Americas Structured Equity Issue
A preferred alternative: There has been very little innovation in convertible bonds since the onset of the financial crisis but one new structure has emerged that provides ratings-sensitive issuers an alternative, less dilutive approach to gain equity credit than existing structures. For trailblazing an innovative route, Stanley Black & Decker’s US$632.5m convertible preferred unit offering is IFR’s Americas Structured Equity Issue of the Year.
Craig Douglas, Stanley Black & Decker’s treasurer, is renowned for his financial acumen. Whether it was a novel floating-rate convertible bond in 2007, the reopening of the bond market at the height of the financial crisis in September 2008, or his ushering through of the transformational merger of Stanley Works with Black & Decker in March 2010, the executive’s fingerprints are on landmark transactions that shaped the company’s fortunes.
Douglas challenged the company’s investment advisers to devise a high-equity content security to honour “intent-based” provisions of a hybrid issued by Stanley Works in 2005. A principle caveat of the assignment was to mitigate the need to actually issue the equity. “The bottom line is that we didn’t want to issue equity,” said Douglas. “We issued a lot of equity through the merger and our shareholders didn’t want to see us issue more equity.”
The solution devised by Citigroup, the structuring agent, was a convertible preferred unit: a five-year forward contract to purchase preferred stock that is convertible into common stock and an eight-year junior subordinated bond. The security combined the benefits of a traditional, three-year mandatory convertible unit (three-year forward and five-year debt) but without the requisite dilution at maturity.
“This is a company that can access any market,” said Mariano Gaut, co-head of equity-linked origination for the Americas at Citigroup. “They are concerned not only about their cost of capital and their credit ratings, but protecting shareholder value as well.”
While Douglas and Citigroup had vetted the security with ratings agencies, securities lawyers and accountants, investors would provide the ultimate sign-off. “You have to know what the structure actually is and what you’re receiving after five years,” said Tom Dinsmore, portfolio manager of the Bancroft Fund and the Ellsworth Fund, two closed-end convertible bond funds.
Citigroup, which was joined by JP Morgan, Bank of America Merrill Lynch and Morgan Stanley, launched the transaction on the morning of November 1 as a US$550m offering. Price talk was set at 4.75%–5.25% and 17.50%–22.50% on the dividend and coupon, respectively. The banks devoted initial marketing efforts to educating investors about the nuances of the security through one-on-one calls with more than 40 investors and a group call with some 130 investors.
The effort resulted in anchor orders from high-quality institutions and lent significant momentum to the bookbuild, allowing for aggressive-end pricing of a 4.75% dividend and 22.5% conversion premium. The strength and quality of the demand was evident in a 1.2% decline in the underlying over the one-day marketing period. Continued buying in the aftermarket pushed prices at the close of first-day trading up to 104, versus a 0.5% rise in the share price.
The convertible preferred unit, rated Baa3/BBB+/BBB (two notches below the corporate), allows Stanley Black & Decker to deduct interest expense at its comparable rate on junior subordinated debenture (4.25%). It is accounted for under Treasury stock methodology, limiting dilution consideration to levels on the underlying above the conversion price. It receives 50% equity credit from Moody’s and “qualitative consideration” from S&P.
While the traditional mandatory unit structure offers those same benefits, the convertible preferred unit provides some additional enhancements. Most importantly, unlike a mandatory, the security does not automatically convert into equity, but preferred that is convertible into equity – preferred claim ranks senior to equity in the event of bankruptcy.
Also unlike a mandatory, it can be called after year five, eliminating the possibility of dilution altogether at low share prices. It has a longer tenor, so the benefits extend beyond three years of a traditional mandatory.
Stanley Black & Decker, rated Baa1/A/A–, is using the deal proceeds to redeem US$312.7m of its 5.902% junior subordinated debt due 2045 in December 2010, when they can be called; to fund pension obligations (US$150m); and to purchase a call-spread overlay (US$50.3m), offsetting economic dilution from the convertible preferred upon conversion to 60%. Other similarly rated companies able to take advantage of the security’s tax benefits are not far behind.
Stephen Lacey
