Polkomtel’s sale of a $200m (£126m) payment in kind (Pik) note has prompted a fresh wave of speculation that the bonds are making a comeback. But many, such as Jeremy Duffy of White & Case in London, believe that Piks remain an uncommon feature of finance structures.
“Pik instruments are usually deeply subordinated and many investors that prefer to hold debt still wish to maintain cash-flow by way of the receipt of interest payments,” added Duffy. “These two factors indicate that Piks are unlikely to suit certain entities.”
Piks are bonds that don’t have to be paid until maturity. Because they are typically subordinated, they are seen as a risky investment and take losses first.
Their popularity peaked during the economic boom because their profile fit LBOs perfectly: they allow private equity firms to compound interest and keep rolling it over by converting existing notes into Piks.
Although the notes were predicted to stage a return last year, as IFLR reported the market was not ready for an instant return to the Pik-heavy days of before the financial crisis.
“When there is a high yield market, there is always an opportunity for Pik notes to get done if the pricing and the credit is right,” said Rob Mathews of White & Case. “But it’s possible that the dividend deals we saw in the legacy Pik market might not reappear any time soon.”
These deals used the proceeds of the Pik note to pay dividends to shareholders. Polkomtel, the Polish telecoms operator, will use the proceeds to repay a bridge financing that was taken in connection with the acquisition.
According to Fabio Diminich of Clifford Chance in London, there is a fundamental misunderstanding about how Piks work, and they carry no risk for companies.
“It really is a very simple instrument,” he said. “Typically, it’s issued outside of the credit group, it’s unsecured and receives no upstream guarantees. It’s basically a substitute for equity with no special terms.”
On this analysis, if the Pik issuer is unable to repay the notes when they come due, the harm is just to the private equity sponsor and the note holder but not to the group itself, because there’s no credit support from the company to benefit the note.
But Tariq Rasheed of Berwin Leighton Paisner said one of the issues with Pik notes is that companies that have issued them may not be in a position to repay the accumulated deferred returns on the maturity date. This is because, when it issued the Piks, the company might have envisaged a certain growth rate which is never achieved in reality.
“There is still a danger that, where a company (or private equity fund) has got its projected calculations wrong, Pik notes are just inflated balloons waiting to explode," said Rasheed.
Too early for toggles
Pik toggles appeared on European terms sheets in late 2006, when the high yield market was strong. But, since this peak, the concept went away and has not been seen in recent years.
According to Diminich, this is not the market to try a Pik toggle.
“Toggles are different instruments altogether since they are issued within the credit group and give the company the choice to decide between paying cash pay interest and Pik interest,” he said.
Mathews hasn’t seen any Pik toggles either. “Typically the reason to put a Pik in place is because the debt below it in the capital structure blocks the ability to send money up to pay cash interest payments on the Pik debt so the toggle in this situation [Polkomtel] doesn’t make sense,” he added.