Structured Equity House

IFR Review of the Year 2012
9 min read
Owen Wild

Gold blend: Banks continue to struggle with structured equity as a global business, such is the regional focus created by accounting and legal differences. But by blending equity and derivatives, Goldman Sachs ensured deals got done when none seemed possible and is IFR’s Structured Equity House of the Year.

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In a market as patchy as pure equity-linked – convertible and exchangeable bonds – success relied more than ever on structured equity. The broader definition includes those ideas that take the best of cash equity, equity-linked and corporate derivatives to form alternative structures to suit issuers and investors.

In 2012, Goldman Sachs used simple derivatives to make both equity and equity-linked trades possible. This included the inclusions of puts and calls as part of accelerated bookbuilds in Europe and the securing of asset swaps at a bargain level for Sony, a defining transaction late in the year.

Goldman won this award in 2011 on the strength of its success in the US and Asia-Pacific and for its investment in Europe, with the caveat that the latter region was a work in progress. To make that work, the bank bought in Antoine de Guillenchmidt and his team from Morgan Stanley, the top ranked bank in Europe for several years.

The investment paid off: having failed to be placed inside the top 10 in Europe in the previous two awards periods, Goldman was third by late October, before large offerings from Nokia and VW pushed it back to sixth.

The league table tracks transactions for Lufthansa, Shoprite in South Africa and the Finnish government (through its Solidium holding company), but when non-league table eligible equity derivative transactions are also taken into consideration the bank can point to even greater progress.

“The contribution from our EMEA business to Goldman Sachs’ overall global equity-linked activity has gone from 3% in 2011 to 30% in 2012,” said Jason Lee, global head of equity-linked based in New York.

Key to this growth was leveraging where the bank was strong in cash ECM – in particular around accelerated placings – and using this to drive structured situations.

Transactions in Norwegian oil services firm Seadrill, which included shares and puts, and in Turkish flat steel producer Erdemir, where warrants were packaged with the shares, were key examples. Both transactions used a sweetener to attract additional interest at a tighter price than was otherwise thought possible.

In the event both stocks traded down. Seadrill’s fall showed that in the worst case the average exit price was around where a straight equity sale would have been completed, while Erdemir’s drop showed seller ArcelorMittal had effectively sold nothing for something with the warrants.

Goldman bankers argue that not only did the trades improve pricing but it may not have been possible to complete them as cash transactions. Erdemir was illiquid, while the sight of Seadrill’s major shareholder John Fredriksen selling US$1bn of stock may have scared off investors. Whether this was true or not, the bank provided structures that suited both sellers and buyers, and had the additional benefit of ensuring sole bookrunner credit and improved margins over a straight equity sale. Seadrill was one of the ECM team’s most profitable trades of the year.

The bank also leveraged its core equity strength on the exchangeable and equity for Solidium into TeliaSonera and the concurrent equity and convertible offering by Shoprite.

The Finnish state sale through its holding company in two parts suited Goldman due to its strength in overnight transactions.

“We were the obvious choice for the accelerated bookbuild, but not for the exchangeable bond,” said de Guillenchmidt.

Pricing on the €600m exchangeable came at the best terms for the issuer with a 0.5% coupon and the €451m equity sale priced at a 4.8% discount. Within 24 hours, the bank was back with another two-part trade for South African supermarket operator Shoprite that raised US$1bn and involved Goldman as joint bookrunner with Morgan Stanley.

Structuring is key

A transaction for Lufthansa was an opportunity to link between regions as the German airline used its stake in US carrier JetBlue in order to minimise funding costs. Historic volatility in the mid-50s meant the JetBlue stake was a natural underlying and should have provided significant costs savings versus Lufthansa’s own stock as the underlying. However, exchangeables – including exchangeables with ring-fencing – are modelled differently from convertibles, undermining this potential saving.

The trick was therefore in the structuring that saw the €234m bonds issued through a Malta-based SPV with the sole purpose of holding shares and paying coupons. Crucially, a trustee holds a golden share to protect bondholders from Lufthansa ever trying to get hold of the shares during the five-year tenor and there is an accelerated exchange into the underlying stock in the case of default.

A trick in the marketing was to ensure the wide end of terms worked if investors used the normal exchangeable model and then work pricing tighter as the structure was explained. The trade launched in the morning in Europe to give time to do this before JetBlue opened in the US. Final pricing was at the best terms for the issuer of 0.75%, up 37.5%.

Goldman was joint bookrunner alongside Morgan Stanley and UBS.

Saving face

Sony’s ¥150bn (US$1.85bn) five-year Euroyen convertible bond stunned the market in November as the electronics company was able to issue with zero coupon and a negative yield, despite being on the brink of high-yield. The structure of the bonds was vanilla, but the credit assumption was not.

Japanese electronics companies have all suffered a fall from grace, with Panasonic declaring a surprise loss at the start of November. Sony’s CDS level of 450bp should have meant the company paying a 1% coupon on a new convertible – an embarrassing move for a Japanese firm. But arbitraging Japanese banks’ desire to lend at lower levels avoided this situation.

An undisclosed major Japanese bank provided the credit at 190bp to cover 80% of the deal. Investors who took the bonds could sell the credit component back through the leads to the Japanese bank, through an SPV, effectively leaving them with a warrant at a 10% premium.

“If a Japanese bank can earn 190bp then it is a fantastic deal in a negative yield environment,” said a banker involved. “While for investors, it is difficult to convince them to model using a 190bp credit – this way it actually is a 190bp credit.”

JP Morgan, Goldman Sachs and Nomura were joint bookrunners. JP Morgan had the largest share of the economics, but Goldman was significant in arranging the asset swaps.

Taking risks

Goldman Sachs was sole bookrunner on the US$1bn convertible issued by in the US, IFR’s Americas Structured Equity Issue of the Year. The trade combined a 1% coupon with a 50% premium and was a result of a competitive situation where banks were asked to bid on the coupon. Rivals thought the pricing too tight but the deal cleared as the bank exploited captive demand for investment-grade issues in March when issuance for the year was still light.

Again, Goldman beat competitors when it was sole bookrunner on the US$325m seven-year issue by Royal Gold in the US, a mining royalty company. The company was not only the first royalty company to issue a vanilla convertible but the first to issue debt of any type (it issued mandatory convertible preferred in 2007). As the first, there were no benchmarks at all and so initial pricing was cautious and final terms came through the aggressive ends of talk.

The bank featured alongside others on other benchmark trades, such as that from United Technologies, but the highlighted transactions show that when structured equity brains were required, Goldman was first to get the call.

Gold blend