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Bond of the Week: 3 May 2017

Aggregated Micro Power Infrastructure 2 PLC

    

Renewable energy (biomass) bond available in small denominations

Aggregated Micro Power Infrastructure 2 (AMPIL2) are selling a new tranche (which will be fungible) of an existing bond. I own the existing bond and a previous sister issue (AMPIL1) and I think the new tranche makes for an interesting investment. This issue is not a retail targeted ORB issue that will be listed on the LSE. However, denominations are a retail friendly £1. And it is listed in the Caymans so should be eligible for ISAs and SIPPs (I hold some in my ISA). While I do not expect the bond to trade much – turnover in the present bond is limited – it is a proper bond and not a mini bond – which as far as I can see are really direct loans. This issue will settle through Euroclear/ Crest and is fully transferable.

AMPIL2 is your chance to get into Ash for Cash (http://www.bbc.co.uk/news/uk-northern-ireland-38414486) although perhaps not on quite such a profitable basis as the Northern Irish have achieved. AMPIL installs and leases boilers to institutions/ corporates on a long term basis and these leases are backed by matching long term government subsidies. Government subsidy accounts for approximately 65% of income. Here are the terms of the bond.
 

Issuer: Aggregated Micro Power Infrastructure 2 PLC

Expected Bond rating: None
Target issue size: £25 million
Settlement date/ Issue date:To be decided
Coupon: 8% p.a., quarterly payable on 17th Jan/ April/ July/ Oct
Maturity: 17th October 2036
Call: Oct 2021 @ 104

Oct 2022  @ 103
Oct 2023  @ 102
Oct 2024  @  101
Thereafter @ 100
Sinking fund: From 2022 the bond sinks. Coupon and amortisation is combined at 10.5% of the issue size from the 6th year (e.g. in year six 8% goes towards    the coupon, 2.5% to the sink. Thereafter the percentage devoted to the sink steadily increases as the outstanding issue size decreases. By redemption it is expected 75% of the bond will have been sunk). Note the dates above relate to the first tranche of the same issue. It is now under 5 1/5 years to the first sink.

Issue price: 100

Listing: Cayman Islands
Denoms: £1
Lead manager: Guy Butler
ISIN: GB00BYVQM755 (existing issue. New tranche will have a new ISIN until it funges).

Before the credit itself is discussed there are some technical matters related to the issue itself.

As it is not a formal retail bond, I do not have a launch date and wealth managers may not be advertising it (for compliance reasons) on their websites. Therefore if you are interested you will probably have to make a direct enquiry to your broker and ask them to contact the lead manager Guy Butler. It is also quite probable that this issue will be oversubscribed and as it will not go through the formal ORB process a purchase will have to be made on the secondary market. If interested your broker should be able to help on how best to proceed.

The structure and how it works

Aggregated Micro Power is listed on Aim with a market cap of £30.6million.  However, the bond issuer is an SPV and the issuer does not have a parental guarantee (this is related to historic tax reasons as the company began as a Venture Trust). The shares of AMPIL (the SPV bond issuer) are owned by Law Debenture Intermediary Corporation as trustee for general charitable purposes.

Aggregated Micro Power installs biomass boilers for large energy users such as schools, care homes, small leisure units and greenhouses. The company is not a boiler manufacturer. The boilers are made by companies such as Hargassner, Binder, Bono Sistemi and ETA (I have not heard of these companies but you may have). When the boilers are installed the aim listed company receives an installation fee of about 10%. This fee goes to Aggregated Micro Power and not AMPIL, the bond issuer. Indeed AMPIL actually pays this fee as it is a capitalised cost of the boiler.

The SPV/ bond issuer comes into play because users of the boilers do not buy the boilers but instead take them on a “take or pay” basis. This is a standard form of leasing in the energy market. It means the boiler users pay for the energy they consume but also guarantee to use a minimum amount of energy. So if they were to turn off the boilers for an extended period they would still be liable to pay for a certain amount of energy. AMPIL pays for the wood chips/ pellets and then in turn is paid for the heat.

