Why are investors excited about the KenGen Bond?

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

27 September 2009

Why all the hullabaloo about the KenGen Infrastructure Bond? Simple: there are 15 to 25 billion reasons why investors are excited! The Electricity Generating Company is looking to borrow Sh15 billion from the public, with a possible extension to Sh25 billion if there is enough demand.

The main reason investors are getting excited is that KenGen is paying a handsome 12.5 percent interest on the bond. And since the money raised will be used for construction of public infrastructure (power stations), the returns are exempt from taxation. Thus, the effective rate is higher than the 12.5 percent.

If you invest the minimum Sh100,000 in this bond, you should expect to get an interest cheque of Sh6,250 every six months for the next two years. This is a  total of Sh12,500 every year. Now if you think that it is a small amount, talk to some one who invested Sh100,000 in the Safaricom IPO; they are expecting Sh1,700 in dividends!

Before looking at what happens after the initial two years, let us see the effect of tax exemption. In order to simplify the discussion, I will assume that the investor has a monthly salary greater than Sh38,892. In such a case, any additional income earned is taxed at 30 percent.

The Sh100,000 bond will earn a tax-free interest of Sh12,500 per year. The question then is: if it wasn’t tax exempt, how much would KenGen have paid in order for the investor to get the same amount in shillings (after deductions)?

We get the answer by dividing Sh12,500 by 70 percent (or 0.7). The result is Sh17,857. If you doubt the calculation, deduct 30 percent tax from Sh17,857 and see what remains. Thus in reality, this bond is paying 17.857 percent before tax. That’s way higher than the government bonds issued by the Central Bank of Kenya.

17.857 percent return, for doing absolutely nothing – just sitting in your office and waiting – is music to any investment manager’s ears!

After the initial two years, KenGen will start paying back the principal sum; that is the Sh100,000 in our example. They will divide it into 16 equal portions and the first instalment will be paid on 30th April 2012.

In our example, the principal instalments will be Sh6,250. In addition, the six-month interest on the Sh100,000 will also be paid, making a total payment of Sh12,500 on 30th April 2012.

After this payment, the principal balance will be Sh93,750 (Sh100,000 minus Sh6,250). This is the amount that will be used when calculating the interest six months later.

Thus on 31st October 2012, you will get Sh6,250 as principal payment and Sh5,859 as interest; making a total of Sh12,109. That will leave Sh87,500 in the account and after another six months (30th April 2013) you will get Sh6,250 plus Sh5,469 equals Sh11,719. This process will continue until the last payment is made on 31st October 2019.

If you get tired of waiting until 2019, you will be able to trade the bond at the Stock Market and get your money back; but don’t expect supernormal profits when you sell! I will explain how to trade in bonds next week.