Heidelberger Zement's rock-bottom appeal

Amount: e1 billion

Type of issue: Corporate bond

Launched: Launched February 7 2000

"A year ago it would have been nearly impossible to sell e1 billion of a triple-B-rated company's bonds," says Matthias Wittenburg, syndicate manager at Dresdner Bank in Germany, referring to Heidelberger Zement's seven-year bond issued early last month. "But this bond generated demand exceeding e2 billion."

Wittenburg might add that a year ago it would have been difficult even to find a German company with a triple-B rating. Most German corporates - if they issued bonds at all - were infrequent borrowers who expected to sell their paper mainly to local investors. And German investors have traditionally cared more for name recognition than credit ratings.

Things are changing fast in euroland. Not only has a mid-size German cement company chosen to fund an acquisition programme in the bond markets, it has done so by targeting international investors with a full roadshow and a credit rating from Moody's and Standard & Poor's. Heidelberger Zement is rated BBB+ by S&P and Baa1 by Moody's.

In fact, there should have been two triple-B bond issues by German corporates in the first week of February. Some of the same investors who bought Heidelberger's bonds came within a whisker of disaster by signing up to a bond issue by its compatriot, BBB- rated FlowTex. The engineering company launched its own bond issue for e300 million just three days before Heidelberger. But hours after the launch, two FlowTex directors were arrested on suspicion of fraud. The bond issue was cancelled and the company later filed for insolvency.

The supply of lower-rated corporate paper from Germany is nevertheless set to grow strongly. "The willingness of German companies to get ratings is changing," says Ralph Berlowitz, syndicate manager at Deutsche Bank in Frankfurt. "Their funding strategies are changing, with capital markets becoming more important and bank lending less available. At the same time, investors are becoming more sophisticated. More and more issuers are now getting rated and the process is not yet at an end."

Heidelberger Zement's deal illustrates the difference a credit rating can make. "When Heidelberger did its 10-year issue last year without a rating, the bond sold mainly into Germany," says Berlowitz. "Now, with an official rating, the door was open to a huge investor base from across Europe." Wittenburg says about 70% of Dresdner's demand came from investors outside Germany.

The presence of a rating certainly gave the company access to a wider investor base, allowing it to issue in a size never before seen for a triple-B company. Getting rated may also have saved the issuer money, although there are few reference points in the market. Wittenburg reckons that a credit rating will generally save a company some 5 basis points to 10bp on a bond issue.

But the success of this deal is due to more than simply the presence of a credit rating. Heidelberger Zement could hardly have timed its issue better, with lower-rated corporate issues suddenly in vogue and investors voicing doubts about the merits of well-rated corporate paper.

The honeymoon period for European corporate bonds is well and truly over and the buzzword on every bond investor's lips is event risk. Many European investors have learnt the hard way that the fashion for shareholder value is not necessarily good news for bondholders. As European companies strive to improve their returns on equity they are taking on more debt and the average rating of European corporate issuers is falling as a result. When a company leverages up, equity investors may applaud this more efficient use of capital, but bondholders see their investments fall in value.

Heidelberger Zement is a good illustration. Last time it issued a bond it was not rated, but Wittenburg estimates that if it had been it would probably have been single-A. Since then the company has made some sizeable acquisitions which it has paid for largely by increasing its debt.

As investors have become wary of companies with higher ratings they are looking instead at borrowers which have already leveraged up as far as they are likely to. "Clearly single-A and triple-B are flavour of the month with investors," says Berlowitz. "There is a lot of consolidation going on in Europe right now and investors are becoming more aware of the risk that higher-rated corporates may be downgraded."

But Wittenburg believes investors are turning to lower-rated corporates primarily because of the additional yield they provide. "The main reason for investors preferring triple-B bonds is that the returns are more attractive," he says. "A lot are pursuing a barbell strategy, with some triple-A government bonds and some lower-rated corporate paper." He estimates that the Heidelberger Zement deal pays investors some 40bp more than a single-A German corporate such as DaimlerChrysler would, if it had any seven-year debt in the market. The Heidelberger bond was launched at 68bp and has tightened to just over 60bp in the aftermarket, reflecting the continued strong demand for the paper in the aftermarket.

The company's efforts to market its bonds to a wide international audience have been an important factor in generating that demand. "The company did a comprehensive roadshow," says Wittenburg. "We went through much of Europe for about 10 days. For a triple-B issuer, a roadshow of this extent is not common."

It also helped that investors liked the company's story. It has transformed itself from a typical member of Germany's Mittelstand into an aggressive international dealmaker, buying Scancem of Sweden from Skansa and Aker RGI in May 1999 with a syndicated loan. The proceeds of the bond issue will be used towards refinancing that loan.

"Heidelberger has been through acquisitions," says Wittenburg. "It has already taken a bit more leverage on board." Investors are betting that the company will not want to leverage up further, since that would probably mean crossing the threshold from an investment grade to a high-yield rating. Investors are also hoping that they might benefit from some positive event risk: if Heidelberger is taken over by a better-rated company, the value of its debt would soar.

But for all the talk of event risk, the failure of FlowTex serves as a timely reminder that good old credit risk has not gone away.