Ok, this is a tough one to write. But I still want to get it out — SIA Rights 2021 MCB.
Yup, you heard me.
The very bond I stayed away is actually worth a second look right now.
Prices have dipped below its IPO price of $100. This means, SIA MCB’s annual yield has gone up to 6.5% to 7.4% (depends on when SIA redeems it).
Let’s dive in.
What’s SIA Rights 2021 MCB?
I last wrote about SIA MCBs here.
Both the SIA Rights 2021 MCB and SIA Rights 2020 MCB were highly contentious.
During COVID, SIA critically lacked funding. As a result, SIA issued 2 different tranches of the SIA MCBs amounting to S$15billion dollars.
Source: SIA Presentation Slides
And Temasek backstopped the entire issuance by taking up most of the MCBs.
The one I’m looking at is the SIA Rights MCB 2021 (SIA MCB).
The SIA MCB is essentially a zero-coupon bond that converts in June 2030 if SIA doesn’t redeem these bonds.
Below is a summary of its key terms:
Source: SIA Presentation Slides
How does SIA MCB work?
So it works like this: SIA MCB was IPO-ed at $100 last year Jun 2021.
Every half year in June and December, SIA can choose to buy back the MCBs at a pre-fixed price. For example:
- If SIA bought the MCBs back within the first 4 years: you get a 4% annual yield.
- If SIA bought the MCBs back within the 5th to 7th years, you get a 5% annual yield.
- If SIA bought the MCBs back from 8th year onward, you get a 6% annual yield.
So, for instance, if SIA bought the bond back on 24 Jun 2025, you’ll receive $117.166, which is about 4% yield per year.
The longer SIA takes to redeem the MCBs, the higher your annual yield.
Since this is a zero-coupon bond, all your interest payments are accumulated and paid out when SIA buys back the MCBs.
That’s why the redemption prices are higher than $100 — to account for the accumulated interest payments.
If SIA doesn’t redeem the bonds, then it will convert all the bonds into shares on Jun 2030.
Why buy SIA MCBs now?
The funny thing is, I expected the MCB prices to trade upward as these bonds move closer to its mandatory conversion date — shorter the maturity date, lower the yield, higher the bond price.
Sidenote: bond price goes up as its yield goes down. And vice-versa.
But it’s not.
Instead, SIA MCBs currently trades at a discount — $96.10.
Source: Singapore Exchange website
Like what Warren Buffett would say: “ Price is what you pay, value is what you get”
At the discounted MCB price, this makes the SIA MCB looks attractive…
What sort of returns am I getting on this?
- Semi-Annual Date: SIA can choose to buy back the bonds on 15 dates (MCB was issued in Jun 2021)
- Expected Date: The exact date when SIA can choose to buy back the MCBs
- Redemption Price: The exact price SIA agrees to buy the MCBs
- Total returns: The total profits you get when SIA buys the bonds back from you. This assumes you bought the bonds at $96.10, instead of the IPO price at $100
- Projected annualized yield: The estimated yearly yield you get when SIA buys back the bonds.
With the SIA MCB trading at $96.10, this discount increases the potential total returns and annual yield you’d get from the SIA MCBs.
Instead of the usual 4% to 6% annual yield you get when you buy at IPO, SIA MCB’s annual yield has jumped to 6.5%-8.6% (see Projected Annual Yield column).
Source: Dividend Titan
In fact, if SIA redeemed the bonds on Dec 2029, you’d get an average 7.4% annual yield 9see below).
Not too bad. Not too bad.
Source: Dividend Titan
For instance, you bought the bonds today at 96.1. And SIA decides to buy the bonds back on 24 Dec 2022, your total returns will be 10% (annualized yield is ~20%).
Of course, I don’t expect SIA to redeem the bonds by end of this year…
The crucial thing is, as SIA chooses to redeem the MCBs at at a later date, your potential returns increases.
So far, so good?
What happens if SIA doesn’t choose to redeem the bonds?
Then on the final date, on 8 Jun 2030, it will convert all the SIA MCBs at $4.84 per share. Since the value of the bond redemption is $169.797, you will receive 35 SIA shares on the final “mandatory convertible” date. But more on this later.
A bond investor perspective: from uncertainty to recovery
The big turning point is actually how SIA’s situation has improved from huge uncertainties during COVID over the last 2 years, to a path of financial recovery.
