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BONDS
Car giant carves its yield curve
Issuer: DaimlerChrysler
Deals: $2 billion 10-year Eurobond, $1.5 billion five-year Eurobond, $1 billion FRN
Date: August 161999
Bookrunners: Credit Suisse First Boston, Salomon Smith Barney
With its $4.5 billion three-tranche financing in August, DaimlerChrysler firmly put itself on the map as a newly merged entity. This was the second-biggest industrial company debt offering of all time.
And it was done at an awkward moment, bang in the middle of the holiday season when Argentina was looking decidedly shaky too. “DaimlerChrysler wanted to do it before the US Federal Reserve’s open market committee [FOMC] meeting,” says Andrew Brownfield, managing director at Credit Suisse First Boston, which was joint bookrunner with Salomon Smith Barney.
It was an “unprecedented marketing effort on the ground for that time of year”, Brownfield adds.
DaimlerChrysler’s aim was to set a benchmark yield curve at three different maturities: six months, with a $1 billion floating-rate note, priced over three-month Libor; and five and 10 years with fixed-rate tranches of $1.5 billion and $2 billion respectively. With three points on the yield curve established, and one hopes a liquid secondary market, DaimlerChrysler should be able to launch new financing deals in future at the most advantageous point of the curve. That’s the theory.
The issuer was looking carefully at the secondary market yields of its peer group: Ford and GMAC.
“We gave initial pricing guidance off the Ford transaction,” says Brownfield. This was to avoid the distortive effect of an imminent auction of US treasuries and, says Brownfield, “take one variable out of the transaction” – the basis risk between treasuries and single-A corporate debt.
DaimlerChrysler was able to issue within the Ford and GMAC spread, and that differential has been maintained: in mid-January Ford and GMAC were trading at 112 basis points and 114bp respectively over treasuries, and DaimlerChrysler was trading at a tighter 104bp.
By all accounts the issues were well placed, with much of the FRN going to Europe and more of the fixed-rate issue finding a home in the portfolios of US investors.
Don’t forget bondholder value, too
Issuer: Alcatel
Deal: €1 billion Eurobond
Date: February 3 1999
Bookrunners: BNP, Deutsche Bank
A year ago, investment bankers’ dreams came true and Europe showed it had a serious, integrated corporate bond market. The first big, liquid benchmark deal to show what could be done was the French telecoms company’s 10-year, €1 billion bond. Lead managers Deutsche and BNP priced it aggressively, in the view of many French bond investors including banks, who pointed during bookbuilding to the fact that Alcatel’s outstanding French franc paper traded around 8 basis points wider. But then, French investors frequently made the mistake last year of using their former domestic market as a guide to life under the new currency.
Anne Roland of Deutsche Bank’s euro syndicate in Frankfurt recalls: “At that time there was a lot of scepticism about the depth in the market for single-A corporates and speaking to a lot of banks in the marketplace, many of them said we didn’t understand the situation. They said there wasn’t room for such a large deal with such a tight spread, which was not where old Alcatel paper was trading.”
The domestic market’s frostiness meant that just over 90% of the bond was placed outside France. That had the accidental result of showing that the pan-European credit market had arrived. Roland comments: “This was the first transaction where a corporate didn’t rely on its home country.”
In subsequent months, French corporate bond issues acquired a bad reputation among many European investors, because competitive underwriting bids and issuers’ determination to compress the spread as much as possible led to overly concentrated placements, often in the domestic market. When domestic investors realized they could get better deals by looking across Europe, a number of French corporate names widened significantly.
Alcatel wasn’t one of them. Instead, its debut euro bond relied on pan-European investor sentiment. Ironically, as Roland points out, this resulted in a tighter spread than the French market offered, whereas later French bonds should have carried rather wider spreads.
Less painful performance
As well as being better executed than some later French bonds, the Alcatel issue performed with greater stability than most other telecoms bonds. Roland notes: “Alcatel didn’t join in this frenzy of acquisitions that we have seen in the telecoms sector. They have not been inactive, but they have been taking more care of their investor base and their credit rating than some other companies and this has been appreciated by the market.”
The bond hasn’t traded over par, but currently trades close to its launch spread of 58bp over OATs, and has thus inflicted comparatively little pain for a telecoms bond. The sector lost some of its attractiveness to the bond market in the autumn, when investors realized that shareholder value and M&A ambition can mean credit downgrades and losses for bondholders. At one point, Alcatel widened along with Mannesmann and other peers, but unlike several other names it recovered quickly.
