The best of two worlds: A marriage of credit yield and equity upside

Michael Goldberg

Collins St Value Fund

High-conviction, contrarian thinking underpins the latest offering from Collins St, a fund of convertible notes that draws on the same investing approach we apply to our successful flagship equities strategy, the Collins St Value Fund.

In these uncertain times, we believe this new fund’s combination of debt and equity considerations – across both the listed and unlisted domains – provides an excellent investment yield opportunity.

The Collins Street Convertible Notes Fund targets an annual return of at least 8% from a portfolio of assets spanning multiple sectors. With a credit maturity of between two and three years, this currently comprises 10 different notes with another 12 deals expected to close over the next six months.

In the following video, I delve into the detail of convertible notes and the coupons they provide. I also discuss how we select assets and how these ultimately transition from debt products into equity.

When considering assets, we’re far less concerned about the share price and market cap than the quality of management, the plan for the business and the security we can get for our loan.

Using the example of a West Australian gold miner we’ve recently funded, I explain how our conversion price aligns with our business valuation, both now and during a two-to-three-year timeline. During this timeframe, we will get a free kick at any upside potential from resource assessments, upgrades and general improvements in the company and overall gold price.

Beyond resources and commodities, we’re also targeting a growing pipeline of opportunities across various sectors including financials, technology, and industrials.

Collins St Convertible Note Fund

To learn more, or express an interest in participating in the current capital raising for the Fund (‘sophisticated’ investors only) please click here.


Hello, I'm Michael Goldberg, portfolio manager and managing director at Collins Street Asset Management. And today I thought we'd talk a little bit about one of our funds, the Collins Street Convertible Note Fund.

Now, the Collins Street Convertible Note Fund is a yield opportunity that leverages many of the same processes and philosophies and thinking as our Collins Street Value Fund, which has been running since 2016. Things like aligned interest with investors, things like capital preservation being first and foremost in our minds, value investing, contrarian thinking, and conviction investing. All of these things make up part of our investment DNA, and so they'll all be reflected in any investment in any fund that we run.

Over the course of the years, we've received feedback from our investors who expressed a keen interest in investing in something that would complement their equities investments. Something that provided a yield, a cash flow. And so to that end, we've launched the Collins Street Convertible Note Fund, which aims to generate an 8% per annum distribution, which we intend to pay out quarterly.

Now, a 2% distribution quarterly is handy for all investors, no doubt, but we found it's especially attractive to pension phase superannuation funds, to charitable foundations that have to liability match over the journey, and even family trusts that need to distribute to family members. Now, I think the attraction of a convertible note fund, something that tends to be less volatile than the regular equity market, is attractive at all stages and cycles of the journey, but I think it's probably especially true in highly volatile markets and certainly in uncertain times. So with that said, I think the natural question is what really is a convertible note? In essence, a convertible note is a private agreement between a borrower and a lender.

Now, because every borrower and every lender is different and every deal is going to be different, every convertible note agreement is also going to be different. We've been doing these now since about 2017. At the moment, we've got about 10 different notes within our funds. We're also in different stages of negotiation for another 12 deals, potentially, that might come up over the next six months or so. And the way we structure them looks something like this.

So first and foremost, we need to find a company that we like. We need to find a company that wants growth capital. We're not looking to fund companies just to pay their salaries or just to give holidays to their board and management. We want to make sure the capital we are providing is going to grow the business. And to that end, we want to know that we've got security as well, so we'll get security against the assets of that business.

Now, security's an interesting thing. If you ask a company what its assets are worth, they'll give you one number. And we've discovered if we send in our own independent experts, that number might be significantly different. And so that's what we do. We are taking a conservative approach, we're sending our own independent experts, and we get an assessment of what we think that security's really worth to make sure that we are well and truly more than covered for any loan that we might provide.

A convertible note, like any loan, will also have an attached coupon, the price to pay. The price that the company has to pay, the interest rate for acts to that capital. Over the journey, we've charged somewhere or anywhere between 8% and 12% per annum. Of course, as markets evolve, those rates will adjust, as well. As an example, our most recent deals have been done at around about 10.5%.

We also set a maturity period of about two to three years for the companies to which we lend money. We're not looking to provide them with bridging finance, and we're also not looking to provide them with forever money. The idea is we're providing them with some growth capital, which will see them put it to work and hopefully see the benefits in the dividends through their share price. So we think, and we tend to sense, that between two to three years is about how long it takes for most of the companies that we're lending to to bring their business to the next level. And again, hopefully, we see that reflected in their share prices.

And that brings us to the last point, which is, of course, the conversion part of the convertible notes. The way that we write them, every convertible note will have a predetermined conversion price. We tend to offer a conversion price above the prevailing share price at the time that we negotiate with the company. But again, we recognise that by giving these companies our capital, we are intrinsically increasing the value of that business, and the prospects of that business go up. And so we are comfortable doing that. Our expectations are if all things go well, we'll enjoy the coupon and the yield along the journey. And as we approach maturity, we'll be able to convert our loan into equity at a premium to the price that we're paying for it, and then sell it into the market, thereby hopefully locking in a capital gain.

If things don't pan out as we'd hoped, then when maturity comes up, we can ask for our capital back, and we can be satisfied with the yield that we achieved along the journey. And really, at the heart of it, that's the asymmetry of a convertible note that really attracts us. On the downside, we behave and are supported as if we were a secured lender to the company. Whereas if things go well, which hopefully they will and regularly they do, we get to participate in the upside as if we were equity investors.