Think about it: one year ago, SIA couldn’t get financing. And management has was upfront on this:
“Given the worsening operating environment in the aviation industry, it has become very difficult for airlines to tap the debt capital markets. We will continue to explore other traditional funding channels such as secured financing and sale-and-leaseback transactions but the opportunities remain limited in the current climate and it would not be possible to raise a similar quantum from these channels. Moreover, such transactions would create more cash outflow obligations on the airline during this period when liquidity is severely challenged.”
So wait, Willie. Are you already flipping your mind about SIA like roti-prata?
I still think airlines are bad businesses in a great industry. SIA still faces the challenge of intense competition, high operating costs and entrants of low-cost carriers.
That’s why SIA shares have traded in the bargain bin.
Will SIA default?
But let’s put away our stock investor’s thinking cap for a moment.
And put on our bond investor’s thinking cap…
As long as SIA can refinance its bonds, I’m comfortable with SIA bonds.
In its latest financial results, what surprised me was SIA’s operating losses started to narrow. SIA carried more passengers and improved its operating cash surplus of S$824 million.
Source: SIA Presentation Slides
What’s more crucial here is during COVID, SIA managed to survive and not default — unlike many other airline companies.
As a bond investor, if SIA can revert to its revenues and profitability to pre-COVID period, even without huge growth and a high operating costs, there’s a good chance SIA could refinance its MCBs.
What’s more, over the last two years, we can see that SIA’s largest shareholder, Temasek has provided backstops to prevent a default on SIA.
Both SIA Rights 2020 MCB and SIA Rights 2021 MCB are a testament of Temasek’s resolve to make sure SIA continues operating.
This is interesting because during COVID, many airline companies simply defaulted.
Source: Wikipedia, List of airlines impacted by the COVID-19 pandemic
Is SIA MCBs misunderstood?
Since Temasek owns most of the SIA MCBs, not many investors, traders and institutional investors know how to price SIA MCBs’ risks.
If you ask retail/institutional investors out there, chances are they will tell you it’s too complex to understand, and rather not waste time to touch it.
Plus, no one really knows whether SIA will eventually redeem the bonds or convert the bonds to shares.
And that’s why the SIA Rights 2021 MCBs are trading at a discount instead of trading upward. This was despite SIA’s improving results.
When will SIA redeem its MCB?
It’s hard to tell.
And that’s the risk of holding onto the SIA MCBs.
What I know is there’s a high chance SIA will eventually buy back the SIA MCBs. Why?
Because it’s expensive for SIA maintain these bonds.
Think about it. The average yield SIA has to pay to bondholders is 4% to 6% — the longer SIA takes to redeem the MCBs, the more expensive for SIA to service the interest.
Before COVID, SIA paid only 3.03% on its last bond issuance before COVID.
Now, as the air travel recovers, SIA could raise a USD bond at 3.493%.
Yet, it’s paying more than double on its SIA MCB.
My take? I think SIA will try to pay redeem the SIA MCBs as soon as it can borrow debt cheaply.
After Temasek stepped in to buy all the unsubscribed SIA MCBs, this also assured many bank lenders that SIA can continue to operate for the long term.
I bet there’s a high chance the SIA MCB will be redeemed instead of converting the MCB into shares.
What if I’m wrong?
Then on Jun 2030, all the SIA MCB gets converted into shares at S$4.84.
If SIA shares then trade higher than S$4.84, you can simply sell the newly converted shares for a profit. But the concern is: what if SIA shares are trading way below S$4.84 in Jun 2030?
That’s the worst case scenario.
As the biggest shareholder at 55% stake, Temasek won’t allow the conversion to take place if shares are trading way below S$4.84.
This is because it affects Temasek’s P&L on its SIA’s investments. And this doesn’t look good when Temasek reports its investments on Singapore’s state-owned companies.
Furthermore, if SIA MCBs are converted when SIA shares are below S$4.84, the dilutive effect will further push prices down.
Not a good sign for Temasek.
With this, as long SIA doesn’t default, this Temasek-linked company is going to repay this MCB with another cheaper debt.
My final thoughts
The SIA MCB is not an easy asset class to understand. It’s a combination of a zero-coupon bond with a “bond convert to shares” clause. Both of these are hard to understand. That’s why prices are trading at a discount today.
What’s more, Temasek’s willingness to buy out most of the SIA MCBs over the last 2 years is a testament there’s some sort of parental support to keep SIA afloat.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan