The world’s best borrowers in 2006
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Bayer: building its business through clever use of debt markets |
Corporate capital market activity has changed dramatically since the glory days of the European debt market at around the turn of the century. Then corporates piled on debt with vigour to finance M&A, but then came the downturn in credit and ever since investors and borrowers have been more careful. Bayer might have been highly acquisitive of late but it generally pursues a prudent debt management strategy aimed at ensuring flexibility. The company made two landmark trades during the past 12 months that mean that it stands out from the rest of the investment grade corporate sector. The first was the sale of €1.3 billion of hybrid bonds in July 2005. This was the biggest corporate hybrid and enjoyed textbook execution. The deal was a balance sheet strengthening operation designed to deal with its €2.4 billion acquisition of Roche-OTC. The rating agencies had voiced their concern that the healthcare and chemical company’s financials were stretched for its single A rating (A3/A – Moody’s and S&P).
“The hybrid we did last year was conducted in order to support our ratings. In fact it was effectively two transactions because we did a tender for some senior debt at the same time,”says Henryk Wuppermann, head of capital markets.
The rise of the hybrid was without doubt a key event in the corporate market in 2005. To some extent the development was slightly over-hyped – there were far fewer deals than many had hoped for – but the significance of this new asset class should not be played down.
Bayer was taking full advantage of the fact that, earlier in 2005, the ratings agencies had adjusted their methodology to allow corporates to issue subordinated capital in a similar fashion to the way banks have done for many years. Suddenly a new powerful corporate finance instrument was at treasurers’ disposal. Hybrids allow companies to lower their weighted average cost of capital because they can be a substitute for common equity. Common equity is rather expensive capital and not tax-deductible, as a hybrid is. Another advantage of hybrids is that they enable companies to boost capital without diluting shareholders. Careful structuring also allows these instruments to be accounted for as equity.
The German firm’s financial strategy is geared towards maintaining a credit rating that reflects a high level of solvency. A hybrid would be a perfect tool for achieving this objective.
So Deutsche Bank and JPMorgan were engaged to structure a hybrid deal while simultaneously buying back between €500 million and €1 billion of an outstanding bond (€3 billion, 5.375%, due April 2007). The proceeds of the tender were used primarily to refinance the tender. The tender was part of a liability management exercise that would help Bayer optimize its debt maturity profile.
There had not been many successes in this prior to Bayer’s hybrid. Danish Oil and Natural Gas did well, as did Vattenfall. Bayer’s deal was important not only because it was the biggest and tightest but because it had no connection to the state, as Dong and Vattenfall did.
Bayer should be credited not just for its innovative use of the capital markets but also for its positive intent towards investors in its credit. The hybrid is classed as Basket D equity with Moody’s, which is 75% equity, and ranked intermediate equity with S&P.
A similar intent was observed on its recent €2.3 billion mandatory convertible. It was structured to achieve the maximum amount of equity credit possible. The deal is part of a refinancing of the €16.3 billion white knight purchase of Schering. Citigroup and Credit Suisse jointly put up cash for the bid, which was a response to a hostile bid from Merck.
Bayer is anxious to minimize the impact that this bid will have on its ratings. It has financed €4.3 billion through equity (including the convertible) and €3 billion with cash. The mandatory convertible is subordinated and ranks pari passu with the triple B-rated hybrid. There is also an important feature for the company where, if the rating falls below Ba2/BB, the bonds automatically convert and interest is paid. The bonds are regarded as high equity by S&P and 100% (Basket E) by Moody’s.
