Z Energy bonds could be subordinated to former owner Shell and a NZ$350 million working capital facility

By Gareth Vaughan

The up to NZ$150 million worth of retail bonds Z Energy plans to issue would probably rank behind both former owner and key supplier Shell and a NZ$350 million working capital facility provided by Z's banks , - ANZ, BNZ, HSBC and Westpac - if Z was to ever default on its borrowings. However, Z says it's not highly leveraged towards working capital.

As tipped by interest.co.nz on Monday, the Infratil and New Zealand Superannuation Fund owned Z has confirmed plans to raise up to NZ$150 million through an issue of seven-year retail bonds. Z says the bonds, which won't carry a credit rating, will pay 7.25% interest per annum through quarterly payments. That's slightly below the 7.35% Z's NZ$147 million worth of six-year bonds issued to about 3,500 investors last year pay.

Z Energy CEO Mike Bennetts told interest.co.nz he was optimistic Z could raise the full NZ$150 million. Z aims to issue NZ$100 million worth of bonds but has the ability to accept up to NZ$50 million worth of oversubscriptions.

"We've obviously taken advice from the brokers about the appetite out there," Bennetts said. "We've even had some of our current bond holders ringing us up and saying 'look could I have more exposure to your company'. So by way of the coupon rate and the timing we think we should have every expectation of getting at least NZ$100 million, and NZ$150 million certainly seems probable."

Going for a seven year term was part of a move to extend the maturity of Z's debt.

"On day one when we started we had core bank debt of NZ$350 million over three years and over the last 12 months we've managed to extend that. I think that's a really important thing to give us financial flexibility," said Bennetts.

Secured, senior obligations

In its prospectus Z says the bonds will be secured senior obligations ranking equally with its previous bonds. And when announcing it was considering an issue last month, Z said any issue would likely be on similar terms to last year's issue, with bondholders sharing the same security as Z's banks, on an equal ranking basis.

However, the prospectus notes that although  its banks and bonds share the same security on an equal ranking basis, "in practice"  the banks providing working capital and product suppliers - Shell -  may be repaid first if Z were to ever default on its borrowing obligations and the security was enforced. Prioritising Shell as Z's supplier and the working capital facility would enable Z to keep trading.

Z would have to fail its major financial covenant, the debt coverage ratio, on two occasions six months apart, before the bondholders could enforce security. This would give the banks time to squeeze as much repayment as possible out of Z before the bondholders could act. In addition, the equivalent debt coverage ratio in the banks' loans will be set at a lower level than the bondholders', again giving them preemptive rights to act.

And in the event of a receiver being appointed, and the banks and bondholders disagreeing on what to do, the banks could overrule the bondholders no matter what amount they are owed.

Therefore, although in strict legal terms the bondholders will rank equally with the banks, in certain circumstances, the banks have the whip hand.

Working capital facility for fuel and risk management; Shell and banks attached to the most liquid assets

Z's NZ$350 million working capital facility is used for the likes of buying fuel, and managing interest rate, currency, carbon and commodity price risk. Shell has security over crude oil, fuel and other products it supplies to Z that it hasn't been paid for. Z says its refined product and crude oil supply is underpinned by contracts with Shell until at least April 2013.

"As it is likely that paid for and unpaid for product supplied by Shell would be mixed together, there may be difficulties identifying product over which Shell has priority," the prospectus says.

"To help address this Shell and the Security Trustee (BNZ) have agreed on a set of principles that would be the starting point for any discussion on allocating petroleum products between them."

Bennetts said it was important to note the link between Shell, the banks and working capital was all about Z's most liquid assets.

"In some cases with our obligations to Shell we actually settle those before the crude or the products even arrive in New Zealand," said Bennetts. "So it never actually gets mixed up with our domestic supply chain."

"But I think it's quite important to draw the distinction between the working capital which is a very, very liquid asset and the rest of the assets inside the firm. If you look at our balance sheet, currently about NZ$500 million of it sits in inventory from a balance sheet of about NZ$1.2 billion of assets. So we're not highly leveraged towards working capital anyway," Bennetts added.

Proceeds to reduce bank debt

Z plans to use proceeds from the bond issue to repay some of its core bank debt facility. This, also with ANZ, BNZ, HSBC and Westpac, currently stands at NZ$203 million. Although the prospectus says the facility due to expire at the end of June, a Z spokesman said new term debt facilities had been negotiated and were now in place with the same banks for a further three year term. The prospectus notes that the bank facilities, both the core bank facility and working capital facility, must be prepaid from the net proceeds of any initial public offering (IPO) or trade sale of Z or its business.

Bondholders have no rights to redeem their bonds before their August 15, 2018 maturity date unless a change of control, other than by way of an IPO, or if Z defaults. Despite a couple of IPO mentions in the prospectus, Bennetts said a sharemarket float was not something currently being discussed.

"We see lots of opportunity inside the company right now for the current shareholders," said Bennetts. "We don't see a big demand for capital beyond what we can currently raise through debt or through further shareholder injections."

Infratil and the NZ Super Fund bought Z, formerly global oil giant Shell's New Zealand downstream operations (or fuel retail and distribution business), for NZ$696.5 million in April last year.

Z consists of a 17.1% stake in Marsden Point oil refinery operator the New Zealand Refining Company, a 25 % stake in Loyalty New Zealand which runs Fly Buys, some 220 petrol stations, about 100 truck stops, plus pipelines, terminals and bulk storage terminal infrastructure around the country. Z is licenced to use the Shell brand until June 30, 2012 at which point all petrol stations and truck stops will be rebranded as Z Energy.

Fixed assets revalued NZ$213 million higher

The prospectus notes that the value of Z's land, buildings plant and equipment rose by NZ$213 million to NZ$469 million at March 31 from NZ$256 million a year earlier. This came after a revaluation of Z's fixed assets by Jones Lang LaSalle that was audited by KPMG and approved by Z's board, which is chaired by Infratil CEO and former Telecom chief financial officer Marko Bogoievski.

Z's fixed assets include freehold and leasehold land and buildings, plant and equipment, storage and distribution infrastructure assets, and NZ$38 million worth of intangible assets including carbon credits.

The company's current cost earnings before interest, tax, depreciation and amortisation were NZ$157 million in the year to March, compared with NZ$138 million in the 2009 calendar year. Z says this earnings measure is the key one for its management and capital providers because it's the cash income generated from the core business.

Investors' have to buy a minimum of NZ$5,000 worth of Z bonds, and multiples of NZ$1,000 thereafter. The offer's being managed by ANZ, First NZ Capital, Forsyth Barr and Westpac Institutional Bank.  Z plans to list the bonds on the NZX's debt market. Issue expenses are put at NZ$2.05 million based on an issue size of NZ$100 million.

The offer is due to open on July 8 and close on August 5.

(Update adds comments from an interview with Mike Bennetts).

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