Tyco International’s penchant for corporate excess under its previous management team made all the headlines last year. Tax dodges, false filing, $5,000 shower curtains: you name it, Tyco appears to have done it.
That excess stretched into the capital markets as well. Last year the company had $23 billion in debt liable for refinancing or repayment, this year it was $11.6 billion. And it had a problem, which it revealed in its 10-K filing in December: a funding gap in 2003 of $3.6 billion.
Last month’s $4.5 billion two-tranche convertible deal, issued concurrently with the closing of a $1.5 billion 364-day bank loan facility, has closed that gap, and should enable the company to meet all its commitments this year, leaving the new management team free to concentrate on running the business rather than fretting about liquidity.
Much of this year’s repayments total is the result of the company’s three-month flirtation with the structure du jour of 2000-01: convertible bonds with zero coupon and zero yield. How could a company like Tyco pass up what was, in effect, free money. So, first in November 2000 and then again in February 2001, Tyco issued multi-billion dollar zero-zeros. The first, lead-managed by Merrill Lynch, was for $3.45 billion and was the first zero-zero to be issued in the US. CSFB brought the second, a $2.25 billion deal.
There was a catch, of course. Investors needed to have an emergency exit, just in case. And that came in the form of put options. Many of these zero-zeroes came with one-year puts. Tyco’s November 2000 deal was one of them, while the CSFB deal had a two-year put.
Unfortunately, says one investment banker, “a lot of issuers were not going into these deals with their eyes wide open. They never considered that investors might actually exercise the puts.” That was a potentially dangerous mistake to make, especially since the vast majority of such deals were sold to hedge funds looking to arbitrage the equity volatility. Last year, according to Anand Iyer, convertibles analyst at Morgan Stanley, $10.2 billion of puts were exercised.
Luckily for Tyco the put on the first convert fell due in November 2001, two months before investors started to worry about the company’s liquidity crisis. No puts fell in 2002, but both are now due this year, at a combined nominal total of $5.92 billion.
Initially, it looked as if Citigroup, Goldman Sachs and JPMorgan were going to win the combined loan-convert refinancing mandate. They had suggested linking the interest rate on the new loan to the yield on Tyco’s benchmark 2006 straight debt issue, by which the loan rate would be renegotiated in the banks’ favour should the spread on the bond widen significantly and for a long enough period.
A coup for Morgan Stanley
But two rivals – Banc of America Securities and Morgan Stanley – stepped in and undercut them. They won the deal and Citigroup, as the lead bank on the loan, joined them as lead arranger. The others took less senior positions in the syndicate. It was a coup for Morgan Stanley. Tyco was not a client it had done much business with before.
What’s more, Morgan Stanley was one of the very few investment banks that did not seem to be trying to hawk the zero-zero convertibles to all and sundry back in 2001. What at the time looked like a poor decision to turn down fee income and league table credits now looks smart. And it has, since the start of 2002, been involved in many of the large mandatory convertible deals with more regular coupons, yields and puts that companies such as General Motors and Aon have been using to repair their balance sheets.
It might have helped that several members of the new Tyco management team come from companies that had worked with Morgan Stanley before: the CEO, Ed Breen, was at Motorola, while CFO David FitzPatrick came from United Technologies and, before that, from General Motors.
The marketing of the deal started at a total size of $3.25 billion. This was increased first to $3.75 billion and then $4.5 billion as investors grew more comfortable with the fact that this would leave the company nicely overfunded, just in case there were any more little surprises. It was split into two tranches to appeal to different investors.
The larger tranche, for $3 billion, is a 15-year deal but with a put at five years, made to appeal to straight fixed-income investors and hedge funds. The $1.5 billion 20-year deal, meanwhile, is intended more for investors wanting the equity.
This second tranche has a put at 12 years, a rather unusual tenor, but, explains one banker, “convertible investors aren’t so concerned about being off the curve. Straight debt investors much prefer the five- and 10-year maturities.” That is good news for Tyco, because that 10-year slot is still available should it need to raise more capital.
As soon as the deal was completed, Tyco stepped into action, announcing that it would seek to buy back for cash all the bonds for its February put, which would cost $1.85 billion for $2.3 billion in notional outstanding. It’s likely to do the same for the November put.
This won’t be the last of the zero-zeros to have their puts exercised in 2003. In total $23.6 billion of converts have puts falling due this year, according to Jeremy Howard, head of US convertibles research for Deutsche Bank. The ones to watch out for that could pose problems, he says, are Omnicom, Xerox, IPG, AMT and Elan.
But for now, at least, Tyco is free from that particular problem.
