A Good Return from a Convertible, Cumulative, Redeemable Preference Share

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Explaining the Balfour Beatty cumulative convertible redeemable preference (BBYB) share isn’t easy. If at the end of the article you still don’t have a clue, don’t worry, focus on the fact you can earn about 6% (after tax) on your money for the next 7 years.

OK, here goes. The yield on this preference share is 10.75% and they are currently priced at £1.22. The redemption date is July 2020 (you get £1 back). The dividend is cumulative, which means that if for any reason it is not paid it isn’t lost but cumulates until the next payout (if ever). And lastly, the holder has the right to convert the Preference shares into Balfour Beatty Ordinary (BBY).

Other than suspension of the dividend, or Balfour Beatty going bust, the worst case scenario for this preference share is that it will pay 10.75% for 7 years and pay back £1 at the end of it i.e. you get a devilishly good yield to redemption of 6.66% (ignoring costs and tax). Unfortunately there is 10% tax on the coupon payment but if held in an ISA or SIPP there is no further tax to pay.

There’s a capital gain element here as well. If the BBY share price rises, BBYB will rise and can we can sell into the market for a capital gain but they are also convertible, which means that there’s a chance of a capital gain from conversion instead.

Conversion simply means that we have the right to swap the Preference shares for Ordinary shares.

Conversion is currently (it can change following Rights Issues etc) 0.2469136 Ordinary BBY share per 1 BBYB Preference share.

Let’s say we bought our Preference shares at £1 and we own just one of them.

If we divide £1 by 0.2469136 then we get £4.05. That means we have the right to swap our £1 BBYB Preference share for a BBY Ordinary at £4.05. Today’s BBY price is £2.71, so we would be nuts to do this as we would incur an immediate paper loss of 49% (£4.05-£2.71)/£2.71*100 but if BBY rose to, say, £4.50 then we would be a bit excited because we could swap our £1 BBYB Preference share for a BBY Ordinary priced at £4.05 and immediately sell it for £4.50.

Today we can buy the Preference share for £1.22, so our current conversion ‘hurdle’ is £4.94 (£1.22/.2469135). That is to say, we start to get interested in conversion when the Ordinary rises above £4.94.

So there we have it. We can sit back and take a redemption yield of over 6% for 7 years and be mindful of the fact we might be able to sell our Preferences into the market for a gain along the way, and we can hope that the Ordinary shares rise enough for us to be able to convert our Preference into Ordinary for a gain. Lots of options here and very little downside.

A take-over of Balfour Beatty at, say, £3 would not work in our favour, and there is always the worry that Balfour Beatty cannot afford to pay out the dividend (cover is currently 2x, so no immediate danger). BBYB could fall further but that shouldn’t trouble us as we’re holding for £1 anyway.

Just a final word about the price: the amount we would currently suffer on conversion is called the conversion premium. Right now it’s a massive 82% (4.94-2.71)/2.71*100 . We can generally say that the higher the premium the less appealing the Preference share, which is why the price has been falling recently. Any gain in the Ordinary shares will reduce the premium and so the Preference shares will become more attractive.

Disclosure: at the time of writing the author holds the Balfour Beatty Preference Shares (BBYB)

Susan Marmor has been trading her ISA and SIPP full time for 7 years. She has made money every year, including 2008. She believes that making money is about picking the right shares at the right time and using sound money management techniques to manage risk.

For her trading she uses a combination of sound fundamental data and technical analysis (which involves using price charts and some of the fancy bits and pieces that go with them). She runs the occasional seminar to show people what she does and how she does it.

Disclaimer:

Please keep in mind that all comments made by Susan Marmor are for educational purposes only and should not be construed as investment advice regarding the purchase or sale of securities, options, futures or any other financial instrument of any kind. Consult with your investment advisor before making an investment decision regarding any securities mentioned herein. Susan Marmor assumes no responsibility for your trading and investment results. Susan Marmor does not warrant completeness or accuracy for any observations made herein, or warrant any results from the use of the information. Susan Marmor may have a position in the securities and/or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies. There is a very high degree of risk involved in any type of trading. Past results are not indicative of future returns. Securities, options, futures and any other financial instruments can go down as well as plunge.

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Comments

  1. Alan Arnold says:

    I am 66 years old and planning for my retirement in April 2017. The value of my many pension funds is currently £550,000 and I continue to contribute £1,000 per calendar month by salary sacrifice. The value of the shares, funds, cash etc held by my wife and myself is held personally or within ISAs is about £107,000. My wife is aged 61. We are looking to engage a single IFA to advise and administer our ‘estate’. Clearly cost is an important factor if the majority of our investments are held in funds where we effectively suffer a double charge, a % of the value of the fund to each fund manager and a % of the value of the estate under management to our advisor/administrator. Please can you provide a brochure explaining your service and charges based on the above.
    Kind regards
    Alan Arnold
    alanarnold@steeleraymond.co.uk and aja@arniesworld.fsnet.co.uk

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