The Azalea Group, a Temasek Holdings subsidiary, has launched Astrea IV, a series of private equity bonds. The deal came two years after Azalea Asset Management Pte Ltd (“Azalea”) launched the first listed PE bonds—known in the industry as collateralized fund obligations (“CFO”)—in Singapore, the Astrea III bonds.
This time round, Azalea is offering three classes of bond, with a total amount of USD501m. The group gets to put its name on the record books again as Astrea IV has a retail tranche of S$242m, a part of which will be available for subscription through ATMs for a minimum investment of S$2,000. To our knowledge, the deal also marks the first time globally where retail investors can subscribe to PE bonds.
In February, in anticipation for Astrea IV, we have published an article that seeks to provide an introduction to the CFO asset class, while updating investors on the performance of Astrea III. You may refer to “The Astrea III Bonds Today” for a primer on CFOs and to understand some of the risks involved. We have also provided the links to a few other articles below, in case you want to know more about the previous product from the Astrea Platform, and how it has performed since its launch in 2016.
Read more about Astrea III:
- What You Should Know About the Upcoming Astrea III Notes - Part 1
- What You Should Know About the Upcoming Astrea III Notes - Part 2
- This A+ Rated Bond Earns You 3.51% for a 16-month Tenor
In this two-part article, we will first discuss in more detail about Azalea Group and its Astrea Platform, and explain what exactly private equity investments are. We will also give a brief overview of the Astrea IV transaction, describe the underlying fund investments, and list the key credit strengths of the product. In part two, we will dive deeper into the transaction details and provide our thoughts on the bond pricing.
About Azalea Group and the Astrea platform
Astrea IV Pte Ltd, a special purpose vehicle (“SPV”), is the issuer of the bonds. The deal sponsor is Astrea Capital IV Pte Ltd, which is also the sole owner of the equity stake in Astrea IV. Sitting at the top of the group is Azalea, which is an indirect wholly-owned subsidiary of Temasek Holdings.
Besides investing in private equity, Azalea is focused on the development of new investment platforms and products based on private assets, starting with private equity. The successful launch of Astrea III in June 2016, which was more than eight times oversubscribed, was a significant milestone in the group’s mission to broaden investor access to private equity.
Temasek Holdings have played an eminent role in launching the Astrea series of PE related investment products. Having invested in PE funds for more than two decades, Temasek launched Astrea I and Astrea II in 2006 and 2014 respectively. Astrea IV is the next step toward achieving Azalea’s vision of connecting retail investors to private equity.
While investor risk aversion and skepticism toward securitized products have increased after the global financial crisis (“GFC”) in 2008, the performance of Astrea I serves as a good illustration that not all asset-backed securities (“ABS”) are created equal. The transaction structure and the sponsor’s track record are important factors to consider. Astrea I went through the GFC unscathed, and its two classes of rated notes maintained their credit ratings throughout their tenor and were fully repaid in 2011.
Even though the entities behind the Astrea Platform are all Temasek units, in a recent investor meeting with Azalea, we were reminded by group CEO Ms Margaret Lui-Chan that Azalea has full autonomy to run its business, with a board and management independent of Temasek. Dr Teh Kok Peng, formerly president of the private equity arm at GIC, is the chairman of Astrea IV’s board. The senior management team is lined with veterans in the private equity industry and led by Ms Lui-Chan, who has been with Temasek since 1985 in various roles.
Ms Lui-Chan also highlighted that in contrast to a typical securitization structure, where the issuer is a SPV set up as an “orphan company” with nominal board members, Astrea IV has an actual board providing oversight and governance. “We are here for the long haul,” she added.
Also, compared to the usual ABS structure where debtholders bear a huge loan-to-value (“LTV”) ratio, Azalea (via the deal sponsor) retains a large equity stake—54.4% of net asset value (“NAV”) at inception—aligning interests with bondholders.
An introduction to private equity
As the name implies, private equity is a type of equity—ownership or a stake in a company—that is not traded on a stock market exchange. Private equity investors, the majority of which are PE funds, make investments directly into private companies or conduct buyouts of public companies that result in a privatization. Due to the large minimum investment sum required, private equity investing is generally out of reach for the average investor, and only the very wealthiest can gain access to PE funds run by prominent houses such as Apollo, Blackstone, and Carlyle (three of the fund managers in Astrea IV’s portfolio).
The fund manager of the PE fund, which is also referred to as the general partner (“GP”), controls most of the investment and management decisions. After raising capital from investors—the limited partners—the fund manager will start looking for investments. Industry participants generally refer to the PE fund’s first year of operations as its “vintage” year.
