have been stable at around £300 million (this peaked at over £400 million in 2007). Bruntwood went into the financial crisis with a low LTV of 40% but owing to downward revaluations since the peak, today’s LTV is a rather high (by today’s standards) 64%. The other ORB bonds, to generalise, are around 50%. Bruntwood expects this level to fall towards the market average of 50% by upward revaluations (maybe in 2014) and retained profit. Unlike listed companies, the great majority of whom have had rights issues since the crisis, Bruntwood has had no post financial crash equity infusion and with no outside holders they have no easy source of cash of course. They were saved however by entering the downturn with the aforementioned very conservative 40% LTV. The management were also proud to tell me that they were among only 10 to 15% of CMBS (collateralised mortgage bonds) not to have breached their covenants.  Another issue to point out is that their occupancy rate at 86% is rather low. However, the explanation is that they are currently going through some heavy refurbishment (I believe partly at the request of tenants) and that in their next figures they should return to a more normal occupancy rate just above 90%. On-going refurbishments on new purchases and at break points will mean they will never achieve the highest levels of occupancy. Incidentally if my memory serves me correctly, Workspace, the nearest comparable issuer, has a similar occupancy rate to Bruntwood.

The company is currently financed by a £309 million CMBS maturing in 2016, a medium term facility of £165 million maturing in December this year (which will partly be refinanced by this retail bond) and a private placement of £120 million maturing in 2022. The last issue was completed recently and until that point Bruntwood had nearly £300 million of debt maturing at the end of 2013. This I imagine must have caused many sleepless nights for the Finance Director (and owners). Under the wrong circumstances this could have been a true credit crunch. However, the fact that they could persuade L&G to give them a private placement and the fact that their bankers have mooted they are happy to extend the medium term facility shows the absolute necessity of having a good name in the market with a sound track record. I think bond holders rather than taking fright at their previously precarious financing state and elevated LTV levels can take added comfort that the company has been through the fire and survived unscathed.

And now to the crucial point; this bond, unlike all those who have gone before on the ORB, bar the oddity of Alpha Plus Schools, is secured. Notwithstanding the positive things I have said above about Bruntwood and their undoubtedly well run business, I do not believe an unquoted property company, especially with a high LTV level, could have come in any other form.  The collateral supplied is covenanted to be at least 100% and there are regular valuations by Knight Frank. This bond will have its own ring fenced assets like the medium term facility and private placement. The first and most obvious thing to note is that 100% is a low level of collateral. Alpha Schools is collateralised to a much safer 150%. Also Bruntwood’s other providers have LTVs of 60% and 65%. However, to look at it purely on these terms is being to my mind unduly negative. This bond gives very considerable downside protection in the event of something going wrong. There will always be a recoverable value, which cannot be said of the other property bonds. Were this bond to have normal levels of collateralisation then you would not be being offered a 6% coupon (it might be around 4%). It seems to me the trade off between risk and return is very fair even if the bond does not entirely neatly within either the category of secured or unsecured bond. Finally this bond has another plus - it does have recourse to the company as a whole not just a given pool of assets which would be the case with a standard collateralised bond.

Conclusion. I like this bond and have put in an order for myself. Given we are in the summer months and it is not a known name it may not fly off the shelves. I have been told there has been more demand up North than down South and of course nowadays there is more brass down here than up there. However, often those issues that have had the slower start (St. Modwens and Workspace for instance) ultimately perform the best. The company has an excellent track record and continuity of management is important. You have to think as a family firm they will not want to take a great existential risk and to that extent the interests of the bondholders and equity holders are aligned.  I also think it is possible both to accept the contention that London is where it is all happening in commercial property from an investing point of view (bulking up as Mike Slade of Helical Bar said) and at the same time accept the value of a carefully run regional company with local expertise and a good reputation and that concentrates on investing for the long term in major city centres. Nevertheless it all really comes down to the security. You are receiving the standard 6% coupon for a property company (although none are offered at this level today). However, this bond is the only one which is secured and not therefore “structurally subordinated”. I think that more than makes up for the lack of an equity listing. A final point: the market has calmed down considerably since the flap of late June. It bottomed (and I am rather pleased with myself that I predicted it had) around the time of my comment on Grafton. You should therefore have no extraneous worries at the moment when considering whether to invest or not.

Oliver Butt

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