In May 2016, the non-dilutive convertible bond, commonly known as a synthetic, was in serious trouble. Priced aggressively to be cheaper than straight debt, the structure had attracted blue-chip issuers to equity-linked, but after a flurry of deals in late 2015 and early 2016 investors were fatigued and deals struggled.
To remove dilution, the issuer purchases call options with a strike price equal to the CB conversion price. The structure and pricing had convinced Vodafone, Total and LVMH, among others, to issue convertibles, often for the first time.
When a Telefonica synthetic struggled badly in March of 2016 and ENI had to be repriced and reduced in size the following month, many sounded the death knell for the product.
But BP was still keen. Raising £400m from seven-year paper, the deal confirmed the UK oil and gas group’s reputation as an issuer with an agile funding strategy. It was risky, however, given preceding synthetic deals, wider ongoing macroeconomic concerns and the looming June UK referendum on EU membership.
For BP, there was reputational risk. But for bankers, the survival of the structure was at risk. As a result, they delayed pulling the trigger until the right moment, which appeared to come following an uptick in equity deal performance and an increasingly bullish view on oil.
“Few people in the market still believed in synthetics, we had to wait for the right moment for it to work,” said Bruno Magnouat, head of equity-linked origination at Societe Generale, a bookrunner alongside Barclays, Credit Suisse and Goldman Sachs. “It would have been terrible to come out with them on something that did not work.”
Then it was a matter of adapting the structure and stripping out some of the more aggressive features used previously, such as restrictive conversion terms. BP was able to issue in any currency, but a euro denomination was avoided on concerns about negative yields on its high dividend.
“Sterling had the highest coupon and that 1% coupon really did help with distribution despite having around a 7% dividend yield, and we were still able with the pricing of the call option to generate meaningful savings,” said Steven Halperin, co-head of EMEA ECM at Barclays.
Orders for 10% of the deal ensured a strong book of demand, including one UK order comfortably above that level, with two-thirds going to the outrights that are essential for successful pricing.
BP was one of just two synthetics at that time in 2016 that had been priced away from best terms for investors; at a 1% coupon off 0.4%–1.2% guidance. That 20bp improvement ensured terms were better than those available from a straight bond. A few weeks later, French auto parts supplier Valeo brought a US$450m synthetic on better terms for the issuer.
Macro events, bond buying by the European Central Bank and cheaper straight debt has slowed the rush of synthetic deals, but BP ensured the structure lives to see another day.
*Syndicate corrected in sixth paragraph to add Credit Suisse.