A PE fund typically has an investment horizon between 3-7 years for each of its investment, after which the fund manager will seek asset monetization through either a resale, an IPO or another option. As a result of capital drawdowns to fund the investments and pay for fund expenses (e.g. management fees), PE funds tend to have negative cash flows for the first several years. Investors could mitigate this “J-curve” effect by acquiring exposure to a portfolio PE funds that are at different stages in their lives. The Astrea IV transaction with its average vintage year of 2011 provides such a channel.
The historical returns for private equity investments have demonstrated attractive risk-return characteristics, with returns typically above those of public markets, over an extended period of time. Given the long investment horizon and illiquid nature of private equity investments, investors rationally demand a sizeable return premium on PE. Furthermore, PE funds often employ leverage in their investments, which magnifies the returns (and losses).
The investment strategies employed by PE funds are numerous and include buyout, growth capital, mezzanine finance, real estate, and venture capital. According to Astrea IV’s bond documentation, buyout and growth equity strategies have consistently delivered superior long-term returns, as measured by their median net internal rate of return (“IRR”), among the major PE strategies (see Chart 1). Buyout and growth equity PE funds constituted 98.4% of Astrea IV’s portfolio as at 31 Mar 18.
Chart 1: Median net IRRs since inception of funds within each of the key PE strategies across vintages 1990 to 2014
Transaction summary
Astrea IV’s structure (see Chart 2) is broadly similar to Astrea III, with one lesser tranche. The bonds are secured by a portfolio of 36 PE funds. The transaction comprises of four tranches, namely Class A-1, Class A-2, Class B, and equity. As mentioned earlier, Azalea holds the entire equity tranche, which serves to facilitate strong alignment of interest with bondholders.
Chart 2: Astrea IV’s funding structure
The alphabetical order of the bond tranches indicates their payment seniority. All three bonds are expected to be rated investment grade (see Table 1) and listed on SGX. The least risky tranche is the Class A-1 notes, which is offered to the retail investors in Singapore.
Table 1: Astrea IV's credit ratings
Class |
Expected Ratings (Fitch) |
Expected Ratings (S&P) |
Class A-1 Bonds |
Asf |
A (sf) |
Class A-2 Bonds |
Asf |
Not rated |
Class B Bonds |
BBBsf |
Not rated |
Source: Astrea IV’s information memorandum |
||
As at 31 Mar 18, the underlying portfolio recorded a NAV of USD 1.1 billion. The portfolio’s undrawn capital commitments—the agreed capital a GP can request from Astrea IV that is still unpaid—stood at USD168m.
After satisfying prior obligations such as payments to reserves accounts, Astrea IV will use the cash flows from its underlying investments to fund any capital calls. In the event of a shortfall, Astrea IV has a ten-year committed capital call facility at DBS that will step in and cover the shortfall.
We think currency risk in the structure is low. Astrea IV hedges fully its SGD exposure to the Class A-1 bonds by having currency forward contracts in place for both principal and interest payments. Based on the information from the transaction documents, we note that Astrea IV also has forward contracts with notional amounts totaling EUR84m, against USD181m of EUR-denominated investments at the end of March.
The fund investments
It is important to emphasize that while Temasek Holdings has an important role in the Astrea Platform, the Astrea IV notes are not "Temasek-backed". Similar to other CFOs, the underlying pool of fund investments will be the source of cash flows for interest and principal payments, and investors have recourse only to this asset pool if things go wrong. As such, the quality of Astrea IV’s USD 1.1 billion portfolio of PE funds is of paramount importance to investors.
As at 31 Mar 18, Astrea IV’s portfolio consists of 36 PE funds managed by 27 GPs with 596 underlying investee companies. We find the portfolio diversification good, with the largest individual fund investment being 9.2% of NAV in Blackstone Capital Partners VI, LP, and the top three fund investments accounting for 22.6% of NAV. Exposure to a single GP is also fairly low, with the largest GP exposure at 10.6% of NAV to Blackstone Capital Partners.
As highlighted earlier, most of the funds employ buyout or growth equity strategies, with only a single fund employing private debt strategy (see Chart 3). We understand from management that the focus on these two categories is due to their strong historical performance, especially in the case of buyout investments where the GPs have more managerial control over the investee companies.
The transaction portfolio is also well-diversified across different vintages, with the weighted average age of each PE fund being seven years old. This increases the probability that the portfolio stays cash generative throughout the life of the transaction. The older funds help to stabilize near-term cash flows, while the younger funds are still in investment mode. Ms Lui-Chan said, “Cash flows from one fund can be unpredictable. But cash flows from 36 PE funds have significant reliability.”