In addition the government offers subsidies for the energy used and it is these subsidies which makes the whole scheme work. The subsidies comes in the form of payments for the energy used and subsidy provides roughly half the income stream. To make it clearer it is perhaps best to look at the first AMPIL bond issue (AMPIL 1) to see cash flow that is comparable to AMPIL 2. The boilers (49 of them) of AMPIL 1 are now all installed (bar a certain amount of re-investing the cash flow) and the SPV is closed to further bond issuance.

As of the 6 month period ending Dec 2016:

Sale of heat to boiler users:   £402,251
Cost of fuel (paid by AMPIL):  £411,658
Government subsidies:            £750,348 (various schemes; the government keeps changing the terms of the subsidies they offer)

 

I have stripped out various small items. However, in effect you can see the cost of the fuel and what the users pay for the heat roughly balances out (the relationship between the two is not constant but never goes far out of kilter). Therefore it is the government subsidy that pays for the coupon, amortisation and the final redemption payment. The government subsidy schemes run for 20 years so will cover the lifetime of the bond. It is also important to note that the government subsidy goes straight to AMPIL without being intermediated by the boiler lessee. This removes some credit risk.

AMPIL, under its covenants, is obliged to buy and install boilers that collectively have a minimum yield of 12.5%. The projected return is 13%. The administrative charge for running the AMPIL is in the region of ½% so over time, even when the sinker comes into operation, if everything goes to plan then cash will be built up within the structure and that cash will be used to buy/ install more boilers providing it can be done at a minimum IRR of 12.5%.

There is also a provision to allow AMPIL to purchase second hand boilers (again with a minimum yield of 12.5%).  Many operating boilers will have initially been purchased outright, not leased, from other installers. However, schools, small enterprises etc often find the sale of the boiler a good way to raise cash to fund a project/ business expansion. The government subsidy is attached to the boiler so when a second hand boiler is bought the subsidy is transferred straight to AMPIL.

Here I should note that Aggregated Micro Power (the AIM company) owns a subsidiary, Forest Fuels, which sells fuel for boilers (to AMPIL boilers and others) and also services boilers. They do this at arm’s length/ market price and Forest Fuels is not part of the bond structure. However, Forest Fuels does allow contact with boiler owners and the drivers are paid a commission when they find a boiler owner who is willing to sell to AMPIL. I was told there is a driver in Telford who is on £18,000 a year and has made £6,000 commission! Nothing like the entrepreneurial spirit. Arguably the purchase of an already operating boiler removes some project risk. AMPIl also argues that as Forest Fuels are likely to be servicing these boilers as well as supplying them with fuel, that they can save on due diligence as they will already know whether these units are in good shape of not.

With subsidies/ leases/ second hand v. new installations,) etc one’s head can start to spin. However, you should really think of this as a series of cash flows. Therefore below I set out a very simplified table of projected cash flows over the life of the bond. The Calculations are based on the existing bond tranche (£10.12 million) and do not include the prospective new tranche of £25m.

 


* Asset valuation on a given Date is the NPV of assets "Contracted" as on that Date

Note: it is assumed that from 2020 when the subsidy scheme (RHI) is up for renewal, subsidies will either cease, or be too low, to allow boilers to be profitably installed and leased out. Doubtless the government will find some other project of virtue on which to spend your money. From 2020 cash starts to build up within the structure as, bar second hand boilers, the opportunity will have passed whereas prior to the end of the current RHI scheme it is intended that surplus cash will be used to acquire more boilers. They might of course use surplus cash to repurchase AMPIL bonds or call them.

The risks:

I think the most identifiable risk is the element of project finance. You are not buying a bond that is secured over an already existing pool of assets.  Although tranche 1 of AMPIL 2 (about £10 million) has either been invested or the projects identified, the new £25 million tranche will, on day one, be sitting on the balance sheet as cash. Typically you would expect a secured deal to already have the backing assets in place. For instance a new issue bond secured on property would already have the property assets in place. If that was not the case the bond would really be a form of development finance.

It will take time for the cash from this new AMPIL tranche of bonds to be spent and the boilers to be installed and for the cash flow to start. For that reason the Debt Service Coverage Ratio (DSCR) only kicks in in year 5. An earlier start to the DSCR would limit the possibility of reinvestment of cash flow in further boilers.

