By Simon Crompton
The UK engineering company ignored a trend among high-yield investors to boycott deals where bondholders are denied equivalent guarantees to senior bank lenders. Investors have turned their backs on similar issues, including February offerings from Jefferson Smurfit and Calpine, both of which had to be cancelled.
Yet Invensys successfully placed £615 million ($1.1 billion) of bonds in March, one of the largest European deals without a US registration. Does this indicate that investors are losing sway? Probably not – Invensys paid heavily for its choice. The decision to structure the deal in ways that investors no longer find acceptable will cost it £165 million – £15 million a year for the bonds’ 11-year term.
Investors have been disgruntled for some time. A revolt against the lack of structural security in European high-yield deals almost halted the market at the beginning of 2003.
A group of investors, including asset management teams from Aberdeen, ING and AXA, wrote to industry bodies saying they would avoid the bonds unless they were structured more favourably.
But several deals, including Brake Bros and Focus Wickes, broke the mould in the second half of 2003, giving bondholders guarantees from issuers’ subsidiaries and a place in insolvency negotiations for the first time.
This brought European high yield closer to the model of junk bonds in the US, where investors can expect to get about a third of their money back from a borrower that defaults. European structures, by contrast, had meant that investors were likely to lose as much as 90% of their outlay.
The impact of the structural alterations was such that total high-yield issuance in Europe in 2003 was €17.9 billion, triple 2002’s figure and the best since the market’s inception.
Only a few deals failed to give bondholders greater guarantees, and on those there were particular reasons why it was not possible. On Vivendi Universal’s offering, for example, the issuer’s US assets reassured investors that a bankruptcy would lead to the more favourable Chapter 11 proceedings. As one high-yield lawyer put it at the time: “You simply cannot get a structurally subordinated deal done.”
Invensys was thus a surprise: a successful, structurally subordinated issue. Original guidance in the bonds’ prospectus suggested a yield of 8.5% to 9%. That was quickly raised to 9.5% to 9.75% by arranger Deutsche Bank. Eventually, the bonds were priced to yield 10.25%, almost 3 percentage points more than the average bond with the same credit ratings. And the issue had to be shrunk from £650 million to £615 million.
Investors baulked at the structure of the Invensys issue when it was announced in late February. Several described the offering as aggressive, adding that there was no good reason for the bonds to be subordinated. Ratings agency Fitch condemned the deal, saying it contrasted with recent progress towards greater support for high-yield investors.
The bonds are issued by Invensys plc, the parent company, with the simultaneous £1.6 billion in bank lending facilities coming out of Invensys International Holdings, a subsidiary further down the chain.
This means the investors are structurally subordinated below the senior bank lenders – the traditional European structure for high-yield debt issues. If the company were to get into trouble, the senior bankers could sell its assets and take their money back. Bondholders would only get any funds left over.
A good example of how this affects bondholders is Energis, which was restructured in July 2002. The structure of the debt meant that although over $1 billion of bank lending stayed on the balance sheet, bonds worth $900 million were converted into shares.
On issues such as Brake Bros, investors won the right to guarantees from the company’s operating subsidiaries. Focus Wickes went further, with the bonds being issued by the same holding company as the bank debt and contractually subordinated behind the senior lenders.
Although Invensys has none of these features, the market is smart enough not to say no at any price, says Aengus McMahon, an analyst at Henderson Global Investors. “Investors hate to be structurally subordinated, but if they are, they want to be paid for it.”
Cecil Quillen, the Linklaters partner who led the team advising Deutsche Bank, says: “The market trend is doubtless towards ways to mitigate structural subordination, but there will always be exceptions that prove the rule.”
Bankers on the deal say Invensys had to be an exception. The high-yield issue was only one part of the company’s £2.7 billion refinancing package, which includes £615 million in high-yield bonds, £1.6 billion in bank lending, and a share offering of £450 million. As the bank portion was almost three times the bonds, the high-yield structure had to be sacrificed to make sure the lending was syndicated successfully. “If the company had had the option, it would have gone for contractual subordination,” says one banker on the deal.
McMahon says the market is on a much better footing now that investors have taken responsibility for their actions. Quillen concludes: “The market needed these structural improvements for bondholders. Hopefully the high-yield market can now be as wide and deep as it has the potential to be.”
