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Analysis & Comment  > Bond of the Week

Bond of the Week: 5 March 2015
New Issue: Intermediate Capital Group plc 5% 2023

Here are the terms of the new retail bond issue.

Issuer: Intermediate Capital Group plc
Guarantors: Intermediate Capital Investments Limited, Intermediate Capital Managers Limited, Intermediate Investments LLP
Format: Senior Unsecured, Unsubordinated, RegS
Bond Rating: BBB-/BBB-
Subscription Period: 4 March to noon 18 March 2015 (may close at short notice, subject to RNS announcement)
Settlement: 24 March 2015
Maturity: 24 March 2023 (8 years)
Size: GBP [TBC]m
Coupon: 5.00% p.a., semi-annually in arrear ACT/ACT ICMA
Listing: London Regulated Market and the London Stock Exchange Order book for Retail Bonds
Sales Restrictions: UK, Channel Islands and Isle of Man only
Denoms: GBP 1,000 (minimum subscription GBP 2,000)
Lead Manager: Canaccord Genuity
ISIN: XS1200576699


This is Intermediate Capital Group's (ICG's) third ORB issue. I refer you to what I wrote last time on 31st August 2012.

ICG, as its name suggests, is a specialist supplier of mezzanine finance to mid market sized companies; frequently as part of private equity deals. They rarely own debt in listed companies. ICG emphasise that they micro manage their investments via 12 offices worldwide (as opposed to idly sitting in a leather arm chair in Throgmorton Ave waiting for a prandial suggestion from their friendly broker). Having made a determination to invest they take a controlling stake (up to 100%) in the relevant tranche of debt, normally with a seat on the board.

The company operates two arms. There is their own book, the “investment company”, and there is the fund management arm. The investment company makes the greater returns, but the fund management arm supplies the quality earnings.

I asked the Treasurer, Sean West, when he came to see us, what had changed since the last issue. In short it is that the plan they had announced then to de-risk the business had been carried out. Gearing which had peeked at 3X during the financial crisis has been reduced to 0.4X and the fund management arm had grown as a proportion of the whole business. In 2012 Assets under Management (AUM) were Euros8.7bn; they are forecast to be Euros12.5bn in 2015. Conversely assets on the balance sheet have shrunk from Euros2.4bn in March 2013 to Euros2.16bn in Sept 2014.

This restructuring to produce a greater proportion of fee income is in the round good for bond holders and one of the reasons behind it is to maintain the investment grade rating (BBB-). I think another reason is that the CFO Mr. Keller, like many in the financial and alternative financial sphere, can not take another near death experience. A good night's sleep comes first.

Profitability has been steady if not exciting over the last few years (2010 £105mil, 2011 £186mil, 2012 £244mil, 2013 143mil, 2014 159mil). A proportion of profits will come when investments are cashed out (eg the exercise of equity warrants which may be carried in the book at nil) which occur at irregular intervals so there is a certain random element to performance. In the last six months' period (Sept 2014) Fund Management fee income was £64mil with costs of £37mil (salaries etc): profit £27mil. The investment company had net interest income of £59.2mil + divs £3.4mil + capital gains £48.3mil = £111mil. Operating costs £20ml+ IC management fee £8.8mil + impairments £21mil + £3mil other = £53mil; profit of £59mil. So you can see that despite the growth of the fund management company it still only contributes 31% of the profit.

ICG has a good record in making a profit on its investments. On average for each £1 laid out (since they started in 1989) they have received £1.65 back (the IRR will obviously depend on how long the investment takes to come to fruition). Only 11% of their assets return less than their outlay (ie make an actual cash loss). Not only is this profit record important in itself, without it it would be impossible to attract funds for the fund management company. Their investors are 35% pension funds, 21% sovereign wealth funds,14% Insurance companies and 10% Asset managers. They do not have retail funds and operate solely in the more competitive institutional sphere where your performance is permanently under scrutiny. Fees average 1 1/4% which does not seem high given the work undertaken, but then in a low interest rate environment it may seem high to the investor.

