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Wednesday, 22 November 2017

EMEA Structured Equity Issue

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VW’s US road trip: A sharp pick-up in activity meant a rare glut of jumbo transactions in Europe towards the end of 2012, but only one took a mothballed structure and made it mainstream. Volkswagen’s €2.5bn mandatory convertible bond issue is IFR’s EMEA Structured Equity Issue of the Year.

To see the full digital edition of the IFR Review of the Year, please click here.

When Volkswagen launched its €2.5bn mandatory convertible bond issue after market close on November 5, there had not been a similar deal in Europe for three years. Even then, Adecco raised just SFr900m (US$962m today), although the transaction also broke a 15-month drought.

Such deals fell out of favour because a large chunk of their audience is hedge funds, whose strategy is to immediately place the delta when faced with a mandatory. That means that, suddenly, there is not one deal but two – the leads have to corral interest in the equity, typically totalling 75% or more of the bond issue, and this inevitably puts pressure on the share price.

Yet, as the US market for similarly structured mandatories is dramatically different with an outright buyer base and no need for a delta placement, the combination of advice from banks and adviser Rothschild was deceptively simple: launch a 144a transaction into the US to soak up the outright demand.

The logic was clear, but the unknown was whether US investors would buy. VW is a global name with production sites in every region of the globe, but the company has no US listing.

US demand was crucial as the more hedge fund involvement, the larger the delta placement and the lower the chance of success. To complicate matters further, a VW equity offering was bound to be tough, with the stock up nearly 44% year to-date and some equity investors beginning to fret that the industry faced more headwinds in the near future. The planned use of proceeds was also vague.

“If hedge funds know that the other holders aren’t just five like-minded funds but a long list of outrights then it changes their behaviour,” said Frank Heitmann, European head of equity-linked at Credit Suisse. “In the US, mandatories sold to outrights price about a coupon point tighter than Europe. VW priced somewhere between the two and then traded tighter.”

The banks talked a good game so VW and Rothschild made them deliver with bookrunner roles awarded to Bank of America Merrill Lynch, Credit Suisse and Deutsche Bank following an auction based on the coupon and minimum pricing for the delta placing. Six banks had pitched ideas to VW and each was also asked for their placement strategy on the bonds and the delta.

It was the adviser that pushed for the Monday night launch, fearing markets could trade off following the US presidential election the next day. It was a judicious move – and one banks holding risk were unlikely to make unprompted – as markets did just that as the fiscal cliff moved into focus.

The plan worked with a bond book of just over 150 accounts and the deal increased to €2.5bn from a €2bn base. Pricing came at the best terms for investors with a coupon of 5.5%, but considering the auction this was not over-generous.

Half of the demand came from the US, plus US$500m from VW shareholder Qatar Holding. Just 13.3% of the bonds were allocated to funds wanting to hedge the full delta, taking the equity placement to €618m – a hedge of 24.7% compared to the theoretical delta of 75%.

But a funky product and strong demand is nothing if the accounting treatment isn’t right. Auditors are not familiar with the structure and Bayer, which was previously the benchmark transaction in Europe, found its mandatory treated as debt by its auditors.

Bankers worked with VW’s auditors from the start and ensured €2.18bn of the proceeds was recognised as equity. It is the treatment of benchmark transactions that tend to determine subsequent auditor behaviour, so the deal not only has redefined the distribution and pricing of mandatories, but as importantly, whether it is worth companies issuing them.

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