GERMAN RETAILER METRO was all set to launch its first European benchmark bond at the end of January, hoping to take advantage of improving conditions in the European corporate bond market since the beginning of the year. For Metro, the world’s fifth-largest retailer, bonds and euro medium-term notes had previously made up less than a quarter of its funding and its outstanding issues were much smaller, largely domestic bonds that are illiquid. The rest of its funding was split between bilateral bank lines, syndicated loans and the money markets.
Metro has to refinance a Dm1.5 billion ($829 million) convertible bond maturing in 2013. It expects investors to put back to it in July this year, so banks had been pitching the idea of a benchmark bond to open up its appeal to a much broader range of investors. Duly, the company did a non-deal roadshow at the end of last year and then felt confident enough to go for it.
However, as Metro was preparing to launch its deal, conditions in the European retail sector were deteriorating. The bidding war for UK supermarket chain Safeway led to high-profile bond issuers from the supermarket sector, such as J Sainsbury and Tesco, being put on review for ratings downgrades, as fear mounted that the eventual victor would over-leverage to fund the deal. Bond spread volatility in the UK retail sector was high. On top of that, consumer electronics retailer Dixons and French supermarket chain Casino had posted disappointing results, increasing investor anxiety across Europe.
Ute Wolf, Metro’s head of treasury, corporate finance and creditor relations, says the company hoped to succeed despite this general malaise, because this was its debut benchmark. Metro operates in 26 countries, generating 46% of sales outside Germany, and Wolf hoped its geographic profile would be a selling point. “We are geographically diverse and only in Europe and Asia, not Latin America, which I think is attractive to investors,” she says.
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Metro has the world’s largest cash-and-carry company, which accounts for 55% of its earnings, and it is also the number one European consumer electronics firm. However, the food-retail business whose steady sales are vital to underpin business in periods of economic downturn is its worst-performing division. Furthermore, while its organic growth strategy might attract investors worried about the credit risk of large-scale acquisitions looming over Tesco and J Sainsbury, its operating margin, at 2.1%, is significantly lower than any of its peers, largely due to its exposure to the depressed and competitive German market.
Metro had other pressing problems. It too had been downgraded – to BBB from BBB+ at the end of December – by Standard&Poor’s, which said that the company’s debt protection measures were not in line with a BBB+ rating. On a lease-adjusted basis, net debt had risen from e7.6 million to e9.5 million between 1998 and 2001.
On January 13 Metro appointed joint bookrunners HSBC, Deutsche Bank, JPMorgan and Dresdner Kleinwort Wasserstein.
Problems mounted three days later when Moody’s assigned a negative outlook to the company on January 16. The deal could not be announced until the Moody’s news was out. “We let the rating agency make their decision first – that’s only fair and that’s how we would always do it,” says Wolf.
The day after the Moody’s announcement, Dutch retailer Ahold was downgraded by the agency by two notches from Baa1 and Baa3, on the basis that the company’s ability to reduce debt was unlikely to improve significantly in the medium term, causing a fresh wave of investor jitters. (Much worse news from Ahold was to follow in February.) So on January 21 the company embarked on a four-and-a-half-day roadshow.
Conditions deteriorated even further during the marketing process as the equity market fell for 11 successive days. Sterling orders accounted for a disappointing 7% of the book. “The investors’ concerns were less about us but more about the sector, the weakened equity performance from the beginning of the year and the disappointing results from retailers such as Dixons,” says Wolf. “We have said we have to meet our profit growth targets, but if you see other companies in the sector fail, that makes people nervous.”
UK investors may have had more specific concerns, particularly Metro’s weak lease-adjusted credit metrics and e2 billion in contingent liabilities and off-balance-sheet guarantees. Luckily, although Metro’s banks had advised it to approach both sterling and euro investors because of the amount of funds it had to raise, the company found it could raise e850 million in euros alone. “We had to refinance our e890 million convertible and that’s why we started with the option of two tranches to be really open to investor demand. However, by the end of the bookbuilding we had a euro book of e1.1 billion, so we decided to just go for that because it’s our natural currency,” says Wolf. “The pricing was a bit more competitive as a lot of orders came from the continent where Metro is more well known as a business.”
In the end, investors from 15 countries were included in the final book, although 45% still went to German investors. The interest from retail investors, who received 16% of the final allocation, was also crucial in driving the deal.
Price guidance for the deal was between 160 and 170 basis points over mid-swaps. In the end, the company paid the top price of 170bp over mid-swaps. However, comparable bonds from French retailer Casino were trading at 180bp. “I think we set the appropriate price range,” says Wolf. “It was important for us that our first benchmark went well and that investors had a good deal in the market.”
The spread on the bond tightened over 20bp to begin with, but after accounting irregularities at Ahold were revealed at the end of February, it had widened – in line with all European retail names – to 190bp over the benchmark, .
This bond will be positive for Metro next time it issues, only assuming that its own credit does not deteriorate significantly before it next needs funding. “It is towards the higher end of leverage for its peer group, but this is adequately reflected in the triple-B rating. It’s also cash generative and food is not so vulnerable to cyclical downturns so leverage levels are more reasonable,” says Belinda Hull, a credit analyst at HSBC.
Some analysts predict a double-notch downgrade by Moody’s if Metro reduces its 2003 guidance when it reports its 2002 results in March. “You can’t rule it out given the negative noises about the state of the retail sector in Europe,” says Hull, “but it isn’t justified in our opinion.”
