A spotlight on convertible notes in the Australian energy and resources sector

Key takeaways

• Convertible notes are a debt-equity hybrid commonly utilised in the start up space. However, over the past 12 months, we have seen an increase in their use by a variety of companies (both listed and unlisted) in the energy and resources sectors.
• In an uncertain market, investors are seeking alternative avenues to better protect their investments from risk without completely forgoing the potential for upside return. Convertible notes offer this flexibility.
• We expect the use of convertible notes to continue over the next 12 to 24 months, not only as a primary source of funding but also to supplement broader deal structures and provide greater flexibility to potential investors.
• Important considerations when looking to utilise convertible notes include tax treatment, takeover thresholds, ESG warranties, FIRB and, if you are a listed company, placement capacity and compliance with the Listing Rules.

Australian economic environment

A noticeable market trend over recent years, particularly in 2023, is the increased use of convertible notes by listed and larger established Australian resources and renewables companies. This fundraising instrument has traditionally been associated with early-stage venture capitalists and start ups in their seed financing stages. However, the utility of convertible notes has traversed to these larger established Australian companies who are utilising the issue of notes as an alternative source of equity or quasi-equity funding for early or developmental stages of a project.

Convertible notes provide investors with flexibility: noteholders receive the benefits typically associated with a loan, such as regular interest payments on the face value of the notes, while also securing the ability to have that debt convert to equity in the issuing company upon the occurrence of an agreed event or milestone.

What is a convertible note?

A convertible note is a type of security issued by a company to raise funds, usually on a short- to medium-term basis, that may either be repaid at a premium (while accruing interest) or converted into equity when a predetermined milestone or conversion event occurs. Key features of a convertible note include:

• a principal loan amount;
• a repayment or maturity date;
• an annual interest rate that accrues over the term;
• a right to convert the notes into equity in the issuing company on a conversion event, usually at the election of the noteholder; and
• repayment in priority to the company’s equity holders in a liquidation.

Conversion events most commonly include ‘exit events’, such as the completion of a sale of all or substantially all of the issuing company’s shares or assets or a qualifying finance, like an initial public offering on a recognised stock exchange or securing further capital through other debt or capital raisings.

Things to note

Takeovers threshold

Where the issuing company is listed on the ASX or is unlisted with more than 50 shareholders, a noteholder cannot obtain a relevant interest in the issuer’s voting shares greater than 20% without shareholder approval. To do so contravenes the takeover threshold under Chapter 6 of the Corporations Act 2001 (Cth) (Corporations Act).

While convertible notes do not confer voting rights or a relevant interest in voting shares on the noteholder, the relevant interest is acquired when a note is converted into shares with voting rights attached. Convertible note arrangements should contain provisions that enable a sensible management of circumstances where the conversion is likely to would exceed the 20% threshold in contravention of Chapter 6.

This could, for example, be by requiring shareholder approval for any interest acquired above 19.99%, or by structuring conversions to fall within the 3% ‘creep’ rule (being acquisitions of up to 3% every six months from a starting point above 19% are exempt under section 611(9)).

Tax

Given the debt-equity nature of convertible notes, tax treatment is complicated, will differ depending on the terms of the note and there is no general ‘one size fits most’ approach. Accordingly, the varied commercial arrangements in each circumstance impact the treatment and we recommend that tax advice be sought on a case-by-case basis.

For example, where notes are characterised as debt (rather than equity), interest withholding tax is required to be withheld and paid to the Australian Taxation Office when interest is paid or credited
to certain foreign noteholders (and before the noteholder can claim a deduction for the interest expense). Returns on a convertible note which is characterised as equity will be treated as dividends and returns to the noteholder are frankable (but not deductible to the issuer).

Environment, social and governance (ESG)

Noting the growth and focus on ESG practices, particularly by foreign investors, it is becoming increasingly common for convertible note terms to include warranties in respect of modern slavery, sanction, anti-bribery and corruption and anti-money laundering practices. These warranties are quite often mutual, which may have more significance for listed companies who are often required to report on such matters.

FIRB

Acquiring shares or entering into an agreement to acquire shares, including by way of a convertible note, will be subject to the Foreign Investment Review Board (FIRB) rules. Therefore, consideration should always be given to whether approval from FIRB is required where an investor is foreign. The type of application and receipt of FIRB approval will be dependent on various factors, including the nature and scale of the issuing company, who the investor is (whether they’re a foreign company or a foreign government entity) and the equity interest the investor will acquire in the issuer.

