WHEN EGYPTIAN COMPANY Weather Investments bought Italy’s Wind Telecom for €12.1 billion last August, analysts heralded the deal as a benchmark transaction. It was, at that time, Europe’s biggest-ever leveraged buyout and also the largest-ever acquisition in Europe by a Middle East/Africa concern. Just as impressive is the financing strategy behind the acquisition. One element is an €825 million exchangeable bond that was issued in February.
The seven-year bond proved a big hit with investors and was several times oversubscribed. The deal, which was lead managed by Citigroup, Credit Suisse and Deutsche Bank, carried a coupon of 4.75% and traded up in the secondary market. The bond is exchangeable into shares of Weather if it lists or, if not, into the global depositary receipts of Orascom Telecom Holding, another company which forms part of Weather owner Naguib Sawiris’s business empire.
The convertible is central to Weather’s plans to refinance the €7.93 billion of acquisition finance it took out last July to pay for the Wind takeover.
On the radar screen
Weather is not the only company in the Middle East/Africa and central and eastern Europe raising money in the equity-linked or convertible bond markets. This year a handful of companies from emerging Europe have issued equity-linked deals, including Hungarian oil company Mol, Russian mining and metals group Mechel and the UAE’s Dubai Ports World.
Bankers are confident that this is just the beginning, and while a deluge of deals is not expected, anecdotal evidence suggests the rest of this year should keep originators on their toes. “It’s difficult to predict the levels of activity we will see. But we are in active dialogue with clients from all sectors and throughout the EEMEA region, so expect the overall market to remain healthy,” says Frank Heitmann, managing director of the global markets solutions group at Credit Suisse.
Even if only five to 10 more transactions get to market this year, issuance volumes will be markedly up on the past few years. The convertible product has yet to take off fully in emerging Europe even though the first exchangeable bond in emerging Europe was issued nearly 10 years ago when the European Bank for Reconstruction and Development launched a bond convertible into shares of Hungarian telecoms company Matav. Since then there have been a splattering of deals, mostly out of Russia but nothing to suggest that convertibles are becoming an integral part of corporate funding strategy.
If anything, the convertible market throughout the Europe, Middle East and Africa region, has been quiescent for the past two years. Between 2000 and 2005, average yearly issuance was $30 billion, according to Merrill Lynch, but between 2004 and 2005, that figure halved to $15.7 billion.
Now, though, the convertible market is hitting EEMEA corporates’ radar screens again. “It’s an asset class that’s coming back into fashion after a two-year hiatus,” says Rupert Mitchell, director, equity-linked capital markets, at Citigroup.
Two reasons stand out. The first is that, with many central banks tightening monetary policy, financial market volatility has returned. This is good news for issuers of convertible bonds: market volatility means they can price the conversion option on more attractive terms. Volatility is also good for investors, who assign a higher probability of a convertible bond reaching its conversion price in periods of increased instability. The second reason for more deal flow is renewed M&A activity. Two of the four EEMEA convertible deals this year – Weather and Dubai Ports – were driven by acquisition financing needs. And many of the deals in the convertible pipeline have an M&A angle, say bankers.
Why are convertible bonds so suitable for funding mergers and takeovers? Viswas Raghavan, head of equity capital markets for EMEA and Asia at JPMorgan, says: “Equity is the most expensive form of financing, debt the cheapest. Issuers need to optimize their capital structure and their weighted average cost of capital. Convertible bonds are a useful tool in this regard.”
They can also be a more efficient and faster source of financing than a straight bond or bank loan. Borrowers, for example, don’t need to engage in roadshows and protracted investor relations affairs. Deals are priced quickly. For high-growth, capital-intensive emerging market companies with big financing needs, a convertible can be a perfect funding option. “It’s an excellent, flexible covenant-free form of financing, especially for unrated companies,” says Mitchell. “In addition, emerging market companies’ share prices are typically more volatile than their western counterparts’ so the option subsidy is greater.”
Structured solutions
A striking feature of this year’s deals is that they have all been highly structured. Today, innovation is the watchword. Investment banks are hired for their ability to structure solutions rather than provide bread-and-butter financing. “One of the reasons why eastern Europe is a growth area is because it’s a region where companies require capital but often with structuring issues and the market is receptive to resolving them,” says James Eves, head of equity-linked origination at UBS.
“The structure is a bridge between the bond markets and the equity capital markets. It works very well for a company going through a transformation”
Faisal Mikou, Barclays Capital |
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Already this year, the full gamut of financial engineering – perpetuals, mandatories, exchangeables and sukuk-structured equity-linked bonds – has been deployed in the region.
Bankers expect mandatory convertible bond issues to attract greater interest. The advantage for issuers of this category – in which the bond compulsorily converts to equity rather than including an option enabling investors to convert at a set price – is that mandatories are classified as equity rather than debt by the credit ratings agencies.