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Debt lessons from EABL’s oversubscribed bond issue

By XN Iraki | November 2nd 2021

The political headlines may have distracted us from an interesting piece of news - the East African Breweries Ltd (EABL) bond that was oversubscribed by 275 per cent.

Companies sell bonds to raise funds either from individuals or other corporations. You lend the bond issuer, in this case, EABL, money and benefit from the interest paid. 

The proceeds of the bond are used to expand the business or retire old debts if the interest rate is more favourable should the company pay off the debt ahead of schedule.

One could ask why such a big firm would opt for debt instead of using internally generated funds.

Technically speaking, the value of the firm is invariant to how it is funded through equity or debt. Remember the Modigliani and Miller theorem? 

The principal, fronted by Franco Modigliani and Merton Miller forms the basis for modern thinking on capital structure. The basic theorem states that in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the enterprise value of a firm is unaffected by how that firm is financed; for the government, equity is the tax we pay. 

Debt allows you to get funds at once. Otherwise, a firm would have to wait many years before accumulating enough retained earnings for a big project.

By then, competitors would have taken over the market. This is also why individuals and governments borrow. 

Noted how teachers in the countryside have prospered through debt mostly through Sacco loans. 

Bonds are often cheaper than an outright loan from a bank. Corporations could also issue more shares (rights issue) to raise more funds. In EABL’s case, it went the bond way.

Let’s go back to the heart of our matter: why was the bond oversubscribed amidst the ravages of Covid-19?

Bond buyers are investors and prefer high returns and lower risks. By oversubscribing to the bond, investors gave EABL a vote of confidence. I must declare here that I happen to own a few shares in the brewer.  Would other firms listed on Nairobi Securities Exchange (NSE) have their bond oversubscribed?

Looking at their stock prices and trends, it is possible to predict which listed firms are likely to see an oversubscription should they decide to issue bonds.

Rating by S&P, Moody’s, Fitch and other agencies can also give a hint on the demand of a given firm’s bond. Our credit reference bureau (CRB) rating should be institutionalised and used to price personal debt.  

Oversubscription also shows that there is a lot of money in the economy for investment.

EABL was looking to raise Sh11 billion, but ended up getting Sh37.5 billion.

So there are some Sh26.5 billion floating around in the economy after EABL surpassed its target.

The interest rate offered for the bond was another attraction for investors besides the allure of EABL as a brand. By virtue of being listed, information about the company is also readily available.  

This oversubscription left me thinking: why can’t we mobilise the money floating around in the economy and invest it?

It seems the Sh73 billion for building the Nairobi Expressway could easily have been sourced locally.

The toll charges that will go to the Chinese contractor would have remained here. The public-private partnership model has opened a window of opportunity to tap excess funds in the economy. Why can’t we use EABL’s approach in funding public projects? When will the counties start floating such bonds? 

It’s paradoxical that while we rant about spiralling national debt, we are willing to lend to someone else! The reason is simple: we believe the money will be put to good use.  

The EABL bond shows clearly why the government should not crowd out the private sector for funds. The owners of the funds seem to believe more in the private sector. Are Treasury bills and bonds oversubscribed to that extent?  

This oversubscription leads to another observation. If entities put their house in order, others will lend them their money.

This applies to corporations, individuals and governments. It is why good governance and fiscal discipline matter.

We need a few well-governed counties to float bonds and use the money to improve their infrastructure. Others will follow suit.

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