Day 976 - The One That Got Away
Lab Notes: Everything Went Right. One Thing Went Wrong.
Sometimes the trade is right. Everything lines up. And then one thing doesn't.
This is a story about Synlait, a missed arbitrage, and the lesson that contingency planning is not optional.
The Setup
Synlait Milk is a Canterbury dairy processor. In better days, it supplied infant formula for A2 Milk’s China business and was the darling of the NZX. It had a good run. Management, as sometimes happens after a good run, concluded they could do no wrong.
They were wrong.
The company expanded aggressively — new plants, acquisitions, new product lines — and loaded up the balance sheet in the process. When market conditions turned, as market conditions always eventually do, the debt that had seemed manageable suddenly wasn’t. Infant formula demand out of China softened. Margins compressed. A large chunk of revenue was tied to a single customer. The half-year result to January 2024 showed a net loss of $96 million. Net debt had climbed to $559 million.
The market was not pleased.
The Bonds
Back in February 2021, Synlait had raised $180 million from retail investors and institutions via a listed bond: SML010 on the NZX Debt Market. The coupon was 3.83% per annum, paid quarterly — roughly one percent every three months. The bonds matured in December 2024. Face value: $1.00.
Yield, for those unfamiliar with the term: it's the return you actually get based on what you pay. If a bond pays 3.83 cents per year but you buy it for 50 cents, your income yield doubles — the coupon is fixed, but you paid less for it. But that's only part of the picture. If the bond is redeemed at face value on maturity — $1.00, regardless of what you paid — you also pocket the difference as a capital gain. Buy at 50 cents, get $1.00 back: you've doubled your money before a single coupon is counted. The more distressed a bond, the lower its price, and the higher the combined return if it survives. High yield is the market's way of pricing in risk. Very high yield is the market screaming.
By mid-2024, Synlait’s bonds were screaming.
The Crisis
The pressure point was a $130 million prepayment obligation to Synlait’s bank syndicate, due July 15, 2024. Synlait had also warned it was unlikely to meet three banking covenants by July 31. The fear was a covenant breach triggering acceleration — banks calling in their loans. The equity market agreed things were dire: Synlait shares hit an all-time low of 20 cents on June 27.
And then, for approximately two days in mid-June 2024, something unusual happened.
The yield on the SML010 bonds spiked to around 50%. There was also another figure — possibly a yield-to-maturity calculation displayed on the NZX debt market screen — that, in my recollection, approached something like 200%. I have held off on stating that second number with confidence. What I am confident about: the primary yield was 50%, briefly, and it was one of the most extreme readings I had ever seen on a listed NZ debt security.
The Arbitrage Case
Here is what I saw in the financial accounts.
