Issuer: Mannesmann Amount: €2.3 billion Type of issue: convertible Launched: October 6 Global co-ordinators: Deutsche Bank, Merrill Lynch
Last month’s €2.3 billion issue of convertible bonds for Mannesmann promised to mark a revival of the convertible market, but within a week of its (successful) launch it was hit by Mannesmann’s bid for Orange of the UK. At its launch on October 6, the deal was significantly oversubscribed, though it had been done on terms which raised plenty of eyebrows. The yield to maturity was 3.875%, towards the bottom of the indicated range and the premium conversion – the share price at which the bond could be exchanged for equity – was one of the highest seen this year at 38% above the prevailing share price. A high conversion premium usually points to a bullish equity market, but this deal came as the equity markets were looking rocky.
“Before the transaction was announced there were some concerns that the market was glutted,” says Farley Bolwell managing director of equity-linked products at Merrill Lynch, one of the two global coordinators – the other was Deutsche Bank. “But not only was the issue completed successfully, it was priced at better than the mid point in the range, at a very high conversion premium and with a positive impact on the stock price.”
But there were squabbles about the structure of the syndicate, more recriminations than usual among the three bookrunners about who had generated most demand and criticism over the way some of the paper was sold.
The deal, to refinance the last part of Mannesmann’s jumbo acquisition bridge loan for the purchase of Olivetti’s stakes in Omnitel and Infostrada, was the biggest convertible issue completed in the international markets since April. It was also notable for being the first big German convertible issue completed with a waiver of shareholders’ pre-emptive rights. The regulation preventing German companies from issuing convertibles without giving their shareholders pre-emptive rights to the paper has so far held back the convertible market in Germany, potentially Europe’s best source of convertible issuance.
For much of the summer Mannesmann and its adviser, Deutsche, were waiting for market conditions to improve. The three factors which govern demand for convertibles had each turned sour. Equity markets were at best standing still, bond yields were moving outwards and equity volatility – which governs the price of the equity option embedded in the convertible – was declining sharply.
In late summer Merrill Lynch was appointed alongside Deutsche as joint global coordinator on the deal. It was decided to create a tranche dedicated to the Swiss market, a traditional source of demand for convertibles. While Deutsche and Merrill led the international tranche, Warburg Dillon Read was picked as bookrunner for the smaller Swiss portion.
“Warburg was given the role of selling to Swiss investors but as it turned out they only brought in about 6% of demand from Switzerland,” says one banker on the deal. “A few years ago that kind of syndicate structure would have made some sense, but now it’s just silly. Swiss investors are not as important as they used to be.”
Simon McGuire, global head of equity-linked at Warburg Dillon Read, reckons Swiss investors are still buying convertibles in large numbers but that demand is more muted on issues with bond-like features. “Swiss convertible buyers tend to prefer a greater equity element than was present on a deal like Mannesmann,” he says. “This issue was more attractive to fixed-income investors.”
Another target was hedge funds, which are active convertible investors. Some issuers don’t like their paper ending up in the hands of hedge funds as this can push down their share price. Many funds are interested only in the equity option of the convertible. They can strip this from the bond by selling the fixed-income cash-flow through an asset swap. The exposure to the remaining equity call option is then hedged by shorting the company’s shares.
Some think that such funds bought a large amount of the Mannesmann deal. “At first glance it looked a spectacular deal,” says one banker. “But a lot of the demand came from hedge funds. If you issue a convertible you want it owned by outright convertible investors.”
According to Deutsche, hedge funds bought only 5% of the deal. “Many of the hedge funds that bought this deal are macro hedge funds which do not hedge their positions by selling the underlying stock,” says Keller at Deutsche Bank.
The deal was launched early on October 6, and by four o clock the next afternoon it was three-and-a-half times oversubscribed. After a long night of discussions on paper allocation, the deal was only just completed in time for the opening of the market the next day.
The Mannesmann deal, with its relatively short five-year maturity and high conversion premium, is at the most bond-like end of the convertible spectrum. Nevertheless, dedicated convertible buyers, who have become an increasingly important source of demand in recent years and who tend to prefer equity-like features, accounted for some 40% of demand for the paper. “While the bond had a very high conversion premium, Mannesmann is a very volatile stock in a highly volatile and fast-growing sector,” says Hubert Keller, global head of equity-linked origination at Deutsche Bank. “Volatility and growth potential make the conversion element more attractive, particularly on a stock which has doubled in price every year for the last three years.” Keller was right about the volatility. Mannesmann’s stock rose by €10 that week, prompting Mannesmann to go for Hutchison Whampoa’s stake in Orange in a complex bid for Orange totalling £21.8 billion, including a €12 billion Olivetti/Telecom Italia-style bridge financing. Rating agencies quickly put Mannesmann on negative creditwatch, hitting all Mannesmann bonds. The convertible was languishing at 97 by the end of October. The stock was also affected by rumours of an impending hostile bid by VodafoneAirtouch for Mannesmann. Vodafone was thought likely to bid a shade above the bond’s conversion price of €209.7. Since change of control is not regarded as a credit event in Germany, bondholders were likely to be offered a replacement bond convertible into Vodafone stock. Deutsche Bank Research pointed out that bondholders could always convert into Mannesmann shares and then take the offer made to common shareholders. At the end of October Mannesmann’s share price was down at €146 compared with €152 at the time the convertible was launched.
