‘Too big to fail’ makes Eskom debt a good bet in low-yield world

South Africa’s pledge not to let Eskom fail is enticing yield-starved investors to the company’s dollar debt.

Bondholders from New York to Seoul say they’re happy to hold onto the power company’s securities -- and in some cases add to their holdings -- because of their extra return relative to the country’s sovereign debt.

The government’s assurance that it won’t let the company default, effectively guaranteeing the debt, allows investors to play that spread without too much risk even though Eskom isn’t generating enough cash to service its own liabilities.

“State support for the company remains very solid and they continue to prioritize the repayment of the company’s debt,” said Paul Greer, a London-based money manager at Fidelity International, which oversees 243 billion pounds ($295bn), including Eskom bonds.

“The valuations of Eskom debt remain on the cheap side of fair value.”

Yields on Eskom’s unsecured 2028 dollar bonds have dropped 250 basis points this year even after it reported a record loss in July. That’s still 250 basis points more than South Africa’s 10-year sovereign debt.

The utility, which generates about 95% of the South Africa’s electricity, has amassed net debt of more than $30bn and is relying on a R128bn  ($8.4bn) bailout over the next three fiscal years to stay afloat.

The government has proposed splitting Eskom into three operating units to help cut costs, but the plan is facing resistance from labor unions opposed to job losses.

While President Cyril Ramaphosa has said Eskom is “too big to fail,” the government has had to increase borrowing too fund the bailout, raising the risk of a credit downgrade to junk.

“It ultimately comes down to government support,” said Jinwoo Kim, a credit analyst at Mirae Asset Global Investments Co. in Seoul. “Ramaphosa is clearly expressing he would not give up on Eskom.

Any investor holding Eskom bonds is seeing there is higher probability that the government will save the company, since the company is just too important for its economy.”

About 70% of Eskom’s R260bn of bonds are guaranteed by the state. The rest are unsecured, but there’s too much at stake for the government to put bondholders in jeopardy, said Shamaila Khan, director of emerging-market debt at Alliance Bernstein in New York, which holds Eskom bonds, according to data compiled by Bloomberg.

‘Strong Incentives’

“A key driver of performance going forward will be the restructuring proposal,” Khan said. While it’s not clear how that would affect bondholders, “the government has strong incentives to structure it in a way that it does not damage bondholder interests,” she said.

Not all investors are convinced. Eskom’s turnaround may still be a long way off given political sensitivities around the restructuring, said Guido Chamorro, co-head of emerging-market hard-currency debt at Pictet Asset Management Ltd. in London, which reduced its holdings of Eskom debt in May, according to data compiled by Bloomberg.

“We still hold some hope that the government will be able to address some of these issues, so we are ok having a neutral position,” Chamorro said. “But we haven’t seen enough signs to have conviction to move to a large overweight position.”

For others, though, it’s too good a deal to pass up. Fuh Hwa Investment Trust in Taiwan has recently accumulated Eskom bonds, betting there won’t be a debt restructuring even as the government reorganizes the company’s operations.

“We know Eskom has lots of problems and inefficiencies, but we also know how important it is for the whole economy,” said Jasmine Wu, who oversees the emerging-market portfolio at Fuh Hwa.

“So we don’t expect a restructuring of the debt and instead we believe the sovereign will do all it can to support Eskom, even if the result is a sovereign downgrade.”

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