The Big Idea
El Salvador | Delayed launch again
Siobhan Morden | March 25, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The launch of bonds backed by Bitcoin intended to raise $1 billion for a new Bitcoin City was once again pushed back to April or May as authorities wait for more favorable market conditions and stronger participation. El Salvador’s President Nayib Bukele has begun pre-marketing by appealing to Bitcoin enthusiasts. More details have come out including the announcement of LaGeo a public thermal energy company, as the counterparty with a sovereign guarantee. It is not clear whether this is a marketing or a legal strategy, but a questionable counterparty should further discourage participation from institutional investors. Success will depend on retail investors. Minister of Finance Zelaya continues to assure a book that far exceeds the $1 billion target and possibly includes participation from local pension funds.
The March 15 to March 20 guidance has become a March-to-April timeframe as officials wait for more favorable market conditions. There is also no publication yet of the domestic securities regulations needed for the legal framework for the bond. This is the first important stumbling block before launch under local law jurisdiction. President Bukele promised to submit 52 laws to encourage investment earlier this month, which would seemingly include the relevant domestic securities regulations. President Bukele also tweeted that “the short delay in the issuance is only because we are prioritizing internal pension reform and we have to send that to congress before.” There is no obvious relation unless the pension funds will serve as anchor orders to boost overall demand.
It’s also curious that the counterparty for the bond isn’t the sovereign but rather the small public thermal power company LaGeo. Minister Zelaya confirmed state thermal power company LaGeo as the issuer with a sovereign guarantee. This explicit sovereign guarantee is critical. The company has a sparse $139 million in annual revenues that will need to support annual coupon payments of $65 million on the bulky $1 billion volcano bond, named for plans to build Bitcoin City near the Conchagua volcano. The LaGeo counterparty may be a marketing tactic as geothermal energy will power Bitcoin City and offer a green energy alternative to fuel imports. Or perhaps it is an accounting tactic to leverage their balance sheet without adding to the sovereign debt burden.
The local law status of the bond may not prove a deterrent for Bitcoin investors that view El Salvador as a potential Bitcoin global financial center. However, it is worrisome that this quasi-sovereign issuer adds another layer of risk to an already high-risk sovereign issuer. There are also other legal considerations. It creates further separation to Eurobonds and no cross-default for the local law jurisdiction as well as the different counterparty risk. Ability to pay will depend almost solely on Bitcoin performance with an almost perverse stronger willingness to pay from a president that has staked his reputation on a Bitcoin financing and growth model. However, if the Bitcoin experiment fails then a quasi-sovereign default would be legally isolated from the sovereign Eurobonds.
There is no investment bank to manage investor relations or provide financial advice, with Blockstream providing only the Bitcoin product technical guidance and lacking a primary spokesperson after the resignation of Samson Mow. This would logically imply higher deal risk with El Salvador bypassing the investment bank fees but also forfeiting their financial, legal, and marketing expertise necessary to maximize investor demand. Minister Zelaya claims $1.5 billion in soft demand. There is no precedent to measure potential demand for this inaugural and innovative transaction. There is logically potential demand for the first mover status; however, multiple series beyond the EBB1 is doubtful with limited retail participation in the global fixed income market and restricted access to US based investors. The success of the transition will depend upon the ability to source external as opposed to forced internal demand from pension funds.
El Salvador bonds have bounced with the overall improvement in external risk. The 2023 tenor should be more sensitive to near-term rollover risk and a successful launch of a volcano bond—proceeds are fungible irrespective of spending plans—that downplays the participation from local investors. Domestic funders typically serves as lenders of last resort. The 2023s are still a few points off their recent price highs while the rest of the curve remains below the breakeven scenario of postponing default until 2025. El Salvador looks oversold against our base case view. That includes a muddling through the 2023 payment with continuing financing options at an early phase of cash flow stress and no options for a pivot towards fiscal discipline.