Allianz was excited about it last year, now the time has come for Zurich Financial Services to join in. UBS Warburg has further developed its market index-linked equity securities (Miles) product since it lead managed the first Miles issue for Allianz last year. Unlike the Allianz deal, which allowed the issuer to choose to exchange the note into one of several of its holdings, the new version is a convertible and can only be converted into Zurich’s own shares.
Zurich’s Miles issue is linked to the Swiss market total return index (SMIC) and offers investors a 1% annual cash premium on the index level at issue, rather than a fixed coupon as usually received by those investing in convertibles.
The main difference between Miles and a more typical convertible is that S&P and Moody’s have classified it as equity credit. Convertibles are not usually treated as equity unless the conversion value is notably higher than the straight value, that is the value of the note if it was not a convertible. Consequently, Zurich has been able to raise Sfr600 million ($400 million) in equity, while avoiding doing so at the current low share price.
However, it seems that investors are not particularly excited over the new and improved Miles. As a fund manager who has actually invested in the issue says: “We do a lot of structured notes anyway. So really this is just a structured note to us. It just goes into our portfolio.”
Some bankers believe that it has limited appeal for investors. As the Miles note is an index warrant convertible into shares, not a convertible bond, a lot of convertible bond funds will not be interested in Miles because they want that bond floor.
Additionally, as one banker points out: “Because it reflects an index, rather than a stock, it’s got a limited appeal. I don’t think you’ve got that middle, broadband appeal. If I’m a convertible bond investor I want a bond that reflects the underlying stock and I want something that’s priced correctly.”
Stephen Crewe, director of derivatives fund management at F&C Management, invested in the Zurich Miles. He says: “By buying this type of note we’re basically getting the index plus 1% per annum and possibly 2% per annum if it goes to three-year maturity.” That is because if investors hold the note until it matures they receive a 3% bonus. This means they can expect to make a total 6% outperformance of the index if they hold it till maturity.
Zurich is able to force investors to convert the Miles into shares at any point after the initial six months, while investors are able to convert from day one. However, investors will receive an additional 3% on the index level if Zurich decides to force them to convert. So, it looks like a win-win situation for investors such as index trackers.
By issuing this type of note, Zurich is sending a strong message to the market that it believes its share price is undervalued.
If Zurich’s stock outperforms the index, the amount of shares it has to deliver decreases. Zurich has also capped its potential exposures in the event that the share price significantly underperforms the index.
James Eves, head of European equity-linked origination at UBS Warburg, says: “Zurich wanted to limit the number of shares if it underperforms.” The number of shares that can be issued is set at 3 million. If exercised today, the Miles would convert into about half that number of shares.
To offset any concern from investors “there is a performance beyond which investors will be given 1% extra shares,” says Zurich’s head of group financing, Morgan Murphy. “That is, if the shares significantly underperform, we offer investors a 1% extra allocation.”
As to the future of the Miles product, UBS Warburg’s Eves says: “Like a lot of new products it takes a little while to evolve. But, I am very hopeful that we will have a couple more Miles issues in the market in the near term.”
