Americas Structured Equity House: Morgan Stanley
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Continued low interest rates and liquidity in the straight debt market continue to stifle equity-linked. Competitive cost of capital requires not only more aggressive upfront pricing, but a holistic approach incorporating equity derivatives to enhance economics for issuers. Morgan Stanley met that challenge and is IFR’s Americas Structured Equity House of the Year.
Convertible bond plus call spread is the standard strategy to offset dilution to ultra-high share prices, achieving fixed income-like accounting in an equity-friendly wrapper.
ServiceNow, a fast-growing software-as-a-service company, was a textbook example of how far the strategy can be taken. Of the US$782.5m it raised in June on the sale of a five-year CB, the company spent roughly US$71m on the call spread – repurchase of the embedded call option and sale of warrants at a higher strike – and another US$55m to simultaneously repurchase stock, allowing arbitrageurs to delta-hedge participation and limiting eventual stock dilution.
Bondholders are eligible to convert at share prices above US$134.75, a 32.5% premium at the time. The call spread offset dilution for ServiceNow to share prices above US$203.40, trebling the premium to 100% of the reference share price.
The coupon paid on the five-year bond was zero percent, making ServiceNow one of eight companies to issue a zero-coupon CB in the States in the past decade.
Morgan Stanley was one of four counterparties on the call spread, as well as being lead-left of three bookrunners underwriting the CB.
ServiceNow represented a progression that saw Morgan Stanley take the company public in 2012, bookrun its follow-on later that year, execute a US$575m five-year zero-coupon CB in 2013 with call spread, and the follow-up CB in June to pre-fund maturity.
Workday, another fast-growing SaaS company covering human resources, turned to Morgan Stanley (along with one other bank) to bookrun a US$1.15bn five-year CB and associated call spread that again offset dilution to a 100% premium, offset by a 0.25% coupon and compared with the 37.5% conversion premium on the bonds, one of the most aggressive coupon/premium pairings in years.
“We were the first firm to merge the equity-linked and derivatives business in 2002. You can’t flip a switch,” said Serkan Savasoglu, head of equity solutions America.
“When Workday talks to Morgan Stanley, they talk to one person, Dave Oakes,” he said, referring to David Oakes, a MD and 17-year veteran of the firm.
Of the 33 CBs Morgan Stanley bookran during the consideration period, 10 used a call spread to offset dilution to premium share prices, according to public filings. On its own count, the bank was counterparty to US$1.4bn of call-spread business, ranking top in “call-spread league tables”.
The case for Morgan Stanley extends well beyond equity derivatives.
Wireless tower REIT Crown Castle International selected the bank as lead-left and stabilisation agent on a US$5.5bn equity and mandatory convertible bond in July to help fund its US$7.1bn, all-cash acquisition of Lightower Fiber Networks. The mandate stemmed from a fully committed bridge that was syndicated the weekend prior to the public markets take-out in the equity-linked and bond markets.
The equity component consisted of 36.5m shares sold at US$96 each, a 0.7% file-to-offer discount, and the US$1.65bn MCB at a 6.875% dividend and 20% conversion premium, more aggressive than the price guidance of 7%–7.5% and 15%–20%. Exercise of the overallotment on the equity, intentionally sized at 10% to limit dilution, put the total size at US$3.85bn.
Overall, Morgan Stanley was credited with US$4bn of equity-linked bookrun business in the consideration period, ranking third. and more than double the US$1.8bn it underwrote in the year-earlier period. Its wallet share ranked second, reflecting the disproportionate role it played in underwritings to earn estimated fees of US$128.3m over the year, according to Thomson Reuters data.
An over-sized wallet was evident by the fact that Morgan Stanley acted as an active bookrunner on 26 of its 33 bookrun transactions.
Competitors frequently groused that the market share gains – taking 11.8% of the US$34.2bn issuance total, a 380bp gain year-on-year – are symptomatic of overly aggressive pricing. True, on average, Morgan Stanley-led CBs broke for trading at 100.5, far tighter than the average of some competitors, but it is a curious complaint that they did a better job of balancing the interests of issuers with investors.