Euroland takes to high-yield
Issuer: Kappa Beheer
Deal: €515 million and $100 million in high-yield notes
Date: July 16 1999
Bookrunner: Barclays Capital
Last year, the European high-yield market finally began to show it was for real. Since 1997, a number of investment banks had puffed up its prospects and invested heavily in building dedicated operations. But early European deals relied heavily on the fall-back bid from US high-yield investors. Only a small number of issuers, principally telecoms operators Orange and NTL, managed to attract much of a following among European buyers. And the credit shock of 1998 was a set-back.
When Dutch paper-products maker Kappa Beheer launched a single-B debut bond predominantly in euros, it was therefore a major stepping stone towards a self-standing European market. Kappa was seeking funds to refinance Dutch-guilder mezzanine debt resulting from its own private-equity buyout. The company thus had to get funding mainly in its own currency and appeal mainly to eurozone investors. The result was, at the time, the largest euro-denominated high-yield bond.
Frank Sekula, head of European high-yield at bookrunner Barclays Capital, explains: “Up to that time, deals of that size had to be marketed in a big way to US high-yield investors, and making it attractive to US investors meant authoring a large tranche in US dollars. Many of the deals that were structured in the past were never even trying to test the European market. We really had a good feeling about this deal and the potential of the European market.”
Kappa and Barclays Capital roadshowed the credit story throughout Europe for a fortnight, and collected enough orders in that period to place virtually the whole bond with European buyers.
But a US roadshow had been arranged, and among US investors the offering was a blow-out. In the end, says Sekula: “The order book was five-times oversubscribed. We could have sold the whole deal in the US or we could have sold the whole deal in Europe.”
A landmark deal
The deal was a landmark because it relied on depth in the euro market and used the US bid because it could, not because it had to. Over 70 European investors participated, and according to Sekula it broke new ground in amassing a significant number of e50 million-plus orders.
In addition, it was a financing operation to support the largest LBO carried out in Europe at the time; it came from a debut issuer, and so was more challenging for Europe’s often-cautious buyers of credit; and it offered a non-telecoms play, helping investors to diversify.
A further step in the growing-up of euro high yield came when NTL issued a
bond of e810 billion in November, without using a dollar tranche at all. But NTL was already well-known in the marketplace. Kappa’s demonstration that the European market can deal with unfamiliar credit stories was arguably the most encouraging deal last year for would-be borrowers. For investors, it wasn’t too bad either, tightening by around 60 basis points so far.
AT&T
Issuer: AT&T
Deal: $8 billion global bond
Date: March 22 1999
Bookrunners: Merrill Lynch, Salomon Smith Barney
This was the largest corporate bond financing in history and is a deal that will be discussed for years to come. “This is now the corporate benchmark and it is a deal that most serious accounts want to have in their portfolios,” says a market observer.
The AT&T issue was in three tranches and beat numerous records including the largest outstanding bonds in the 10-year and 30-year portions. But the most staggering thing about it was the demand it attracted: some $16 billion of orders. Even after increasing the size of the deal twice from between $5 billion and $6 billion to $7 billion and then to $8 billion, lead-managers Merrill Lynch and Salomon Smith Barney were nowhere near exhausting all the offers.
There were three reason for the bond’s huge success: AT&T had been absent from the debt markets for four years and had a good story to tell about its transformation and there was a general depth of demand for top-quality corporate paper at the time.
Investors were so taken with the AT&T story that a $2 billion five-year tranche was increased from $1.75 billion and tightened to 64 basis points over from spread talk of 65; a $3 billion 10-year tranche was increased from $2.5 billion and tightened from 85bp spread talk to 84; and a $3 billion 30-year slice came at 94bp over after guidance of 95bp and was increased from $2.75 billion.
AT&T executives were particularly pleased at the reception to the bonds in Europe where they did an extensive roadshow, something that hasn’t been done from the debt perspective for many years. Some 15% of the deal was sold in Europe, which was notable since it was a pot deal, which European investors don’t normally like, and the spreads were tight compared with similar European credits.
“We had the broadest book of any deal we have been involved with. In total we had orders from 600 accounts, about 100 of which were from outside the US,” says a banker with one of the leads.
Very few companies in any country could launch a deal of this size and when such supply hits strong demand the results are truly formidable. Market liquidity was given a huge shot in the arm by the AT&T transaction.
AT&T planned to use the proceeds to repay commercial paper raised during its acquisition of TCI and for a $4 billion share repurchase programme as well as continuing its aggressive efforts to transform itself from a long-distance telecommunications provider to a new-media technology company.