It's been really interesting to see where demand for our convertible notes has been coming from over the journey. Certainly, historically, a lot of the interest has come from resource companies and that makes sense. Resource companies tend to be hungry for capital, to bring their projects to the next stage of development. But in recent times, it's been very interesting to see a more broad range of sectors expressing interest in dealing with us and our convertible notes. Most likely it's got to do with the volatility we're seeing in general markets. Perhaps it's got to do with general financial markets.

Whatever the case may be, when push comes to shove, we're happy to look at any opportunity, wherever it lies. So long as the security is sound, the company is solid, and the opportunity is good.

We've been building out our resources to make sure that our investors get the best possible outcomes. And internally, we've brought on a credit analyst who does a lot of the day-to-day work with our lawyers as they draught the terms of our agreements and also the industry experts who provide insight into the underlying businesses and projects that we're investing in to make sure that we get the best possible outcomes for our investors. We've also built out our process of investment committee meetings whereby we engage with outside expertise, including external lawyers, to make sure that we don't suffer from the risk of tunnel vision or falling in love with a particular idea and making sure that at every step, at every key step of the negotiation, and every key step of the transaction, our best interests and the interests of our investors are properly looked after.

And of course, even after the deals are done, the work doesn't end. Our team reviews company progress on an ongoing basis. Even getting so granular as to have ongoing access to the company's bank balance to make sure that they are in compliance with our expectations and their promises. 

And I suppose even, being satisfied that all those above boxes are checked, we also have an additional layer of oversight and security for our investors insofar as we have our companies prepay better than half of their interest owed over the term of the loan into an account held by our fund, such that if, heaven forbid, something should go wrong, not only do we have security against the assets for our loan, but we also have additional capital available to us to continue to pay out our yield to our investors. Now, to add some colour to our process and philosophy, I think it's probably worth having a quick look at one of our more recent deals.

GBM Resources (ASX: GBZ) is a great example. It's a Perth-based Australian company with projects in South Australia, in Queensland and Victoria, and its main focus recently has been in the Drummond Basin, which is a gold-rich area. 

They are, of course, a gold explorer and also a gold producer. Now, as the chart shows on the screen, the share price of GBM, stock code GBZ, has had a bit of a difficult time of late. The current market cap is somewhere between 20 and 25 million dollars. But for us, we're far less concerned about what the share price might be doing or what the market cap is, and far more concerned about the quality of management, the plan for the business, and the security that we can get for our loan. So management, especially Peter, the managing director, is experienced. He's well regarded, he's aligned his interest, as has the whole board by investing alongside other investors in regular equity.

We like that they're focusing on the Drummond Basin project in Queensland, which is the most prospective and promising of their assets. And additionally, we like that they are selling down all of their non-core assets. So having sent in the experts to do due diligence on the value of their assets, we came back with a conservative valuation of $50 million against which we were happy to lend $10 million in two tranches.

As you can see, the interest rate that we're charging is about 10.5%. That's more reflective of the current interest rate environment. And we've struck an 8.75-cent conversion price, which is very much in line with what we think the business is currently worth today. So what that means is we have a conversion price that aligns with what we think it's worth today. And for the next two or three years, we get a free look in, and a free kick at, any upside potential from resource assessments, resource upgrades, general improvements in the company, and even the gold price.

If all things go well, we think this company could certainly be worth between 10 and 12 cents in the next two to three years, in which case we will have enjoyed our yield along the journey. We are likely to convert our loan into equity, and then we're likely to sell it to a prearranged buyer. But if heaven forbid, things don't play out, we are abundantly confident in the company's ability, both from a security perspective and their ability to pay us back our loan if necessary. While GPM is a good example of one of the investments we recently made, our pipeline of opportunities is certainly growing, both in number and also in diversity. It seems to us that any sector within financial markets that is unloved can provide a treasure trove of opportunities for investors looking to take advantage. Now, we don't have a firm range in which we must lend.

Typically, we've offered companies between five and 50 million dollars in negotiations. It seems that our sweet spot, certainly at the moment, seems to be somewhere between the five and 20 million dollar range. We have the vast majority of our deals ongoing and locked in that range. But we've certainly spoken to some companies who are looking for smaller loans, and we've certainly spoken to companies that are looking for larger loans. Again, we're less concerned with the size of the loan, we're less concerned with the market cap of the company and far more concerned about number one, security, and number two, security. And number three, the price we're paying. In an effort to jealously protect the yield of our investors, we only actually raise capital when we have a new deal that requires funding. So if anything we've said today is of interest to you, I'd encourage you to reach out to us through our office.

The details can be found on our website. We expect to have two new opportunities for investors to participate in this fund this year. We'll be raising capital through October for an early November issuance of around about 10, 11 million, dollars. And we expect to also be raising money in November for an early December issuance of around about $40 million.

Now, again, given that we only intend to raise as much money as we need to fund every particular deal, I would encourage anyone with interest to reach out to our head of distribution, Rob Hay, to express that interest and lock in your investment. His details will be available in this presentation. We are only available to wholesale and sophisticated investors, and we are also in the process of arranging to be available through a number of platforms. So if you've got any questions about how to invest, generally what a convertible note might mean, or specifically some of the deals we've invested in, please feel free to reach out to either me or Rob.

We'd be happy to answer any questions you might have, and I hope to hear from you soon. But in the meantime, bye for now.

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Michael Goldberg
Managing Director and Portfolio Manager
Collins St Value Fund

Michael is the MD and one of the founding partners of the Collins St Value Fund. The Collins St Value Fund is one of the best performing Funds in Australia - having ranked among the top 10 performing funds across all Australian Equity mandates by...

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