On 24 June, Singapore Airlines completed the full redemption of all its outstanding MCB (mandatory convertible bonds) that had been issued during the throes of COVID-19.

This means that if you had put in money to buy those bonds in 2021, the company returns the entire sum that you had invested, with a pre-agreed premium on the investment, even if you were content to keep it to maturity and have them converted into shares.

The Business Times calls this "an interesting chapter of its history". I think it's a good lesson in corporate finance and financial management, and we need more creative structuring like this in our capital markets.

The premium for the final redemption works out to about 12.6%, which translates to be roughly 4.0% per year:

Had SIA not followed through with the redemption, allowed you to hold those bonds, and converted the face value at S$ 4.84 per share at maturity, the IRR would be closer to 8%, depending on where you think the share price lands in 2031.

Now a 4% to 8% annualised investment return over ten years may not seem like a lot if you compare it with interest rates today and also look back on how delicate things were during COVID-19. Some airlines even came close to bankruptcy during that period of time. Cost of capital was high.

Buying airlines and all things travel-related were high risk investments, especially if you think about the speed at which SIA was haemorrhaging capital to the tune of S$ 8.8 billion in a year after its band aid of a rights issue in 2020.

Even with sovereign underwriting from Temasek Holdings, there was simply no saying when the bleeding would stop.

But ignoring the grim backdrop, a 10-year sovereign-backed corporate bond with step-up interest rates of 4 to 6% would have been a highly attractive investment, considering SOFR rates were at approximately 1.5% in 2020.

The real pot at the end of the rainbow was swapping those bonds into SIA shares, in which the conversion price was at a big discount to SIA’s share price at pre-pandemic levels.

After all, the prime minister had given his soft endorsement, saying that “SIA will be a great way to fly again”. How much worser could it get?

What made a significant difference also was that the convertible bond offer was given exclusively to existing shareholders - a creative concoction of debt and equity.

If you had missed out on the 2020 rights issue, buying SIA shares off the market would provide another window of opportunity to get in, or double down, albeit at an even lower price. And then you get the bonds as well, which ultimately increases the probability of a successful convertible bond issuance.

It’s an ingenious way to market a deal.

Most companies will just go on roadshows, paint a rosy picture against a hockey stick chart and promise the eventuality of brighter days ahead.

But these MCBs were essentially structured as a “private club”, open only to existing investors, with a ten-year bet on the aviation sector and SIA’s reigning leadership over that period.

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Looking back, I think the conversion mechanics in the whole deal was arbitrary.

The huge equity upside from swapping those bonds into equity at S$ 4.84 per share was probably meant to justify the low cost of debt.

If you ask me, I think no one really baked in a scenario to have those bonds converted to shares.

Ten years would give SIA sufficient runway to set aside capital to redeem those bonds at any time: Three years tops for the pandemic to play out and the economy to recover, plus another seven years or so to turn around.

The worst case?

Air travel doesn’t recover and the company’s business model becomes permanently altered. A remote possibility nevertheless, in which case, swapping those bonds into equity wouldn’t really be such a bad deal after all.

[Disclaimer: I was a holder of SIA shares and its MCBs.]