It is possible to have FIRB approval as a condition of a conversion.

ASX

If you are an ASX listed company seeking to issue convertible notes, there are a few key factors to consider. Primarily:

• you must have 15% placement capacity under Listing Rule 7.1 at the time of issuing or agreeing to issue the notes, which are characterised as ‘equity securities’ under the Listing Rules. Alternatively, you may be able to make the conversion of the notes to shares subject to shareholder approval, although recent guidance indicates that ASX’s preference is FOR approval at the time of issue. Separately, and in any case, investors will likely want approvals at the time of issue to provide greater certainty that the option of conversion is available to them; and
• the convertible note terms must be ‘appropriate and equitable’ in accordance with Listing Rule 6.1. Following an increase in use of convertible notes, ASX placed further emphasis on this requirement in a compliance update from May 2023 noting that listed entities must be able to demonstrate how the notes comply with the Listing Rules and that ASX may investigate and take action where it has any concerns with compliance. In-principle advice from ASX is recommended where the proposed note terms are not market standard.

Convertible notes in the resources sector

Some recent examples of convertible notes in the market include:

• BCI Minerals Limited (ASX:BCI) entered into agreements with its two largest shareholders, AustralianSuper and Wroxby, to secure $60 million via the issue of convertible notes. The raising included an initial conversion price of $0.43, being in line with its 2021 share issue price, and an 87% premium to BCI’s closing share price on 27 April 2023. The funds raised from the issue of the convertible notes will be used to fund critical path contracts for BCI’s Mardie Salt and Potash Project (Mardie Project) and working capital whilst BCI progresses discussions with financiers regarding the full funding of the Mardie Project. Once operational, BCI expects the Mardie Project to become the largest salt operation in Australia and the third largest solar salt operation in the world.
• BHP Billiton Finance (USA) Limited, a wholly-owned finance subsidiary of BHP Group Limited (ASX:BHP), announced in September 2023 it had successfully raised US$4.75 billion in unsecured convertible notes through the US market. The purpose of BHP’s raise was to utilise the net proceeds from the offering, together with available cash on hand, to repay in full the indebtedness outstanding under its $9.4 billion acquisition facility which was fully drawn down in April 2023, as well as for other general corporate purposes. Borrowings under the acquisition facility were used to finance a portion of the consideration for BHP’s acquisition of OZ Minerals Limited, by way of scheme of arrangement.
• Syrah Resources Limited (ASX:SYR) announced in April 2023 new convertible notes issuable to AustralianSuper in three equal tranches, at SYR’s option, for up to $150 million. The first $50 million tranche of convertible notes were issued in May 2023 to fund transition detailed and long-lead items engineering and other early activities on the Vidalia Further Expansion project to prepare for a FID proposal and Balama working capital, TSF expansion and sustaining capital as well as for general corporate purposes. Subject to shareholder approval, the remaining $100 million will provide funding options for operating strategy and project development.
• NOVONIX Limited (ASX:NVX) issued South Korean-based LG Energy Solution US$30 million of unsecured convertible notes in June 2023, which coincided with the parties entering into a joint development agreement for the research and development of artificial graphite anode material for lithium-ion batteries. Upon successful completion of certain work under that joint development agreement, NVX and LG Energy Solution will enter into a separate purchase agreement under which LG Energy Solutions will have the option to purchase anode material from NVX.
• In May 2022, Glencore plc (LON:GLEN) entered into a strategic partnership with Li-Cycle Holdings Corp. (NYSE: LICY), a leading lithium-ion battery recycler in North America. Glencore subscribed for US$200 million convertible debt in Li-Cycle with Li-Cycle becoming a preferred partner for Glencore in the lithium-ion battery recycling sector. Key commercial arrangements underpinning the strategic partnership include a global feedstock supply agreement under which Glencore will supply all types of manufacturing scrap and end-of-life lithium-ion batteries to Li-Cycle and global, long-term strategic contracts, which would complement Li-Cycle’s existing off-take and marketing agreements (which were in the non-binding term sheet stage at the time of the announcement in May 2022).

This is an article from our 2024 Edition of Emerging Issues for the Australian Energy and Resources Industry. To read more from this publication, click here.