Expedia returned to the capital markets last week with a two-part US$1.9bn bond and equity-linked financing, allowing it to make massive interest savings on its 2020 pandemic financings.
The decision by Expedia, rated Baa3/BBB–/BBB–, to finance the takeout of bonds issued in April with a convertible bond is particularly notable, and likely to prompt other investment-grade-rated companies to offer up equity as part of their funding strategies.
Goldman Sachs, Bank of America and JP Morgan placed an upsized US$900m five-year CB at a zero-percent coupon (fixed at launch) and 72.5% conversion premium, well through the aggressive end of the 57.5%–62.5% premium marketed for one day on Tuesday and a launch size of US$825m.
The 72.5% premium is the highest ever on a plain-vanilla CB, topping the 65% threshold Peloton Interactive achieved on its US$1bn zero-coupon CB a week earlier.
The same banks priced Expedia’s new US$1bn 2.95% 2031 senior unsecured at 175bp over Treasuries, inside the Treasuries plus 225bp area at initial price thoughts.
The new financings were blowouts. Expedia’s bond offering garnered US$8bn of demand, allowing for pricing at a negative 15bp concession, according to communications from the underwriting banks and IFR calculations.
"T+225bp area at IPTs seems to be the right starting point to garner interest,” said one syndicate banker away from the deal. “But I would have expected it to price just inside 200bp."
While Expedia is attractive, investment-grade new-issue pricings are precise, even scientific, yet in this case the launch terms excited investors and allowed bankers to ratchet down pricing.
Standing out
Expedia nevertheless stood out for its cuspy investment-grade rating and the fact that investors are relying on a rebound in consumer travel, said analysts.
"While [fourth-quarter] earnings were disappointing due to the intensifying pandemic during the winter, we expect demand for leisure transient travel to pick up this year as coronavirus vaccines are more widely distributed," wrote analysts at CreditSights.
Expedia is on negative watch by all three credit agencies, but that has been the case at both S&P and Fitch since the onset of the pandemic with Moody’s only joining them on Monday. If it were to be downgraded, the company will increase the coupon on the new bonds by 25bp, subject to a maximum 2% bump – a standard covenant.
Expedia is using the proceeds to fully redeem US$750m of 7% senior notes due 2025 as well as tender for up to US$950m of its US$2bn 6.25% senior notes, both issued in April last year at the height of the pandemic.
The sevens can be called at par on March 3, though the 6.25s must be repurchased through a tender offer that will expire on March 15. The 6.25s trade around 117.
The refinancing will save Expedia roughly US$80m of interest expense annually.
Take-outs of corona-era funding has become a standard trade. Coca-Cola, TJX Companies and Ross Stores, all Single A rated, have all dipped back into the bond market to tender for “corona bonds”. Avis Budget Group, rated B3/B, is doing the same in the high-yield market.
Valley of Giants
While Expedia’s bond sale impressed, its CB was the type of jaw-dropping outcome that is certain to draw attention from other highly rated issuers.
Notably, Expedia is the first investment-grade-rated company to take advantage of new accounting rules for CBs that went into effect this year.
Under the new accounting rules, convertible bonds are a single instrument on both the income statement and balance sheet. That means that interest expenses flow through the income statement and earnings dilution is limited to prices above the conversion price – so-called Treasury stock methodology.
Previously, companies were required to bifurcate a CB into its original issue discount debt and equity components. For Expedia, the OID approach would have equated to its five-year equivalent borrowing costs of 2.2%, according to Refinitiv data, as an interest expense.
Now, Expedia’s interest expense is zero on the new CB.
“The changes to the accounting treatment are certainly relevant for investment-grade issuers,” said one banker involved in the Expedia CB. “As IG companies think through their funding strategies, cleaner accounting of convertible bonds provides them an alternative to selling straight debt.”
Others are less convinced. One debt banker claimed that “the stars would have to be aligned” for investment-grade issuers to consider CBs.
The reality is that investment-grade companies are getting fantastic funding given persistently low interest rates. A straight bond, after all, means no stock dilution whatsoever, and 2.95% 10-year funding is compelling.
That is unless the conversion premium on a CB is so high (and the coupon so low) that dilution becomes acceptable.
At the 72.5% conversion premium Expedia achieved, its shares would have to top US$255.02 before investors would be eligible to convert and the CB would factor into earnings per share.
Expedia shares closed on Thursday at US$156.73, an all-time high and 6% above the US$147.84 reference used on the CB pricing. The new CB closed at 106, capturing all of that upside.
The vast majority of companies that issue CBs don’t earn money, so the new accounting rules are irrelevant. Investment-grade companies do and have now been advised that CBs are on the funding plate.