| Bertrand Collomb | ||||||
Around this time of year bankers are struck by a strange affliction. Maybe they’re bored – summer markets are notoriously quiet – or perhaps they reckon most people will be on vacation and won’t notice. Whatever the reason, there’s a marked increase in silly deals. Two recent issues have left observers scratching their heads.
What’s particularly baffling is that bankers are skating on thin ice in one of the safest areas of the market – convertibles.
In June, French cement company Lafarge came to market with a e1.5 billion convertible bond. Lead managers Schroder Salomon Smith Barney and Société Générale did it as a bought deal with a conversion price of e130.
By the afternoon of the same day, the banks realized that the deal probably wouldn’t get done at that level. However, under French rules, a fixed-term bond cannot be repriced. The only option was to start all over again, this time with a conversion premium of e127 – a fall in value of about 2.3%.
“The leads came with terms that were far too aggressive – only fair value even at the best end of the range – and tried to shove them down investors’ necks,” says one London-based analyst.
Yevgeniy Zenchenko, European convertibles analyst at HSBC, agrees: “When the banks started to price the bond, they didn’t have enough flexibility. The terms were too expensive, and the deal ended up leaving a bad taste in people’s mouths. In the end they cut the conversion price and set the terms at the best possible level.”
Issuers cannot afford to annoy investors in this way, Zenchenko explains: “Market sentiment at issue is important in determining how long the bond will remain cheap. All good deals are cheap at launch and then trade up to fair value. This one will probably take a long time to do so.”
Bankers involved deny this. “Initially, the terms were quite attractive. But on the day of launch, the stock performed badly, mainly due to general market weakness, caused by profit warnings from Infineon and some of Lafarge’s so-called comparables,” says Raphael Ramseyer in the equity capital markets group at SSSB. “The share price went down by about 4%, which made the terms look less attractive. We did not have a strong book – the usual names were there, but not in the usual large quantities. Therefore, we decided to reduce the conversion price.”
This strategy created another problem, however. By the time the original terms were scrapped, the bonds had been trading in the grey market for almost a day. None of these trades honoured which meant that anyone who had gone short on it lost money. A lot of traders had done so and this negative sentiment probably helped prompt the decision to pull the deal.
“It just looked expensive,” says one analyst. “And although the new terms were better, the managers still had trouble. I’d imagine [the bookrunners] are still holding a fair bit of paper.”
Ramseyer at SSSB disputes this: “The bonds were fully-placed, largely with French accounts, with interest also coming in from Switzerland, Germany, the Benelux countries and the UK.”
He claims that the deal went well, considering market conditions: “This was about 10% of Lafarge’s market capitalization, and the biggest ever convertible in the European industrial sector.
Overall, it was a very successful issue, and the company is very happy to have been able to execute such a big deal in very difficult markets.”Representatives of Lafarge, whose chairman and CEO is Bertrand Collomb, were unavailable for comment.
This is the latest in a series of bought deals that have been priced extremely aggressively. In early June, Morgan Stanley led an e354 million ($311 million) exchangeable into UBS for Zurich Financial Services. Investors were distinctly unimpressed with the terms. It was structured as a zero-coupon, zero-yield note with a conversion premium of 22.6%.
According to some, Morgan Stanley ended up retaining most of the bonds on their own books. Once the dust had settled, barely a month later, it announced that the bond-holders had approved a decision to redenominate the bonds into Swiss francs. This increased their value, making the paper easier to sell.
It’s easy to see why bankers might be tempted to do these sorts of deals. Equity-linked is one of the few asset classes that is still buoyant. Competition for league table credit means that there is a fine line between pitching aggressively and promising undeliverable terms in the hope that the issuer’s expectations can be gently reduced before launch, that the market improves, or that there will be enough demand, even at unattractive prices.
On occasion though, underwriters have overstepped the market. Did Lafarge agree to the new price for its convertible? Probably not. Many suspect that the bookrunners paid the extra 3% themselves.
The question is, how much can underwriters afford to lose? “People are putting their P&L by the wayside, sacrificing P altogether and hoping the L isn’t too hefty,” says one London-based head of equity capital markets.
But the real losers are the companies themselves. Next time Lafarge or Zurich Financial Services comes to market, it may find that investors are more wary. The market, so we are told, has a short memory but tarnished reputations do tend to stick.
