* Chilango "mini-bond" lacks protections of junk bonds
* Flimsy document provides limited financial information
* No secondary market means investors are locked in
By Robert Smith
LONDON, June 20 (IFR) - London burrito restaurant Chilango
is spearheading a new wave of crowdfunded "mini-bond" deals, but
retail investors hungry for high returns could face a nasty
shock if the company does not perform in line with expectations.
This is because the debt instruments may offer coupons
equivalent to those in the high-yield bond market, but they
offer none of the protection professional investors demand when
lending to junk-rated companies.
The companies are raising the mini-bonds on a new
crowdfunding platform called Crowdcube, which allows everyday
investors to place orders as small as £500. Chilango has raised
more than £650,000 of its £1m target, and can raise up to £3m if
it receives enough demand. Restaurant business River Cottage has
also raised a £1m five-year bond on the platform.
Chilango's four-year deal pays 8% annual interest, exceeding
even the highest yielding tranche of the recent record-breaking
12bn-equivalent high-yield bond package sold in April for the
buyout by cable companies Altice and Numericable of French
telecoms business SFR. Investors who put in more than £10,000
for Chilango's deal also get the added perk of one free burrito
a week for the life of the bond.
TEQUILA SHOTS AND DANCING
Professional investors, however, have not found this an
"It's incredible that they're able to do this; are yields
really so low that payments in burritos look attractive?" said
one London based high-yield bond portfolio manager.
"Unfortunately, the average buyer of this isn't someone
who's going to check the cash flow statements."
The offering memorandum for Altice's bonds ran to more than
1,100 pages, presenting detailed financial information and
outlining the risks associated with the deal. In contrast,
Chilango's "invitation document" is just 33 pages, with only one
page outlining the deal's key risks and two pages presenting the
company's financial performance.
Details may be lacking in the brightly coloured document,
but it does employ a healthy dose of humour. Explaining what
will happen if the deal is oversubscribed, the document states
that Chilango's management will "have a shot of tequila, which
will lead to a celebratory dance around our office".
One of the reasons high-yield offering memorandums run to
hundreds and sometimes thousands of pages is that institutional
investors usually require a robust covenant package to lend to
companies without an investment-grade rating.
High-yield bonds typically carry incurrence covenants, which
restrict the amount of debt a company can incur, as well
limiting the amount of money that can be used to pay dividends.
This stops a company from raising more debt than it can afford.
The invitation documents for mini-bonds such as Chilango's
contain none of these restrictions on debt raising or dividend
payments, meaning investors have less control than in some of
the riskiest types of junk-rated debt.
This is particularly concerning as Chilango's bond is
unsecured but the company also has secured borrowings. As of 3
June 2014, Chilango had £51,000 of drawn secured debt
facilities, but the absence of covenants means the bond places
no limits on how much it can draw.
DOING THE MATHS
Directly after discussing tequila shots and dancing,
Chilango's invitation document states "with careful help from
our advisors we've done the maths and worked out that we can
afford to repay up to £3 million".
But while Chilango may have done the maths, it does not show
If the company raises £3m, 8% annual interest would equate
to £240,000 a year. For bond investors the key metric for
whether a company can service its debt is Ebitda - earnings
before interest, tax, depreciation and amortisation.
While corporate bond issuers have to present their most
recent quarterly earnings, Chilango lists the nearly
nine-month-old results for the 53 weeks ending 29 September
2013. Chilango posted Ebitda of just £111,708 in this time, less
than half the required amount needed to service the coupon if it
sells the full £3m.
Chilango is using the bond to fuel expansion, and hopes to
open six new stores in London if £3m is raised. The company does
not list what the expected Ebitda would be from six additional
stores, however. In contrast, high-yield offering memorandums
often present a run-rate Ebitda figure showing expected gains
from any planned changes to a business.
Chilango has misjudged expansion in the past, closing two
stores in shopping centres after they failed to perform. The
company booked more than £1m in closure costs, losses and
write-offs to wind down the stores in 2011 and 2012.
Some investors are evidently concerned by the lack of
information. The deal's fundraising page has a forum where
potential investors can ask questions, and one person has asked
for a more detailed version of the company's balance sheet.
Chilango responded that some of these figures are
commercially sensitive and "we'd like to keep
confidential to make sure Chilango continues to kick ass."
The mini-bonds also lack one of the key ingredients of
fixed-income investors' returns: a secondary market. While
coupons look attractive, the returns from holding an asset are
just one way bond investors usually make money.
If a company performs well, for example, then the risk of it
defaulting on its debt lessens and the bond appreciates in
price. With an active secondary market, an investor can realise
these added returns by selling the paper. Mini-bonds such as
Chilango's are explicitly non-transferable, however, meaning
investors cannot sell before maturity.
This not only caps returns if things go well, but locks all
the exits if things turn ugly. If a company with publicly listed
bonds runs into trouble, investors can sell their holdings,
staunching potential losses.
This is not possible with mini-bonds, so investors will have
to hope Chilango has done its maths correctly if they want to be
repaid in full.
Chilango's co-founders Eric Partaker and Dan Houghton did
not respond to a request for comment.
(Reporting by Robert Smith; editing by Alex Chambers, Julian