Chart 3: Astrea IV’s fund level diversification (as at 31 Mar 18)
Astrea IV’s portfolio investments at the investee company level are similarly well spread out (see Chart 4). The portfolio’s biggest exposure to a single company is 2.6% of NAV. It is invested across multiple industry sectors, with the top two sector groups being information technology (22.9%) and consumer discretionary (21.3%).
We note that 26.2% of the transaction portfolio comprises of listed companies. These are the PE investments that are close to an IPO exit. PE funds generally are unable to monetize their investments fully right after IPO; there is usually a “lock-up” period of six to twelve months. The substantial portion of listed investments in Astrea IV provides a good level of cash flow visibility over the near-to-medium term.
Chart 4: Astrea IV’s investee company level diversification (as at 31 Dec 17)
Overall, we think the quality of Astrea IV’s underlying collateral is good and on par with that of Astrea III. Since its inception, Astrea III’s performance has been impressive. The underlying portfolio distributed USD588m over three distribution periods since 31 Mar 16, which was about 52% of the initial portfolio value (USD 1.14 billion).
One last thing to note about the transaction portfolio is that it is fixed at Astrea IV’s inception. Post issuance, the Azalea Group has limited discretion over changes to the portfolio lineup, and changes in the fund investment schedule will be mostly due to fund distributions, capital calls, and fair value gains or losses.
The bond documentation provides an option to the issuer that allows it to sell up to 10% of the initial portfolio NAV. Should Astrea IV exercise this disposal option, proceeds from the disposal will be paid to the reserves accounts (meant for the redemption of the Class A notes) or the repayment of Class B notes.
The mostly fixed composition of the transaction portfolio provides transparency and certainty to investors in terms of what they are getting. In Ms Lui-Chan’s words, “Investors can see what’s inside the portfolio from the onset, and they can then decide whether they like the portfolio investments.”
Over-collateralization and reserves payments mitigate risks
In our meeting with Azalea’s management team, Ms Lui-Chan advised us that the biggest risk in PE bonds comes from the unpredictable nature of the cash flows from private equity funds. Azalea seeks to mitigate that (and other risks) through over-collateralization and the structural safeguards of Astrea IV.As with any debt investment, the extent of leverage employed by the issuer is an important consideration. The more borrowings behind the same pool of assets, the riskier the structure is.
As shown in Chart 2, Astrea IV has a conservative capital structure that is over-collateralized at a LTV ratio of 45.6%. The substantial amount of equity behind bondholders should provide sufficient cushion against a valuation decline in the underlying portfolio and other potential negative scenarios.
Furthermore, the bond documentation contains a covenant which prohibits Astrea IV’s LTV ratio from exceeding 50%. The purpose of the LTV test is to ensure there is sufficient equity in the structure to protect bondholders. If the LTV ratio exceeds 50%, Astrea IV will divert cash flow to the reserves accounts and, if necessary, repay the Class B bonds until its leverage is below the threshold.
We note the maximum LTV ratio covenant in Astrea IV is weaker than that in Astrea III. The latter’s maximum LTV clause starts at 45% initially and drops gradually to 20% after the tenth distribution date. Nonetheless, we think Astrea IV’s over-collateralized funding structure together with the large equity ownership of the sponsor still provide ample buffer against impairment risk.
Similar to Astrea III, Astrea IV has scheduled for payments to be made to reserves accounts. The issuer will pay USD40m and USD39m from the 1st to 5th and 6th to 10th distribution dates respectively to the reserves accounts until 14 Jun 23. On the aforementioned scheduled call date, Astrea IV will apply the total amount reserved toward the redemption of the Class A bonds.
Should the transaction portfolio manage to return more than USD313m (50% of Astrea IV’s equity) of cash to the sponsor, payments to the reserves account would accelerate by half of the cash sweep to sponsor thereafter. We like this sponsor sharing feature (which is absent in Astrea III) as it enables a faster build-up of reserves.
Find out more about the Astrea IV notes
We hope you now have a better overall understanding of PE bonds and the Astrea IV transaction. You can go to part 2 of this article to find out more details about the three note classes and our opinion on their pricing.
Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a principal position in ASTLC 3.900% 08Jul2019 Corp (SGD) - Class A-1, ASTLC Jun2028 Corp (SGD) - Class A-1 - Retail, ASTLC Jun2028 Corp (USD) - Class A-2 Classified as SIP and ASTLC Jun2028 Corp (USD) - Class B Classified as SIP. The analyst who produced this report holds a NIL position in the abovementioned securities
The Research Team is part of iFAST Financial Pte Ltd.