Privatisation talks creates angst for Crown hybrid-holders

While it may only be a few days out from Crown Resorts' (ASX: CWN) releasing its interim result, the market is rightfully titillated by what might happen to $1.1 billion of ASX-listed hybrids should the company's major shareholder (53%) the James Packer-controlled Consolidated Press Holdings (CPH) decide to take the company private.

It's no laughing matter for those who bought original Crown Notes at the $100 issue price only to see it close at $86, having traded as low as $75.40 only weeks earlier.

While hybrids are extremely complex financial products that few understand, the penny has finally dropped that should Crown go private, the greater the likelihood that it may choose to stop making payments to hybrid investors.     

It's understood that Packer has spent the last few months courting cashed-up, buy-out firms and sovereign wealth funds – including the state-run Canada Pension Plan Investment Board – to see if he can raise part of the estimated $5 billion or more he would need to privatise his sprawling business empire.

There's also some speculation that CPH may also be looking to acquire Crown's 34% stake in Melco Crown.

Should Crown find itself with the means to 'go-private', it would technically be obliged to stop paying dividends and returns of capital to its ordinary shareholders. However, whether this so-called 'penalty' is the disincentive that it's designed to be is a moot point in Crown's case, especially given that CPH is the majority shareholder.

Admittedly it's unlikely, but the biggest fear for those who hold Crown Notes is that instead of redeeming after six years as expected, Crown may not choose to redeem Notes, before they have to on14 September 2072.

It's true, a 'change in control' event does require the notes to be redeemed if a party acquired more than 50% of Crown. But it excludes CPH which already had control.

The bottom-line is it can proceed to buy 100% of Crown without having to repay these 'optional interest' notes for 36 months short of 60 years.

Some traders have speculated that Crown is committed to paying interest and redeeming the notes in 2018 – to protect its investment grade credit rating. While Crown subordinated Notes I and Notes II recently gained around 11% – on the strength of this optimism – that's cold comfort for those who are still seriously out of the money.

Renewed optimism that Crown will do the 'right' thing, also contributed to a 5% uptick in the share price from $11.70.

Meantime, while all this hybrid angst is playing out, the Australian Tax Office (ATO) is now chasing Crown over $362 million in income tax, split between $250 million relating to tax and interest for the 2009 to 2014 financial years and $112 million in penalties.

Assuming Crown is unsuccessful in fighting an extra $362 million in claims by the ATO, it's expected to have a 50c a share impact.

Given its existing capital commitments over the next few years on its Alon casino in Las Vegas and its Sydney casino at Barangaroo, the unexpected tax hit puts greater pressure on Crown's balance sheet.

While the stock has strong long term cash flow relative to reported profit, it has a funding gap of $3.6 billion, and a net-debt to equity that's increased from 27% in 2011 to 50.96% in 2015.

Return on equity (ROE) has softened in recent years, but it remains in double digits at 10.46% in 2015. Meantime, earnings per share (EPS) which has been excellent over the last five years is expected to remain good; with EPS of $0.61 in 2015 growing to $0.80 by 2018.

Crown does look attractively priced based on a 28% discount to its two year high of $17.45, and targets closer to $14 a share.

However, those contemplating buying should wait until next week's interim result announcement. Struggling earnings from Melco Crown – which plunged approximately 61% year over year – are likely to put downward pressure on the result.

What's needed is greater disclosure on plans to privatise Crown, any insights into what that does for those holding hybrids, and whether Crown can successfully ward-off the ATO's claim for an additional $362 million in income tax.