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Thursday, 14 December 2017

The periphery strikes back

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Most of the high-yield activity so far remains centred on the asset class’s TMT stronghold, but some expect an increasingly diverse array of deals in coming years.

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The CEE high-yield market is gaining momentum as banks scale back their balance sheets, forcing companies to look elsewhere for cash. The phenomenon is well under way in the West, but has been steadily spreading east.

In 2012, the CEE region, excluding Russia and Turkey, saw US$4.3bn in issuance. That figure more than doubled to US$8.7bn in 2013, implying that high-yield issuance grew considerably faster than DCM issuance. Although this was skewed by a number of very large deals, such as Play’s €900m debut bond deal in January, it is still an encouraging trend for the market.

Polish TV broadcaster TVN was credited with kicking off a flurry of high-yield deals in the region in September when it issued €430m of bonds to refinance existing debt. The deal was priced at 7.378%, its lowest coupon ever, an indication of things to come in later months.

Play was one of the stand-out deals of the past 12 months in terms of size and the excitement generated among investors. A strong growth story, the Polish telecoms company has established an 18% market share, despite only entering the market in 2007. The bond issue was split into €630m of senior secured debt, rated B1/B+/B+, with five-year euro and zloty tranches, and a €240m 5.5-year non-call 2.5 senior unsecured tranche, rated B2/B–/B–. The senior euro tranche was priced at 5.25%, with the unsecured euro tranche at 6.5%, while the senior zloty tranche, a mere Z130m (€30m), was priced a little wider at 350bp.

However, the smaller economies in the region are increasingly turning to the capital markets as well. RCS & RDS, the Romanian and Hungarian cable group, issued a €450m seven-year non-call three senior secured bond offering in October that experienced incredible demand, allowing it to be both accelerated and upsized by €100m, and being priced to yield 7.5%.

In Bulgaria, Vivacom’s €400m five-year non-call two senior secured issue was priced at 6.625% in November, the same month in which SBB-Telemach, or Serbia Broadband, issued its own deal backing an acquisition by KKR. It priced a €475m senior secured bond issue at 7.785%, despite concerns about a loose covenant package. Evidently, investors did not take too much persuading to consider deals on the other side of the former Iron Curtain.

The development of the high-yield market in CEE promises to make financing available for companies for which the bank market has become a much harder sell. Under new owners and having gone through a restructuring, Vivacom had reached its limits in the bank market but was looking for a capital injection to give it breathing space for the next five or six years without necessarily making any covenant adjustments, said Tanneguy de Carne, head of high-yield at SG. The bond market provided this where it is unlikely the bank market would have, he said.

The growing influence of the high-yield market owes much to the technology, media and telecommunications sector, from which all the examples cited so far are taken. It is the same sector that nurtured the growth of high-yield in the US. TMT has always been the stronghold for the high-yield market and still provides a large number of deals coming through the pipeline globally. But this is especially true in CEE. 

It is easier for investors to make investments outside their geographical comfort zone if they are in sectors with which they are intimately familiar. Evidence can be found in CEE TMT names currently trading on Nasdaq. A TMT credit in Germany is broadly comparable to one in Romania or Bulgaria, said De Carne.

Widening the scope

But as CEE matures, the high-yield market should attract more names from other sectors. “This is already starting to happen, we have seen deals from other sectors like health and services,” said De Carne. “We need to see more deals from energy, capital goods and other sectors. TMT deals will start to dry up when most of the region’s companies have already brought deals, unless we are doing refis for them.”

This process is likely to be pushed by the international banks that have a presence in the high-yield market internationally, and in CEE locally. “The advantage universal banks have here over the investment banks is local knowledge, which is vital in the high- yield market,” said De Carne.

“You need to have a close eye on what is happening in the local FX markets, cultural considerations and other local factors. Having a broad network of local banks in countries such as Romania and Slovenia gives a valuable insight into the needs of businesses operating in those countries.”

In Romania, for example, SG provides the day-to-day banking needs of RDS and therefore has an intimate knowledge of its business that made it the obvious choice to handle its high-yield bond issue.

Tired of investing in the same old deals?

The evolution of the high-yield investor base is also likely to change the nature of the deals being done, particularly with increasing investor comfort with smaller-cap credits. In 2012, only two companies with Ebitda below US$75m brought deals to market, but in 2013, 28 such companies did deals.

“In the past, we advised any client with Ebitda under €50m against considering the high-yield market, but now this would present no problems,” said De Carne. “And as investors are looking at these smaller deals in Spain, for example, it is easier for them to consider looking at them in CEE.”

There is plenty more work to do. For many high-yield investors CEE remains something of a mystery, with the possible exception of Poland. For deals outside TMT, anything from smaller economies such as Slovenia, Montenegro or Serbia require that investors are given the investment case not just of the credit itself but also an explanation about the country’s risk.

“You lose 50% of your traditional investor base when you are dealing with CEE, a lot of these investors just don’t have the resources to analyse these markets,” said De Carne.

High-yield deals in CEE therefore usually attract a different class of investor, such as emerging markets fund managers. But there is no shortage of investor interest as long as you have that experience and knowledge about who to target, he added.

Valuation mismatch

The prevailing market conditions may encourage those specialist high-yield investors to re-evaluate their attitudes to CEE, if they want the best-value deals. With heightened political risk in Turkey and Ukraine, in particular, emerging markets spreads have suffered disproportionately relative to Western European credits, said Ben Bennett, credit strategist at Legal & General Investment.

This does, however, represent a misunderstanding of the increasing importance of emerging markets to the global economy, Bennett said. What was needed, he added, was “a change in the perception that EM risk is somehow isolated and idiosyncratic, to one where EM problems take on a more systemic nature and investors wake up to the valuation mismatch”.

L&G is overweight emerging markets in its high-yield portfolios, with Eastern European credits representing the biggest share of those allocations.

“If you look at countries like Poland, Bulgaria and Romania, you can get an extra 100bp–200bp relative to what is on offer for a comparable cable company in Western Europe,” said Bennett. “Even if something happens that causes emerging markets to deteriorate, the issue is likely to be systemic, in which case Western Europe is likely to be hit much harder.”

In the event of another crisis in Europe, highly liquid and more valuable French assets are likely to get sold off before more illiquid and cheaper Bulgarian ones, said Bennett.

Diversity erosion

There is some evidence that the difference between core, Western European credit and peripheral, Eastern European credit is already eroding, right across the credit spectrum.

“Our multi-factor model suggests that most of the ’cheapness’ in peripheral corporates is explained by weaker fundamentals, rather than country bias,” said Morgan Stanley research.

“Peripheral corporates have wider spreads but more leveraged balance sheets. Leverage-adjusted spreads look similar to the core, suggesting that incremental peripheral returns have to be earned either through further deleveraging or stronger growth.”

 

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