Convertible Notes
I have in the past received insightful and helpful advice from this board. I appreciate all input as it takes time to reply to someone’s question. I am familiar with and often find interesting two of the fine people who responded. Thankyou for the replies.

Now it may be my broken arm, it may be that my broken arm has stopped me from going on a two week ski holiday around Kimberly Canada, it may be my time of the month, whatever the reason if you have replied to me please don’t take the following personally, these are grumpy generic comments simply using your replies as examples. It’s me being an ungrateful fork and I won’t even blame the erudite and insightful posters who frequent this board for setting my expectations to high.

Perhaps my initial question was to open, to lacking in detail, to obscure being Australian convertible notes. Perhaps it was lost in translation and I should have taken the time to think that y’all may be more familiar with the term convertible bonds; though my understanding is convertible bonds are slightly different from convertible notes, perhaps a superset. There are dozens of reasons why my question may have received the replies that it did, most of the reasons are my own failing, but I would like to take a minute to discuss how replies to question could be more helpful.

1. Check your ego at the door. There is no need to show of, everyone here is clever.
2. Communicate with people how you prefer to be communicated with.
3. Try to communicate to people in a way that they will find more helpful.
4. Stick to the forking point. The obsession with and squabbling about details around here is borderline obsessive. If you followed tip one then this point should be moot.
5. Educate, amuse and enrich.

I just made the first four points up on the fly, so feel free to spit on them all you wish, I am not attached them. I primarily pen them as thoughts for my own consideration. Perhaps rule one for me should be: You get what you get and don’t get upset.

The first reply was amusing and even contained one of what I consider the golden rules of convertible notes investing. So it educated and amused, nice one, but if warrl is versed in convertibles I am sure he could have provided more helpful information. I hope to get to that helpful information later.

The second reply missed the point by a mile, though did manage to display the posters informed view on a virtually meaningless detail. It showed effort and hey I always love a link or two.

At that point I was content to wait for an informed view, but alas et, who I like, came out with an emphatic statement that I had not adequately considering the risk of getting zilch. How the fork would he know and why be so condescending? Was the reply meant to be of value? Is rudely asserting your wrong opinion a god way to communicate? I don’t know, but this post is my way of finding out :-)

Sorting through the mirth and attitude of the replies I did find my first and second golden rules in my fledgling foray in to convertibles.
1. Security of loan. How sure are you to get your initial capital back. Every investment has risk, some is so statistically minimal that it can be called risk free. Most investments have a meaningful amount of risk and as et said you must consider risk. Bonds are only as good as the strength of their underlying security.
Check where you rank in debt obligations.

2. Know the terms of conversion. Are then any positive kickers, any pit falls, what are the likely outcomes.

3. Read the entire contract, PDS or whatever it is called in your neck of the woods. Take notes and make sure you understand it. This is a shitte rule and was the rule I was hoping to add detail to. Like understand and evaluate the covenants, read and evaluate the risks…

4. Determine probabilities and reduce to an expected outcome.

My Convertible Notes/Bonds Primer
A Convertible Note is a type of coupon paying debt security that converts to the issuers ordinary shares (equity) at maturity.
Generally speaking these securities pay a fixed (or floating) return until a certain date when the security can be converted into the underlying shares of the issuer. ASX

ATO’s tax take on convertible notes http://www.ato.gov.au/individuals/content.asp?doc=/Content/36723.htm

The Handbook of Financial Instruments By Frank J Fabozzi, Inc NetLibrary http://tinyurl.com/2h35p7 provides some excellent information on valuing convertible bonds.

The allure of convertibles is more evident in their attractive long-term risk/reward profile. The typical convertible fund's returns over the past 10 years doesn't trail the venerable S&P 500 by much, and it has been much less volatile to boot. http://ibd.morningstar.com/article/article.asp?CN=NSC123&id=79901

So now to quickly run through my analysis.
1. Security of loan – the underlying is extremely unlikely to default, 1% chance. However, there is no guarantee the coupons will be paid and payments rely on the company having distributable profits. Coupons are paid in priority to dividends. The notes are subordinate to other debtors. If the coupon is not paid the notes are callable at face value. If they miss coupon payment I get to ask for my $100 back sooner. Whether other debtors will get in ahead of my claim depends on their agreements.

2. Terms of conversion. These notes were originally sold with the kicker of participating in growth of underlying above $4.40, with the underlying trading at $1.71 that upside has eviscerated. All that remains is a note with a face value of $100 being sold at $87 for the 20 month note and $77 for the 2.5 year out note (which has slightly different terms). So the notes are respectively selling at 15% and 30% discount.

3. Covenants all appear extremely safe and unlikely to be triggered. The main two are liabilities will not exceed 65% of the Group’s assets and net assets will not fall below $280 million.
Going back to the long winded title of these notes, perpetual subordinated reset convertible notes, it seems to me that rather being too many syllables marketing decided to shorten the name by dropping a reference to the non-cumulative nature of the note. The name may have been perpetual subordinated reset convertible non-cumulative notes. It is what it says on the tin, each word has meaning and is simple enough to understand.

4. Probabilities. My calculations show I need to insert a 23% risk of total capital loss for the probability of a capital loss. As I said earlier I believe 1% is appropriate. Heck if I go up to 5% it still looks like a good deal to me.

Buying TREES2 is extremely likely to yield 15% capital gain, which unfortunately in Australia will be considered income and a 15% dividend payable in four instalments over the next 20 months. 30% return 17% CAGR, not risk adjusted.

Buying TRRES3 is very likely to yield 30% capital gain and 27% dividend payable in six instalments over the next 2.5years. 57% return 18% CAGR, not risk adjusted.

After the amazing run the Australian share market has had over the last five years I expect both investment to have a better than fair chance of outperforming the ASX indexes. However, for comparative purposes these funds are invested instead of cash holdings.

Cheers
Dean
Yes I will now crawl back in to my hole.