Going, going, Gunns

Yesterday, Gunns (ASX: GNS) notified the ASX that its lenders had withdrawn their support and the company could no longer continue trading so it has appointed PPB Advisory as the voluntary administrator.

The collapse of any company impacts a range of people including employees, suppliers, creditors, and, of course, investors. Given the swag of hybrid investments recently offered by companies such as Bendigo & Adelaide (ASX: BEN), Crown (ASX: CWN), and Suncorp (ASX: SBK) among others that some Foolish investors might be considering, it is perhaps sobering to review what happened to investors in the Gunns’ hybrids (ASX: GNSPA).

Gunns issued $120 million worth of hybrids back in 2005 with a face value of $100 that paid floating interest at the bank swap rate plus a margin of 2.5%, which is a similar arrangement to many of the current hybrid issues. In October 2008, these were to be redeemed for cash, converted into ordinary shares or the margin would “step-up” to 5%, which is what actually happened.

By early 2009, as the global financial crisis hit, the hybrid share price had halved, which meant that the effective interest rate that investors received soared to around 18% per annum. The company apparently had assets that more than covered all its debts, so there was a possibility of a 100% capital gain if and when the hybrid was redeemed. Distributions continued without interruption through until April this year even though trading in both the hybrid and the ordinary shares was suspended in March.

In August the company announced it was converting the hybrids to ordinary shares, removing any hope that hybrid holders would rank as creditors — they were, and always had been, equity investors. To rub salt into the wound, a clause in the issue documentation limited the maximum number of shares to 421.7 per hybrid, which, at the last market price, was about $67 worth.

It’s  a bit irrelevant as to how many shares a hybrid holder gets if they are worthless as seems likely, but there is a final twist. The actual conversion doesn’t happen until the 15th October and the company is now in administration, so can it legally issue another 500 million shares. Does this make any difference to the outcome for hybrid holders?

Foolish takeaway

High interest rates equals high risk, and no amount of interest compensates for the loss of 100% of capital. Hybrids have bond-like returns but equity-style risks. If you choose to invest in any hybrid, make sure you understand the terms and condition,s as they are all different and most of them heavily favour the issuing company — not the individual investor.

If you’re in the market for some high yielding ASX shares, look no further than our “Secure Your Future with 3 Rock-Solid Dividend Stocks” report. In this free report, we’ve put together our best ideas for investors who are looking for solid companies with high dividends and good growth potential. Click here now to find out the names of our three favourite income ideas. But hurry — the report is free for only a limited time.

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Motley Fool contributor Tony Reardon owns Gunns’ hybrids. The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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