A complex exchange
Issuer: Federative Republic of Brazil
Deals: $2 billion and $1 billion Brady exchange
Date : April 23 1999
Bookrunners: Morgan Stanley, Salomon Smith Barney
Devaluation of the real could have kept Brazil out of the international bond market for years. In fact the country recovered swiftly and so was able to return to the market last April only three months after the currency crisis.
Not only that, but Brazil was able to do a $3 billion deal, almost twice as large as most market observers were expecting, of which $2 billion was new money. Even a few weeks earlier the sovereign would have needed to add incentives such as warrants just to get the deal away.
Lead-managers Morgan Stanley and Salomon reported that they received $6 billion in orders from more than 300 accounts and ended up distributing over half in the US with a substantial proportion in Europe and lesser tranches in Asia and Latin America. European investors were attracted by the bond’s five-year maturity.
Exchanging Brady bonds is a project that will occupy Brazil for several years given that it still has $40 billion outstanding even after recent exchanges. From the investors’ point of view there is a chance to get rid of a bond that has a certain stigma attached to it and to take advantage of the arbitrage the issuer usually offers them. From Brazil’s perspective the Bradys are complex, with 10 different instruments. They typically but don’t always involve US treasuries as collateral and worst of all are used by investors as a proxy for fallout in emerging markets generally. The C bond market is the most liquid emerging bond market in the world and is often shorted as a hedge against troubles elsewhere. The exchange last April involved mainly IDUs and EIs.
Later in the year a Brazilian $2 billion Brady exchange was done for C bonds, pars, discounts and debt conversion bonds. This deal did not have a cash tranche because of the volatility in the emerging markets following the US release of bad inflation numbers that sent the equity market down. Lead-managers JP Morgan and Chase Manhattan executed a deal that enabled Brazil to buy back $2.9 billion in Brady bonds in exchange for 10-year global bonds.
“Brazil couldn’t have been more unlucky with its timing,” said Michael Schoen, co-head of emerging markets syndicate at JP Morgan in New York. “The inflation numbers were a bit of a surprise. The deal was coming together in the right fashion using a cash and bonds model. Then when the inflation numbers came out the emerging markets took it on the chin and the cash tranche became a difficult proposition. The decision was taken just to do the exchange.”
Oil is hot
Issuer: Conoco
Deal: $4 billion global bond
Date: April 14 1999
Bookrunners: CSFB, Salomon Smith Barney
A clear sign that the energy sector had finally come in from the cold was this incredible deal from US oil company Conoco. It attracted an order book of $15 billion and was increased from $3 billion to $4 billion.
What’s more, spreads on all three tranches were tightened significantly from original spread talk: from 95 to 100 basis points over down to 88bp on the five-year $1.35 billion portion; from 125 over to 120 on the 10-year $750 million portion and from 140 over to 136 on the $1.9 billion 20-year portion.
Now the energy sector is being talked about by some investment bankers in their sales pitches as the “darling of the bond market” with only normal hyperbole. But back in December 1998, when the roadshows for the deal were done, investors were asking how Conoco expected to manage with oil prices of $10 a barrel.
The mandate was awarded to CSFB and Salomon Smith Barney in January with the intention of doing the deal in February. But both the bankers and the issuer agreed that holding on and allowing oil prices to improve just that bit more would be worthwhile.
No-one imagined that the results would be quite so dramatic. Some 12 investors in the US were up for $500 million each and Europe, which many of the co-leads thought would be extremely tough, produced demand of $2.5 billion – almost enough to take the whole deal in its original size. In the end 10% was placed overseas and one market watcher described the book as “like reading a Who’s Who of investors”. Three hundred accounts participated in the deal.
“The demand was absolutely phenomenal,” says Peter O’Malley, director of debt capital markets at CSFB. “What it shows is that for a global company like Conoco the story can be put out far and wide until every major investor feels they must have a slice.”
Conoco needed the funds to pay back a note to DuPont from which the oil company was spun off in October 1998. After nearly two decades under DuPont’s ownership the issue was also a chance for Conoco with its long traditions in the oil business to tell the world that it was back as an independent concern.
Schneider plugs away at investors
Issuer: Schneider
Deal: €750 million Eurobond
Date: March 19 1999
Lead banks: Paribas, Morgan Stanley
By the time French electrical components and equipment company Schneider came to the new euro-denominated corporate bond market in March, confusion was still widespread over how to price deals. That stemmed from the different views of domestic investors and international investors across Europe on the same credits. Various earlier deals had shown that domestic investors would reward well-known issuers of national standing with tighter pricing than investors from neighbouring countries might grant.