As the cash gets put to work and the assets become cash generative, the overall project gets de-risked. Even though there is provision for future tranches of AMPIL 2, the degree of project risk must decline in line with the percentage of cash to boilers in the SPV. [There is also a decline in LTV over time as post tax profits are retained within the structure]. Therefore over time, all other things being equal, AMPIL should be a naturally improving credit. Indeed I expect that the plan is to call the bonds and refinance at a substantially lower rate when the bond reaches a critical size that is of interest to large institutions and/ or government subsidies change or cease such that the SPV, by then fully invested, becomes “closed”. The opportunity for AMPIL to expand will have gone but they should then be able to refinance their assets more cheaply.

The question to ask, of course, is what visibility does AMPIL2 have with regard to investing the proceeds of the new tranche? It has taken about five months for the £10 million of the original tranche to be fully spoken for and it will take some further months for the boilers to be installed and generating full cash flow. [And for obvious reasons cash flow is lower in the summer]. Typically it takes from five to six months to get all the permissions and install a boiler and there may be some time lost for negotiations. Given the cash drag before boilers start to produce revenue, this increases the attraction of buying already installed units on a sale and lease back basis. With Forest Fuels servicing around 2,000 of the country’s 16,000 medium to large sized boilers this does give them the chance to put on assets more quickly (although with marginally lower yields).


I believe AMPIL are on course to meet the figures projected for the £10 million issue which settled on 19th Oct 2016. These figures should give some idea of expected cash drag while the money waits to be invested.

As of Dec 2017

EBITDA          £718,691.

Admin costs    (£83,034)

Bond coupon   (£813,600)
Loss                 (£177,943)
 

The figures are for the full year and include very limited cash flow at the beginning of the year. By Dec 2018 they have projected to make a profit of £571,368.

The other main risks I would list as:

1) The boiler lessee defaults. In this case the boiler (which are housed in moveable containers) can be taken away (with the attaching subsidy) and installed somewhere else. I am told they have thorough credit checks and to date they have had no defaults although they did agree to take away one boiler from a client with financial problems and it was installed elsewhere.

2) The boiler doesn’t work properly and there are complaints from the lessee. AMPIL only supplies the boiler and not the pipes/ radiators. The heat is put into the system via a heat exchanger so there should be no dispute as to where any problem lies and whose responsibility it is.

3) The government removes biomass subsidies. The government cannot amend or remove subsidies already given. The level of subsidy has changed over time will undoubtedly change or cease in 2020. However, this is taken into account for their projections.

4) There is less independent verification/ due diligence on the performance of AMPIL versus what you might hope for on a larger project. For instance AMPIL themselves ensure insurance and proper leasing contracts are in place as opposed to this being done by an independent outside body/ contractor. This increases the level of trust required but it is understandable in view of the level of compliance costs that would accrue by bringing in outside contractors for a relatively small issue. You might also take some comfort from the fact that the founder of Aggregated Micro Power, Neil Eckert, has a successful career behind him having also co-founded the insurance company Brit Insurance.

5) Can the overall project for AMPIL become unviable such that they walk away? I tackled them on this. Firstly their interests are aligned with bond holders (and I believe the directors are also bond holders). A large amount of value becomes trapped within AMPIL as first assets and then assets and cash build up within the structure. This cannot be released until all debt has been paid off.  For management to get a large payday they need to see this bond through. Also once the boilers have been installed the business of running AMPIL on a day to day basis is mostly outsourced and that cost should easily be paid for out of cash flow.

If you refer to the LTV row in the table above showing the projections for the first tranche of AMPIL2, the imbedded value that will be released when the issue is paid off can be clearly seen.


Conclusion: 8% is undoubtedly very attractive in these years of coupon famine and the high yield makes me sanguine about the long maturity date. There is a very considerable cushion against any rise in rates. The sinking fund starting in 5 ½ years’ time and the high likelihood that the issue will be called before maturity should also help one avert one’s eyes from the 2036 end date. I expect the reasons for the attractive yield are a) small issue/ illiquidity b) the element of project finance and c) getting people to pay attention and understand how the AMPIL issues work. I am happy to take these negatives given the compensation of yield and the arithmetic/ government backing behind the issue. As boilers are installed and accredited (to get the government subsidy) the issue should de-risk. Finally I also think that with the increased issue size as a result of the second tranche, there might be more turnover in the bond in future and it should not be too difficult to realise the asset if needs be.

Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.

ODRB

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