What are the major risks for a bond holder? With regard to the business itself, the fund management arm should be seen as fairly low risk. Their operating margin (the inversion of a bank's cost income ratio – Lloyds' for example is around 50%) is 35% with a target of 40%. The companies position is actually slightly more secure than that as 26% of costs are variable (in the form of performance pay) so poor fund performance will lead to reduced costs.

The main risks lie with the investment management company and some future blow up in the world economy or a collection of individual bad decisions. Here I would make the following points: a) Single name risk is much lower than in 2012. To use the rather ghastly modern lingo, the book is becoming more granular. b) ICG does have a good track record (89% of investments make a cash profit) and their micro management of investments, although doubtless more costly to run, appears to pay off. c) On the negative side much of their investment is in the Eurozone and France is their biggest office. In part France is justified by the local expertise they have acquired, in part because of strong legal debt holder protection. I do seem to remember something along the lines that writing a bouncing cheque in France is not for the frivolous. However, France appears to be the new laggard of the eurozone and I did seem to get some sort of acknowledgement that there have been some recent restructurings there. Apparently if you go to court as part of a bail out plan and say you are going to fire all the employees it does not go down well and you are told to think again. Therefore, if I have understood it correctly, there is a tendency to murky obfuscation in re-organisation when things are not going too well as job preservation comes first.

A word on gearing; at 0.4X it is very low, but do not expect it to stay there. ICG has a target of 1X for gearing. This is not unreasonable and should be consistent with a BBB- rating, but 1X is still worse than 0.4X for bond holders. Numis has just put out an equity research piece on ICG (HOLD) pointing out that return on equity at present is a low 8.8% and that the company needs to get gearing up to 1X in order to get return on equity to a more decent 13 or 14%. How this increase of gearing will come about, by additional investments or return of funds to shareholders, I do not know but I expect it to happen.

A final word on risk is to say that as a listed company much can be told by a look at the share price. In August 2012 it was 280p, today it is 487p. Even though the whole equity market has rallied, this is encouraging.

Conclusion. ICG is a solid credit that has improved. Fee income is up, gearing is down (albeit unlikely to stay at the current level). The ICP 7% 2018 is offered at Gilts + 266, the ICP 6 1/4% 2020 is offered at Gilts + 309. The new issue is offered at Gilts +315; a marginally better spread. However, the new issue is par priced, a substantial advantage for those who seek capital gain for tax reasons. On a value basis, therefore, this issue is attractive even if it is unlikely to give the supercharged returns that have occurred for investors in first time issuers on the ORB.

This new issue has unusually been targetted at both retail/ wealth managers and institutions, unlike other ORB new issues. This should make for greater depths of liquidity (good) but bear in mind the more of a stake institutions have in the issue the more likely it is the issue will track Gilts. This could affect returns if there is a substantial government market sell off. I would also note that there was a rather unhappy Enquest style episode post the last issue (August 2012) when CFO Mr. Keller tried to do an institutional deal offering a huge 8%+ coupon (which would certainly have caused ructions with ORB bond holders who had been offered and bought into a 6 1/4% coupon). But the institutions turned round and said no thanks which in the long run prevented egg on face all round. However, the past is the past and the whole attitude to credit has improved since then. I assume institutions will be more happy to invest in ICP than they were then, and anyway the issue can still be got away even if institutional support is moderate.

A 5% yield is at the top of the indicated 4 ¾ to 5% range and an 8 year maturity at the bottom of the indicated 8-10 year range. I shall be putting in an order. In the current environment a 5% yield is hard to come by, I am happy with the credit and it will be a liquid issue. However, I do not delude myself that it is a fantastic return so I shall probably “park” my money in the bond until some better opportunity comes along. As to price performance, I think the open ended nature of the offering (up to £200 million has been suggested) and the slight signs of wobble in the Gilt market, might limit the upside; at least at first. However, if bond yields do not sell off, then the price should ratchet up as the great hunt for yield continues and this will be one of very few investment grade near-par priced bonds that are liquid enough to be available.

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.

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