Redeemable preferred shares (RPS) are a type of preferred stock that gives the issuer the right to buy back the shares at a predetermined price and time. This can be an attractive option for both the issuer and the investor, as it provides flexibility and potential benefits for both parties. However, investing in RPS also involves some risks and challenges that investors should be aware of before making a decision.
As I’ve just recently invested in MAA Group’s Maax Fidelity RPS, I thought it would be a good time to discuss some of the red flags when investing in RPS, and provide some case studies of successful and fraudulent RPS investments so you can make informed decisions and not blanket label RPS as a bad thing.
What are the risks of investing in RPS?
One of the main risks of investing in RPS is that the issuer may redeem the shares at an unfavorable price or time for the investor. For example, if the market price of the RPS is higher than the redemption price, the investor will lose the difference when the issuer calls back the shares. Alternatively, if the market price of the RPS is lower than the redemption price, the investor may be forced to sell the shares at a loss if they need cash or want to diversify their portfolio.
Another risk of investing in RPS is that the issuer may default on paying dividends or redeeming the shares. This can happen if the issuer faces financial difficulties or goes bankrupt. Unlike debt holders, preferred shareholders have no legal claim on the issuer’s assets in case of liquidation. Therefore, investors may lose their entire investment if the issuer fails to honor its obligations.
A third risk of investing in RPS is that the investor may face tax implications or regulatory issues. Depending on the jurisdiction and the terms of the RPS, the dividends paid by the issuer may be taxed as ordinary income or capital gains, which can affect the investor’s after-tax return. Moreover, some regulators may impose restrictions or requirements on issuing or investing in RPS, such as minimum capital adequacy ratios, disclosure standards, or approval processes. Investors should consult their tax advisors and legal counsel before investing in RPS.
What are some case studies of successful RPS investments?
Despite these risks, some investors have made successful RPS investments by choosing reputable issuers, negotiating favorable terms, and timing their exit strategies.
Here are some examples of successful RPS investments:
– In 2017, Berkshire Hathaway invested $300 million in RPS issued by Home Capital Group, a Canadian mortgage lender that was facing a liquidity crisis. The RPS paid a 9% annual dividend and had a redemption price of $25 per share. In 2018, Home Capital Group redeemed all of its RPS at $25 per share, giving Berkshire Hathaway a 9% return on its investment.
– In 2019, KKR & Co. invested $500 million in RPS issued by Campbell Soup Company, a US food manufacturer that was undergoing a strategic review and divestiture plan. The RPS paid a 5.75% annual dividend and had a redemption price of $100 per share. In 2021, Campbell Soup Company redeemed all of its RPS at $100 per share, giving KKR & Co. a 5.75% return on its investment.
– In 2020, Silver Lake Partners invested $750 million in RPS issued by Twitter, a US social media company that was facing activist pressure and governance issues. The RPS paid a 0.25% annual dividend and had a redemption price of $1 per share. However, the RPS also had a conversion feature that allowed Silver Lake Partners to convert its RPS into common stock at a conversion price of $36 per share. In 2021, Twitter’s common stock price rose above $60 per share, giving Silver Lake Partners an opportunity to convert its RPS into common stock and realize a substantial capital gain.
What are some case studies of fraudulent RPS investments?
Unfortunately, some investors have also fallen victim to fraudulent RPS investments that were designed to deceive or defraud them. Here are some examples of fraudulent RPS investments:
– In 2014, Stanford Financial Group, a US-based financial services company, was exposed as a Ponzi scheme that had sold billions of dollars worth of RPS to investors around the world. The RPS promised high returns and safety, but were actually backed by worthless assets and fictitious revenues. The founder and chairman of Stanford Financial Group, Allen Stanford, was convicted of fraud and sentenced to 110 years in prison.
– In 2016, Platinum Partners, a US-based hedge fund manager, was charged with fraud for inflating the value of its RPS portfolio and misappropriating investor funds. The RPS were issued by companies that were either bankrupt or facing litigation, and had little or no chance of being redeemed. The co-founders and executives of Platinum Partners, Mark Nordlicht and David Levy, were convicted of fraud and sentenced to prison.
– In 2018, Theranos, a US-based health technology company, was accused of fraud for misleading investors and regulators about its blood-testing technology and financial performance. The company had raised over $700 million from investors, including $100 million from RPS issued to Rupert Murdoch, the media mogul. The RPS were worthless, as the company had no viable product or revenue. The founder and CEO of Theranos, Elizabeth Holmes, is currently facing trial for fraud.
Recently, a startup aviation company that claims to revolutionize the aviation industry with its innovative technology and business model has been in a bit of a pickle. A recent investigation by the Financial Times has revealed that the company was using Redeemable Preferred Shares (RPS) to raise funds from unsuspecting investors. Companies Commission of Malaysia (SSM) data showed that its director and businessman Datuk Allan Goh Hwan Hua is the airline’s single largest shareholder. SSM data previously showed that international trade consultant Zillion Wealth Bhd had an 88% equity interest in MYAirline and Trillion Cove Holdings Bhd, a money lending and financing company, a 10% stake. Both Zillion Wealth and Trillion Cove named Goh as a director of the companies.
The airline’s former chief executive officer (CEO) Rayner Teo Kheng Hock, meanwhile, had owned the remaining 2% of the airline’s shares.
This is an example of how some startups use deceptive and unethical methods to raise funds and fraud their investors. Investors should be wary of such schemes and do their due diligence before investing in any company.
How to avoid the red flags when investing in RPS?
To avoid the red flags when investing in RPS, investors should conduct thorough due diligence on the issuer, the terms of the RPS, and the market conditions. Some of the questions that investors should ask are:
– Who is the issuer of the RPS? What is its credit rating, financial performance, and reputation?
– What are the terms of the RPS? What is the dividend rate, redemption price, maturity date, and call option? Are there any conversion features, protective covenants, or voting rights?
– What are the market conditions for the RPS? What is the supply and demand, liquidity and volatility, and price and yield of the RPS? How does it compare to other investment alternatives?
– What are the tax implications and regulatory issues for the RPS? How will the dividends and capital gains be taxed? Are there any restrictions or requirements for issuing or investing in RPS?
By answering these questions, investors can make informed decisions and avoid potential pitfalls when investing in RPS.
Sources:
– https://www.wallstreetmojo.com/redeemable-preference-shares/
– https://www.accountingtools.com/articles/redeemable-preferred-stock
– https://www.termscompared.com/redeemable-vs-irredeemable-preference-shares/
To reach the My Money Insights editorial team on your feedback, story ideas and pitches, contact us here.