Canadian Pacific’s bonds have benefited from the company’s improved efficiency and profitability since activist investor Bill Ackman became the company’s biggest shareholder in 2011 and installed a management team led by Hunter Harrison, pictured.MARK BLINCH/Reuters
More than 100 years after it was formed to link the country, Canadian Pacific Railway Ltd. just convinced the bond market to wager that it will be around for another century.
The railway's $900-million (U.S.) 100-year bond, sold with a coupon of 6.125 per cent, shows how the once-troubled company has won over investors' hearts and minds under chief executive officer Hunter Harrison, even as it embarks on a share-repurchase plan that would boost its debt load.
"CP had its fair share of issues up until Hunter Harrison took over," said Roshan Thiru, director of Canadian credit at Manulife Asset Management. "Then they fixed a lot of the operational problems and the company is in excellent shape now."
Canadian Pacific's bonds have benefited from the company's improved efficiency and profitability since activist investor Bill Ackman became the company's biggest shareholder in 2011 and installed a management team led by Mr. Harrison. Even the plans to let debt levels rise by returning money to shareholders, such as Mr. Ackman's Pershing Square Capital Management LP, hasn't deterred investors from snapping up company debt.
The Calgary-based railway didn't respond to a message seeking comment.
Investor demands
Canadian Pacific likely decided to issue its first century bond at the request of an investor looking to match long-term liabilities with assets, such as a pension fund or insurance company, Mr. Thiru said. He said he wouldn't be interested in tying up money in a bond with such a long timeline.
There are only a handful of bonds with terms 80 years or longer and they have about the same value to an investor as a 30-year bond, said Joel Levington, a Bloomberg Intelligence U.S. credit analyst.
"The further out you go, the less valuable that cash flow is today," Mr. Levington said. "The present value of it is less and less because it takes longer and longer to get."
The century bond sale was the biggest by CP since 1986. The company also issued $300-million in 20-year bonds with a 4.8-per-cent coupon. The average maturity on the Bank of America Merrill Lynch 15+ Year BBB U.S. Corporate Index is 25 years with a yield of 5.5 per cent, according to Merrill Lynch data. The last century bond was issued by Brazil's Petrobras Global Finance in June with a 6.85-per-cent coupon, according to data compiled by Bloomberg. Calgary-based Enbridge Inc., a pipeline operator, issued $100-million (Canadian) of century bonds in Canada in 2012.
Longevity bet
Investors tend to purchase ultralong bonds and hold them to maturity, which is why confidence in the longevity of the business is so important. Canadian Pacific has been rescued by a hotshot U.S. executive once before – William Cornelius Van Horne was brought in to get the floundering original railway construction project back on track in 1882.
CP may also have chosen to issue a century bond now because low interest rates are favourable to long debt timelines, Mr. Levington said. The yields on BBB rated bonds are lower today compared with five years ago, and companies see opportunity to finance at relatively lower interest rates, he said.
The financing will allow CP to bolster its share price with buybacks. The company has bought back three million shares and might buy more than six million additional shares under its repurchase plan. It has funded the buybacks almost entirely with cash from operations, tapping the bond market only once, for $700-million (U.S.) this year, since Mr. Ackman's management team came in.
To be sure, CP is paying up in order to fund its share purchases. The company's bonds, with $4.4-billion outstanding, have seen the premium investors demand to hold them over government debt rise faster this year than the average among transportation companies with U.S. debt, including competitor Canadian National Railway Co., according to Merrill Lynch data.
Bond covenants
Still, CP – which paused its buybacks this year to renegotiate the terms on its bond covenants – is prepared to let its debt-to-earnings ratio rise above 2.5 times from 2.2 times as it continues buying shares, said chief financial officer Mark Erceg in a July 21 earnings call.
"You would expect that," Mr. Thiru said of the company's continued buybacks. "They have created a lot of efficiency within the organization."