big article in the australian criterion

http://www.theaustralian.news.com.au/story/0,25197,23965606-23634,00.html


Timbercorp preference shares (TIMPB) $1.34; other hybrids

CRITERION only makes occasional forays into the exotic world of hybrid securities, mainly because there's enough conventional shares to choose from. But according to one reader who we'll dub Hybrid Man, there's some handy returns to be made -- and with less risk.

Take Timbercorp's preferred shares, issued at a $2 face value in a $80 million raising in 2004. The shares offer an annual dividend of 6.75 per cent (or 9.64 per cent pre-tax) up until September 30 2009, when Timbercorp can reset (change) the terms.

But at that time holders have the option of requesting redemption, which means that Timbercorp either has to redeem the shares at $2.05 apiece, or convert them to ordinary shares. In these capital-constrained times, conversion looks likely.

The conversion is based on a ratio of between 0.9 and four ordinary Timbercorp shares for every pref, depending on the prevailing price of the ordinaries. But the idea is that holders receive value equivalent to $2.05, the extra 5c reflecting a 2.5 per cent discount.

But there's an upper limit of four "ordinaries". Thus, value is eroded only if Timbercorp shares are trading below 51c at the time.

The prefs are currently changing hands around $1.30 a pop, which implies a 57 per cent capital gain over 15 months, plus the value of three 6.75 per cent, fully franked coupon payments.

The danger, of course, is that Timbercorp shares tank, but they would have to fall below 26c for the investor to be in negative territory. If the worst does happen -- and nothing can be ruled out -- the pref holders rank ahead of ordinary holders in terms of both dividends payouts and on wind-up.

Other hybrid securities offering similar returns -- but subject to different redemption conditions -- includes Australand's prefs, (AAZPB), Babcock & Brown convertible notes (BNBG) and Multiplex's interest securities (MXUPA).

In September, Australand either steps up the distributions by 2.5 per cent or pays out the notes. According to Hybrid Man, the former action produces a 20 per cent return and the latter, 54 per cent.

Remember Multiplex? The troubled developer was taken over by Canadian concern Brookfield Asset Management, but the MXUPAs are still on issue and redeemable for face value in April 2010.

According to Hybrid Man, investors don't like hybrids because the prospectuses are hard to find and, when found, harder to understand. Funds shy away because of poor liquidity, while traders stay away because they're poorly marketed.

Criterion nominates the Timbercorp prefs as a buy, but his head exploded before he could work out the ins and outs of the other goods on offer.