Schneider encapsulated this dilemma. Very well known and respected by debt and equity investors in France, the company was far less familiar to institutions elsewhere in Europe. This set a challenge to the lead banks on how to market the name and set the pricing.
Orders quickly flooded in from French accounts but it took a while for other European buyers to step forward. A key to laying the base for Schneider’s debut benchmark euro issue was implanting in investors’ minds the French company’s position within a top-ranked peer group of international companies. As much as they emphasized its strong credit fundamentals, the lead banks also hammered home the notion that Schneider could be compared to Siemens and ABB.
As marketing proceeded, large orders came in from Germany, UK and Italy. An open book-building method was employed and the leads, having talked initially about a basis point spread to OATs in the low 50s for the five-year deal, were able to price flat at 50bp over. Some competitors suggested this was a tight spread for a single-A corporate, but there was sufficient demand for Schneider to launch a fungible €250 million ($250 million) add-on deal just one month later, effectively topping up the issue to the e1 billion size the borrower had always sought.
Enron tests boundaries
Issuer: Enron
Deal: €400 million Eurobond
Date: March 31 1999
Lead banks: Lehman Brothers, Paribas
When Houston-based diversified energy company Enron tapped the fledgling euro corporate bond market last March, it proved a real test of investors’ new-found appetite for credit risk.
European buyers had shown themselves eager to take up large 10-year bond issues from A-rated European corporates in the first months of 1999 but the Enron deal – rated BBB+ by Standard & Poor’s and Baa2 by Moody’s – forced many investors to seek special new approval to buy bonds at the lower end of the investment-grade credit spectrum. “Many fund managers had never bought triple-B-rated corporate bonds before and had to lobby for permission to do so inside their organizations,” says a banker who worked on the deal.
So there was some initial uncertainty, as the deal was marketed in Milan, Madrid, Amsterdam, The Hague, Paris, Zurich and London. What helped the company and its bankers to make a success of the €400 million ($400 million) six-year deal was an enticing company story. Enron provided an unusual combination of old and new technologies in the power sector. Its mainstay is gas transmission through the largest regulated pipeline system in the US.
This provides the kind of steady, stable income that bondholders love. The company had also acquired a large integrated electricity utility, Portland General Electric, in 1997. It was this acquisition that had increased the company’s leverage and pushed down its ratings. But even while it prepared this bond issue to finance new ventures in Europe, Enron continued working to improve its leverage ratios by selling equity.
A sophisticated operator
There were other compelling elements to the Enron story that were of interest both to equity and debt investors. The company’s steady traditional businesses produced 40% of annual earnings but much of the remainder was now coming from a gas and electricity services company, which had barely existed 10 years earlier.
Increasingly Enron had become a day-to-day trader in electricity and a hedger of electricity price risk for its customers – including independent oil companies, electricity and gas producers and distributors and, increasingly, large industrial companies.
Enron has moved into outsourcing, by managing energy requirements and risks on behalf of large corporate customers such as IBM, Lucent and McDonald’s. Through negotiating with various suppliers and hedging through long-term energy swaps and options contracts, Enron delivers a fixed-price energy supply to these customers.
The fact that an increasing portion of the business was bound up in long-term derivatives, where a low credit rating can impose high costs or even deny market access, gave bond buyers comfort that the company would be careful not to let its credit rating deteriorate and might even seek to improve it.
Enron’s purpose in raising the euro funds was to invest in infrastructure for sophisticated trading in the deregulated and fragmented European energy market. Earlier investments in traditional power generation and transmission assets had given it strong positions in the UK and the Nordic region. Now Enron saw opportunities to arbitrage discrepancies in electricity prices across Europe, just as banks used to trade European currencies and interest rates. Andrew Fastow, Enron’s chief financial officer, told potential investors in the deal: “We believe that the correct strategy is to be pan-European, because within a few years, when the snow falls in Norway, that will affect the price of electricity in Spain and Italy. And we believe we have the skills to manage that kind of price risk.”
The deal was priced following a book-building at a market consensus rate of 90 basis points over OATs. It was a success without being a blow-out. The leads suggested that they could have sold e500 million. But they did not increase the deal.
Subsequently, Enron’s shift from being a traditional capital-intensive asset-based energy company to a network-based business has gained increasing recognition. In January this year, Duff & Phelps Credit Rating put its BBB+ rating for the company on positive outlook.
In Europe, the precedent for selling triple-B rated bonds had been set, but the sector still lacks depth. “You don’t have a constant ability to do triple-B yet,” says one banker.
