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Monday, 23 October 2017

Looking for high-grade

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The European equity-linked market stumbled through 2008 with patchy issuance, yet there was a sign that the emerging European markets could provide another avenue. However the events of recent months have led investors to demand big, liquid issues and not the small, tightly-placed convertibles possible in CEE. Owen Wild reports.

The equity-linked market in Europe began to slow in the summer of 2008, following a glut of issues in May. Issuance became increasingly patchy and exotic. A €573.4m LT2 convertible bond issue from Bank of Cyprus in July was the last fully-marketed bond of the year as conditions became increasingly challenging for issuance.

Equity market volatility surged as the year went on, yet for a product that sees volatility as an asset, levels were too high. At the same time equity values were falling and most companies felt, at that point, their stock could still bounce back and so were unwilling to consider issuing bonds off a low base.

Bulgarian conglomerate Chimimport took a different view, and produced the first convertible deal from CEEMEA in several years with a club deal in August. The company's willingness to invest time and profile in Bulgaria (it accounts for 1.7% of GDP) made it suitable to issue convertibles, and it found a handful of investors willing to buy.

Chimimport is essentially a private equity company, yet unusually the firm had never issued straight debt. To make life even more interesting for the lead managers, no Bulgarian firm had ever issued a convertible.

The convertibles issuance was therefore viewed by the firm as essentially equity at a premium. Through the convertible the company was able to, potentially, sell equity up 30%. It was so convinced the premium would be exceeded in the seven-year life of the bonds it was keen to include a premium redemption structure and back-end the cost of borrowing. Investors were not so keen, but the firm still managed to keep the coupon at 7% with the yield to maturity a punchier 9%.

The major difference with other European convertibles was the marketing: a convertible is normally launched with the release of a termsheet early in the morning that heralds the start of bookbuilding. Hours later the book closes, bonds are priced and allocations completed. ArcelorMittal followed this timetable at the end of March 2009, even though the public market had been closed for eight months. This was clearly not an option for an issuer investors had not heard of.

Therefore the structure and pricing of the bond was put together over a period of weeks. Investors were introduced to the company in a process that required the commitment of resources from the company, investors and the bookrunner. Getting interest also required the lead manager UniCredit to provide an asset swap, so investors could hedge the credit and access to some stock borrow.

It is partly due to the commitment involved that corporate convertible bond issuance is expected to remain slight in CEEMEA. The deal sizes, such as €65m for Chimimport, will not give a sufficient reward for bulge bracket banks.

The firm must also be able to deliver the stock underlying the bonds. Approval could be given to issue the shares, but they would not actually be issued until conversion, which opens up the possibility of approval being rescinded. In the case of Chimimport the major shareholder was willing to provide the stock, but without a major shareholder this would not be possible. Chimimport can also settle in cash.

While the €65m Chimimport deal showed appetite for emerging market exposure if packaged appropriately (and providing something on the credit side was crucial here), secondary market performance has been a deterrent.

"With a portfolio of BBB+ you can get a yield of 8.4%. With some spread tightening the total return could be pushed into double digit territory," said Alan van der Kamp, portfolio marketing manager for global convertible bonds at F&C in Amsterdam. "In the secondary market you are also effectively getting the equity option for free right now, so new investors are well positioned."

Such high yields at low risk is helping to attract new investors to the convertible market, but not to the more speculative end of the market. As such a banker said the only way to attract interest (and even then it would be limited) in CEEMEA issues would be to offer a hedge for the credit.

Another originator agreed. Although a lot of time has been spent working on opportunities in the European emerging markets, most corporate issues would struggle to complete, he added. The best prospect comes from a government seeking to dispose of a stake in a known company - referencing when the Hungarian government issued an exchangeable for parts of its stake in Gedeon Richter - which doesn't suggest an issue any time soon as Gedeon Richter was back in September 2004.

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