What a great idea. Since a new tax law will allow German companies to sell their domestic stakes without the punitive 53% tax rate, insurer Allianz thought of how best to unwind their extensive cross-shareholdings.
It could have done a straight convertible, which it had indeed before and which had allowed Allianz to get the cash and the tax benefit now, instead of waiting for the law to come into effect on January 1 2002.
But it invented something better, something much more more flexible. Its e2 billion market index-linked equity security (miles) is similar to a mandatory exchangeable bond in that it will be converted into shares at maturity on February 20 2004 – with the option of early conversion after March 1 2002.
But the flexibility Allianz sought was created by the unusual feature that allows Allianz to exchange the miles into the shares not of one company, but of one of three German blue chips: BASF, E.ON or Munich Re. Plus, it can of course choose which one.
“This construction allowed us to make use of the shares we have in our portfolio that have upside potential,” says Stephan Theissing, director of corporate finance at Allianz, and one of the developers of miles. “We can sell our portfolio without losing out on future performance. It is really a bet on the undervaluation of the three shares.”
And miles is good for investors, too. “Allianz has an incentive to dispose of the highest-valued share, since it needs to pay out fewer shares the higher their price, and will thus have more funds left for other investments,” says Theissing.
Not all investors got excited over these outlooks, though. Traditional convertible investors were put off by the structure because they were looking in vain for a conversion premium – and no, there isn’t a fixed-income coupon either. Miles holders will receive a return of 1.25% over the Dax, as valued on February 20 2002, 2003 and 2004. The price of the miles therefore reflects the movements of the Dax, rather than prices movements of the three shares. The miles was initially priced at e6,5967.72 in line with the Dax level over the previous two days.
But equity fund managers who often struggle even to replicate an index found it hard to ignore an attractive 1.25% outperformance premium paid over the Dax, especially when it comes from a triple-A rated entity and on equal terms with other senior debt of Allianz.
So, is there no catch? Well, there is the argument that equity funds which agree with Allianz’s view on the undervaluation of the three companies could buy their shares in the market. This would give them at least the certainty over which of the shares they end up with, and neither would they be exposed to a forced exchange, which Allianz can undertake any time after February 2000, if it converts at least 20% of the total of the issue.
Moreover, Allianz’s promise to exchange the most valuable shares is not necessarily as beneficial to investors as it sounds. The highest-valued share at maturity could be the one with the biggest upside potential. By the same token, the company that most outperforms the Dax could still be thought undervalued. Would Allianz then not prefer to give away one of the other, less attractive shares (especially when it wants to sell them sooner or later anyway)? Investors will know the answer by 2004.
