Coca-Cola Hellenic adds fizz to its debt management
KPN cleans up with complex deal
SPECULATIVE TRADERS AS well as some institutional investors are now buying the short-dated debt of almost any European company on the bet that they might be able to cash in on the next liability management trade to come to market.
It's the latest sign that liability management, for some time now a regular feature of US debt capital markets, has found a home in Europe.
A lot of time and energy is being devoted on the buy and sell sides to predicting which company will be next to offer investors a juicy premium to buy back its bonds. Dresdner Kleinwort Wasserstein recently produced a list of companies it covers in the iBoxx non-financial index with debt maturing before January 1 2009, identifying the next likely candidates to do a liability management trade. Contenders include Telecom Italia and Dutch media company VNU.
One credit trader says that over the past few months, as issuers buy back short-dated debt and extend their maturities, there has been strong investor support for short-dated corporate paper. "Some trading desks are clearly taking views on this," says Chris Tuffey, head of corporate syndicate at CSFB. "We are not seeing extremely high volumes but leveraged funds are buying the bonds when they become available."
But predicting the next buy-back or exchange candidate is an inexact science. "I can't see how anyone can set much store by credit research predicting who will come to market next," says one banker disdainfully.
Yet these deals do offer some welcome spread pick-up for investors, amid the dearth of new issuance and extremely tight credit spread levels at the moment.
Issuers are prepared to offer pretty decent premiums to persuade investors to part with securities. These vary, depending on a company's rating, the number of its bonds in the market, how investors feel about the credit, even the availability of comparable securities. They can be particularly attractive if investors tender their bonds and buy into a new longer-dated offering at the same time. This can earn investors about 20 basis points more than if they did this trade in the secondary market. "A 20bp pick-up and a good reinvestment opportunity is a good prospect for institutional funds," says Tuffey.
It's true that short-dated paper is proving popular with investors for other reasons, such as worries about rising interest rates, duration risk and the quality of their portfolios. "Spreads have been so tight all year that we have seen a lot of investors buy short-dated corporates," says a European credit trading head. "They sell long-dated, lower-quality corporates and switch into higher-rated paper. The give-up in yield is small considering the increase in quality of the portfolio. With the credit curve so flat, I think these trades make a lot of sense."
But investors buying on a hunch can run into problems. They can be left with expensive short-term debt they can't offload if a liability management trade is not done. And even if it is investors might get more than they bargained for. "If you were an investor hoping for a straight buy-back and you got an exchange, you might make five or 10 basis points by buying the bond in the secondary market and doing the exchange, but then the added duration risk to your portfolio could mean that you lose much more than that," says one banker.
Money market funds, which often hold a corporate's short-dated paper, might not be able to take part in exchanges at all if the new bonds have much longer maturities.
Investors complain that some debt buy-backs and exchanges don't offer much value whatever the premium to market is, particularly when it comes to high-yield issuers wanting investors to swap into new lower-yielding paper or issuers changing bond documentation in their favour.
Karl Bergqwist, head of credit fixed income at Gartmore, says: "Twelve months ago, some of these high-yield credits couldn't have come to the market at all. Also, when companies start inserting call features, these deals become less attractive to bondholders. We're seeing more and more companies looking at these deals."
Investors might have reservations about buy-backs but banks are clamouring to advise on them. Euromoney has not spoken to a single debt-focused bank in the past six months that has not boasted about how strong its liability management team is.
That's no surprise given the environment. Corporate credit quality has improved this year. August was the first month since 1999 that the monthly global high-yield default rate dropped below 3%, according to Moody's Investors Service. Standard & Poor's also produced a report in July showing that the number of global rising stars – companies moving from high-yield grade to investment grade – exceeded those heading the other way for the first time since 1998.
In general companies now have better earnings, better cashflow, higher cash balances without a renewed M&A binge and an effort to deleverage. But those same factors mean that there hasn't been a lot of primary corporate supply to buy. Hunting out corporate investments that offer extra spread performance is tough. Meanwhile underwriters have been scratching around in search of new business.
This is part of the reason why European liability management deals are so popular. These offer investors spread pick-up while enabling corporates to deleverage, term out debt or reduce cost of funds. They even allow advising banks a slightly higher fee than a straight new issue.
On the face of it, everyone wins.
When Vodafone completed a multi-billion pound bond buy-back at the beginning of 2003, bond buy-backs not linked to acquisitions were unusual in Europe, particularly outside the telecoms sector. In fact, part of the reason for Vodafone's deal was to take out old Mannesmann bonds that it had inherited as a result of its acquisition of the German company in 2000.
But since this July companies have launched straight debt buy-backs (ABB), debt buy-backs and subsequent new offers (Coca-Cola Hellenic Bottling Company), debt exchanges (Lafarge), simultaneous debt buy-backs and exchanges of the same security (RWE), and simultaneous debt buy-backs of different securities (KPN).